Excel Problem #5
Accounting Error Analysis and Correcting Entries
Chapter 22 (Kieso 12th Edition)
You have been asked by a client to review the records of XYZ Co., which was formed on Jan 1, 2004. Your client is interested in buying the business and arrangements have been made for you to review the accounting records of XYZ Co. Your examination reveals the following:
#1. XYZ has been reporting on a calendar year basis. The company has never been audited, but the annual financial statements prepared by the bookkeeper reflect the following income (loss) before deducting income tax expense or benefit of:
Year ended Dec 31, 2004.....$800,000 Loss
Year ended Dec 31, 2005.....$200,000 Loss
Year ended Dec 31, 2006.....$2,300,000 Income
#2. XYZ employs a perpetual inventory system and included in 2004 operating results was a sale made on Jan 2, 2005 for a sales price of $35,000, which was priced at a 40% markup on cost. Also, included in 2005 operating results was a sale made on Jan 3, 2006 for a sales price of $39,000, which was priced at a 30% markup on cost. Further, excluded from 2006 results was a sale on account made on Dec 31, 2006 for a sales price of $54,000, which was priced at a 35% markup on cost.
#3. XYZ recorded sales commission as expenses in each year based upon when they were paid. Included in 2005 operating results were sales commissions of $56,000 related to 2004 but paid in 2005. Included in 2006 operating results were sales commissions of $67,000 related to 2005 put paid in 2006. Also, unrecorded commissions at Dec 31, 2006 to be paid in 2007 amounted to $99,000.
#4. Before the accounting error sales corrections in #2 above, reported sales in each of the past three years were as follows: $41 mil in 2004, $74 mil in 2005 and $201 mil in 2006. XYZ has used the direct charge off method in accounting for bad debts in each of the three years. The amounts written off in each of the three years were $145,000 in 2004, $355,000 in 2005 and $1,700,000 in 2006. Experience of similar enterprises indicates that bad debt losses will approximate 1% of sales in each year.
#5. Research and Development costs incurred at the beginning of 2004 for $450,000 were capitalized as Patents and amortized on a straight-line basis over a ten-year period.
#6. Equipment costs incurred at the beginning of 2005 for $230,000 were recorded as Maintenance and Repairs expense. This Equipment should have been capitalized and depreciated on a straight-line basis over a five-year period.
(a) Present a schedule in good form starting with preliminary income per bookkeeper (#1 above) for each year and reflecting the impact of each of the items above (# 2 through #6) for each year and thereby working down to revised income (loss) for each year. Show your detailed computation of the impact on earnings in each year of each of these items #2 through #6. Make each computation to the nearest whole dollar. Ignore income taxes.
(b) Prepare the correcting journal entries you would have the bookkeeper make at Dec 31, 2006 to reflect the accounting errors you discovered above. Assume the books have already been closed for 2004 and 2005 but that the books have not yet been closed for the year ended Dec 31, 2006. Again, disregard income taxes.
This is a rather comprehensive problem and even the solution will require some thought and time to sort out. Following are some comments and hints to understand the results:
1. Because the books have been closed for ...
The solution presents a schedule covering a three year period for correction of errors beginning with net income as prepared, and ending with net income as adjusted in a columnar format. The errors often affect multiple years and a column was added to assess the balance sheet effects of the adjustments to provide a check figure. Following the schedule is a full page of adjusting entries together with explanations. This is a comprehensive problem in which concepts of multiple year adjustments are fully tested.