Lenexa State Bank has followed the practice of capitalizing certain marketing costs and amortizing these costs over their expected life. In the current year, the bank determined that the future benefits from these costs were doubtful. Consequently, the bank adopted the policy of expensing these costs as incurred. How should the bank report this accounting change in the comparative financial statements?
Marketing costs refer to the cost of showing goods to its future customers, and they should be reported immediately.
Marketing costs are defined as the cost incurred on presenting the goods and services of the company to their prospective customers.
This situation is an example in which it is difficult to differentiate between a change in accounting principle and a change in estimate. In this situation, the change is considered the change in estimates, which should be handled currently and prospectively. Therefore, all the costs which are capitalized should be expensed immediately.
On March 5, 2018, you were hired by Hemingway Inc., a closely held company, as a staff member of its newly created internal auditing department. While reviewing the company’s records for 2016 and 2017, you discover that no adjustments have yet been made for the following items. Items
1. Interest income of $14,100 was not accrued at the end of 2016. It was recorded when received in February 2017.
2. A computer costing $4,000 was expensed when purchased on July 1, 2016. It is expected to have a 4-year life with no salvage value. The company typically uses straight-line depreciation for all fixed assets.
3. Research and development costs of $33,000 were incurred early in 2016. They were capitalized and were to be amortized over a 3-year period. Amortization of $11,000 was recorded for 2016 and $11,000 for 2017.
4. On January 2, 2016, Hemingway leased a building for 5 years at a monthly rental of $8,000. On that date, the company paid the following amounts, which were expensed when paid. Security deposit $20,000 First month’s rent 8,000 Last month’s rent 8,000 $36,000
5. The company received $36,000 from a customer at the beginning of 2016 for services that it is to perform evenly over a 3-year period beginning in 2016. None of the amount received was reported as unearned revenue at the end of 2016.
6. Merchandise inventory costing $18,200 was in the warehouse at December 31, 2016, but was incorrectly omitted from the physical count at that date. The company uses the periodic inventory method.
Indicate the effect of any errors on the net income figure reported on the income statement for the year ending December 31, 2016, and the retained earnings figure reported on the balance sheet at December 31, 2017. Assume all amounts are material, and ignore income tax effects. Using the following format, enter the appropriate dollar amounts in the appropriate columns. Consider each item independent of the other items. It is not necessary to total the columns on the grid.
The before-tax income for Lonnie Holdiman Co. for 2017 was $101,000 and $77,400 for 2018. However, the accountant noted that the following errors had been made:
1. Sales for 2017 included amounts of $38,200 which had been received in cash during 2017, but for which the related products were delivered in 2018. Title did not pass to the purchaser until 2018.
2. The inventory on December 31, 2017, was understated by $8,640.
3. The bookkeeper in recording interest expense for both 2017 and 2018 on bonds payable made the following entry on an annual basis. Interest Expense 15,000 Cash 15,000
The bonds have a face value of $250,000 and pay a stated interest rate of 6%. They were issued at a discount of $15,000 on January 1, 2017, to yield an effective-interest rate of 7%. (Assume that the effective-yield method should be used.)
4. Ordinary repairs to equipment had been erroneously charged to the Equipment account during 2017 and 2018. Repairs in the amount of $8,500 in 2017 and $9,400 in 2018 were so charged. The company applies a rate of 10% to the balance in the Equipment account at the end of the year in its determination of depreciation charges.
Prepare a schedule showing the determination of corrected income before taxes for 2017 and 2018
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