In 2014, Swan Company discovered that it had for the past 10 years capitalized as a production cost certain expenses that are properly classified as administrative expenses. The total amount of the expense for 2013 was $300,000, $60,000 of the item was included in the ending inventory that year and $240,000 was deducted as cost of goods sold.
A) The company should amend its 2013 tax return and reduce its income by $240,000.
B) The company should change its accounting method in 2014, with a $60,000 negative § 481 adjustment which decreases its 2014 taxable income.
C) The company should change its accounting method in 2014, and increase its 2014 income by $60,000, the amount of the positive § 481 adjustment to income.
D) The company should change its accounting method in 2014 and recognize a $60,000 negative § 481 adjustment that will be spread equally over 2014-17.
E) None of the above.

Question

Quizplus · Accepted Answer

The company should change its accounting method in 2014 and make a negative § 481 adjustment equal to the amount of the ending inventory that was previously capitalized as a production cost ($60,000). This will decrease the company's taxable income for 2014. The company cannot amend its 2013 tax return as the statute of limitations has expired for that year. It also cannot recognize a positive § 481 adjustment as there was no additional income in 2013 due to the error in accounting. Option D is also incorrect as there is no need to spread the adjustment over multiple years.

In 2014, Swan Company Discovered That It Had for the Past