Hennesey
Tool Corporation’s December 31 year-end financial statements contained the following
errors:
December 31, 2010 December 31, 2011
Ending
Inventory 9,600 overstated 8,100 understated
Depreciation
Expense 2,300 overstated ---
An
insurance premium of $66,000 covering the years 2010, 2011, and 2012 was
prepaid in 2010, with the entire amount charged to expense that year. In addition,
on December 31, 2011, fully depreciated machinery was sold for $15,000 cash, but
the entry was not recorded until 2012. There were no other errors during 2010
or 2011, and no corrections have been made for any of the errors. Hennesey
follows accounting standards for private enterprises.
Instructions
Answer
the following, ignoring income tax considerations.
(a)
Calculate the total effect of the errors on 2011 net income.
(b)
Calculate the total effect of the errors on the amount of Hennesey’s working
capital at December 31, 2011.
(c)
Calculate the total effect of the errors on the balance of Hennesey’s retained
earnings at December 31, 2011.
(d)
Assume that the company has retained earnings on January 1, 2010 and 2011, of
$1,250,000 and $1,607,000, respectively; net income for 2010 and 2011 of
$422,000 and $375,000, respectively; and cash dividends declared for 2010 and
2011 of $65,000 and $45,000, respectively, before adjustment for the above
items. Prepare a revised statement of retained earnings for 2010 and 2011.
(e)
Outline the accounting treatment required by ASPE in this situation and explain
how these requirements help investors.
(a) Effect of errors on 2011 net income:
$10,700
understatement
Calculations
– Effect on 2011 net income:
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Over
(under) statement
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Overstatement of 2010 ending inventory
Understatement of 2011 ending inventory
Expensing of insurance premium in 2010
($66,000 ÷ 3)
Failure to record gain on sale of fully depreciated
machine in 2011
Total effect of errors on net income
(understated)
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$ (9,600 ))
(8,100 ))
22,000
(15,000 )
$(10,700 ))
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(b) Effect of
errors on working capital: $45,100 understatement
Calculations
– Effect on working capital:
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Over
(under) statement
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Understatement of 2011 ending inventory
Expensing of insurance premium in 2010
(prepaid insurance)
Cash from sale of fully depreciated machine unrecorded
Total effect on working capital (understated)
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$( (8,100))
(22,000)
(15,000)
$(45,100)
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(c) Effect of errors on retained earnings:
$47,400
understatement
Calculations
– Effect on retained earnings:
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Over
(under) statement
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Understatement of 2011 ending inventory
Overstatement of depreciation expense in
2010
Expensing of insurance premium applicable
to 2012 in 2010
Failure to record sale of fully depreciated
machine in 2011
Total effect on retained earnings (understated)
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$( (8,100))
(
(2,300))
(22,000)
(15,000)
$(47,400)
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(d) HENNESEY
TOOL CORPORATION
Statement
of Retained Earnings
For
the Years 2011 and 2010
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2011
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2010
(restated)
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Retained earnings, January 1,
as
previously reported
Less: Effect of error in
inventory
in previous year
Add: Depreciation error in
previous
year
Add: Error in insurance
Retained earnings, January 1,
as
restated
Net income
Dividends
Retained earnings, December 31
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$1,607,000
(9,600)
2,300
44,000
1,643,700
* 385,700
(45,000)
$1,984,400
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$1,250,000
_
1,250,000
** 458,700
(65,000)
$1,643,700
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* Net income
for 2011 = $375,000 + $10,700 understatement.
** Net income
for 2010 = $422,000 – $9,600 + $2,300 + $44,000
(e) Correction of error: The financial statements must be
restated for all prior periods, when it is practicable to do so. Opening
retained earnings are adjusted.
The required disclosure includes a description of the
errors, the effect of the correction of the errors on the financial statements
of the current and prior periods; and the fact that the financial statements of
prior periods that were presented are restated. More specifically, the amounts
of the corrections to basic and fully diluted earnings per share and to each
line of the financial statements presented for comparative purposes, as well as
the amount of the correction made at the beginning of the earliest prior period
are presented.
Retrospective restatement enhances the consistency,
and more specifically the comparability of the financial statements.
