In 2019, 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 2018 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 2018 tax return and reduce its income by $240,000.
B)The company should change its accounting method in 2019, with a $60,000 negative § 481 adjustment which decreases its 2019 taxable income.
C)The company should change its accounting method in 2019, and increase its 2019 income by $60,000, the amount of the positive § 481 adjustment to income.
D)The company should change its accounting method in 2019 and recognize a $60,000 negative § 481 adjustment that will be spread equally over 2019-2022.
E)None of these.

Question

Quizplus · Accepted Answer

The company discovered that it had been capitalizing certain expenses as production costs for the past 10 years that should have been classified as administrative expenses. Therefore, the company should change its accounting method in 2019 and correct the error. The negative § 481 adjustment will decrease the company's taxable income in 2019. The adjustment is negative because the company capitalized too much in prior years and is now correcting that mistake. Option A is not correct because the $60,000 of expenses that were included in the ending inventory in 2018 were already capitalized as a production cost and cannot be reduced again. Option C is not correct because the positive § 481 adjustment would increase the company's income in 2019, which is not appropriate given the correction of the accounting error. Option D is not correct because it assumes that there will be an adjustment in the following years, which is not necessary once the error is corrected in 2019. Option E is not correct because a correction of the accounting error is required.

In 2019, Swan Company Discovered That It Had for the Past