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XYZ Co error corrections - adjusting entries

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AC557
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.

Required:

(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.

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Solution Preview

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 ...

Solution Summary

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.

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See Also This Related BrainMass Solution

XYZ Company Adjustments and Errors: Journal entries for income & retained earnings

XYZ Company's net incomes for the past three years are presented below:
2009 2008 2007
$480,000 $450,000 $360,000

During the 2009 year-end audit, the following items come to your attention:

1. XYZ bought a truck on January 1, 2006 for $196,000 with a $16,000 estimated salvage value and a six-year life. The company debited an expense account and credited cash on the purchase date for the entire cost of the asset. (Straight-line method)

2. During 2009, XYZ changed from the straight-line method of depreciating its cement plant to the double-declining balance method. The following computations present depreciation on both bases:
2009 2008 2007
Straight-line 36,000 36,000 36,000
Double-declining 46,080 57,600 72,000

The net income for 2009 was computed using the double-declining balance method, on the January 1, 2009 book value, over the useful life remaining at that time. The depreciation recorded in 2009 was $72,000.

3. XYZ, in reviewing its provision for uncollectibles during 2009, has determined that 1% is the appropriate amount of bad debt expense to be charged to operations. The company had used 1/2 of 1% as its rate in 2008 and 2009 when the expense had been $18,000 and $12,000, respectively. The company recorded bad debt expense under the new rate for 2009. The company would have recorded $6,000 less of bad debt expense on December 31, 2009 under the old rate.

Instructions

(a) Prepare in general journal form the entry necessary to correct the books for the transaction in part 1 of this problem, assuming that the books have not been closed for the current year.
(b) Compute the net income to be reported each year 2007 through 2009.
(c) Assume that the beginning retained earnings balance (unadjusted) for 2007 was $1,260,000. At what adjusted amount should this beginning retained earnings balance for 2007 be stated, assuming that comparative financial statements were prepared?
(d) Assume that the beginning retained earnings balance (unadjusted) for 2009 is $1,800,000 and that non-comparative financial statements are prepared. At what adjusted amount should this beginning retained earnings balance be stated?

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