Shawn
Kimble Enterprises Ltd. follows IFRS and reported income before income taxes of
$176,000, $180,000, and $198,000 in each of the years 2009, 2010, and 2011,
respectively. The following information is also available.
1.
In 2011, Shawn Kimble lost a court case in which it was the defendant. The case
was a patent infringement suit, and Shawn Kimble must now pay a competitor
$25,000 to settle the suit. No previous entries had been recorded in the books
relative to this case as Shawn Kimble’s management felt the company would win.
2.
A review of the company’s provision for uncollectible accounts during 2011
resulted in a determination that 1% of sales is the appropriate amount of bad
debt expense to be charged to operations, rather than the 1.5% used for the preceding
two years. Bad debt expense recognized in 2010 and 2009 was $25,000 and
$17,500, respectively. The company would have recorded $22,500 of bad debt
expense under the old rate for 2011. No entry has yet been made in 2011 for bad
debt expense.
3.
Shawn Kimble acquired land on January 1, 2008, at a cost of $40,000. The land
was charged to the equipment account in error and has been depreciated since
then on the basis of a five-year life with no residual value.
4.
During 2011, the company changed from the double-declining-balance method of
depreciation for its building to the straight-line method. Shawn Kimble changed
to the straight-line method because its parent company uses straight-line, and
it was required to match its policies to those of its parent company. Total
depreciation under both methods for the past three years is as follows.
Double-declining-balance depreciation has been used in 2011.
Straight Line Double Declining Balance
2009 32,000 60,000
2010 32,000 57,000
2011 32,000 54,150
5.
Late in 2011, Shawn Kimble determined that a piece of specialized equipment
purchased in January 2008 at a cost of $54,000 with an estimated life of five
years and residual value of $4,000 is now expected to continue in use until the
end of 2015 and have a residual value of $2,000 at that time. The company has
been using straight-line depreciation for this equipment, and depreciation for
2011 has already been recognized based on the original estimates.
6.
The company has determined that a $225,000 note payable that it issued in 2009
has been incorrectly classified on its balance sheet. The note is payable in
annual instalments of $25,000, but the full amount of the note has been shown as
a long-term liability with no portion shown in current liabilities. Interest
expense relating to the note has been properly recorded.
Instructions
(a)
For each of the accounting changes, errors, or transactions, present the
journal entry(ies) that Shawn Kimble needs to make to correct or adjust the
accounts, assuming the accounts for 2011 have not yet been closed. If no entry
is required, write “none” and briefly explain why. Ignore income tax
considerations.
(b)
Prepare the entries required in (a) but assume an income tax rate of 25%
throughout the fiscal periods that are identified.
(c)
For each of the accounting changes, identify the type of change involved and
whether retrospective or prospective treatment is required.
(a) (1)
Estimated Litigation Loss.................. 25,000
Estimated
Litigation Liability......... 25,000
(2)
Bad Debts Expense.......................... 15,000 *
Allowance
for Doubtful Accounts........ 15,000
* ($22,500 ÷
1.5%) X 1% = $15,000
(3)
Land....................................... 40,000
Accumulated Depreciation—Equipment......... 32,000 *
Depreciation
Expense................... 8,000
Retained
Earnings...................... 24,000
Equipment.............................. 40,000
*$40,000 ÷ 5
= $8,000 per year;
$8,000 X 4
years = $32,000
(4)
Accumulated
Depreciation—Building*......... 22,150
Depreciation Expense—Building.......... 22,150
*($54,150 –
$32,000)
(5)
Accumulated Depreciation—Equipment......... 5,600
Depreciation
Expense—Equipment......... 5,600 *
*($54,000 –
$4,000) ÷ 5 = $10,000 per year
($54,000 – [$10,000 X 3] – $2,000) ÷ 5 =
$4,400
($10,000 – $4,400 = $5,600)
(6)
No entry required. This is an error in
classification. No amounts or items are missing in the financial statements. A
formal entry is possible to report the partial reclassification for reporting
purposes:
Note Payable – Long Term................... 25,000
Current
Portion of Note Payable – Long Term.. 25,000
(b)
Note to Instructor: Corrections to Future Income Taxes are only necessary
when a prior period adjustment is being made and where the item involves a
temporary difference between accounting and taxable income. The entries below
also assume that the income tax entry(ies) for 2011 taxable income will be made
subsequently.
(1)
Estimated Litigation Loss.................. 25,000
Estimated
Litigation Liability......... 25,000
(2)
Bad Debts Expense.......................... 15,000
Allowance
for Doubtful Accounts........ 15,000
(3)
Land....................................... 40,000
Accumulated Depreciation—Equipment......... 32,000
Future
Income Tax Liability ($24,000 X 25%) 6,000
Depreciation
Expense................... 8,000
Retained
Earnings [$24,000 X (1 – 25%)] 18,000
Equipment.............................. 40,000
(4)
Accumulated Depreciation—Building*......... 22,150
Depreciation
Expense—Building.......... 22,150
(5)
Accumulated Depreciation—Equipment......... 5,600
Depreciation
Expense—Equipment......... 5,600
(6)
No entry required. This is an error in
classification. No amounts or items are missing in the financial statements.
Formal entry possible, as noted above.
(c) 1. This
item is an adjustment to the current year financial statements. It is not an
error in a prior year’s financial statements and does not require retrospective
adjustment.
2. This is a change in estimate – prospective treatment.
3. This is an error in a prior year – retrospective
treatment.
4. This is a change in estimate – prospective treatment,
but requiring a change in the current year as adjustments have already been
recorded.
5. This is a change in estimate – prospective treatment,
but requiring a change in the current year as adjustments have already been
recorded.
6. This is a balance sheet change in classification. No
journal entry and no adjustment to opening retained earnings are required.
However, comparative financial information will need to be restated to properly
reflect the change in classification. A note indicating the nature of the
adjustment would be included.
