P22-2 (comprehensive Accounting Change and error Analysis problem)
Botticelli Inc. was organized in late 2012 to manufacture and sell hosiery. At the end of its fourth year of operation, the company has been fairly successful, as indicated by the following reported net incomes.
2012 140,000a* 2014 $205,000
2013 $160,000 b* 2015 276,000
a* includes a 10,000 increase becuse of change in bad debt experience rate.
b* includes extraordinary gain of $30,000
The company has decided to expand operations and has applied for a sizeable bank loan. The bank officer has indicated that the records should be audited and presented in comparative statements to faciliate analysis by the bank. Botticelli Inc. therefore hired the auditing firm of Check & Doublecheck Co. and has provided the following additional information.
1. In early 2013, Botticelli Inc. changed its estimate from 2% of sales to 1% on the amount of bad debt expense to be charged to operations. Bad debt expense for 2012, if a 1% rate had been used, would have been $10,000. The compamny therefore restated its net income for 2012.
2. In 2015, the auditor discovered that the company had changed its method of inventory pricing from LIFO to FIFO. the effect on the income statements for the previous years is as follows.
2012 2013 2014 2015
Net income unadjusted-LIFO basis $140,000 $160,000 $205,000 $276,000
Net income unadjusted--FIFO basis 155,000 165,000 215,000 260,000
$15,000 $5,000 $10,000 $(16,000)
3. In 2015, the auditor discovered that:
(a) The company inorrectly overstated the ending inventory (under both LIFO and FIFO) by $14,000 in 2014.
(b) A dispute developed in 2013 with the Internal Revenue Service over the deductibility of entertainment expenses. In 2012, the company was not permitted these deductions, but a tax settlement was reached in 2015 that allowed these expenses. As a result of the court's finding, tax expenses in 2015 were reduced by $60,000
(a) Indicate how each of these chanes or corrections should be handled in the accounting records.
(Ignore income tax considerations)
(b) Present comparative income statements for the years 2012 to 2015, starting wit hincome before extraordinary items. (Ignore income tax considerations)