Question 1

If undetected, what is the effect of this error on Berkshire's 12/31/08 balance sheet?

Accepted Answer

The error causes assets to be understated by $600,000. If liabilities are understated by $180,000, then shareholders' equity is understated by the difference, which is $420,000.

Question 2

Powell Company had the following errors over the last two years: 2007: Ending inventory was overstated by $30,000 while depreciation expense was overstated by $24,000.
2008: Ending inventory was understated by $5,000 while depreciation expense was understated by $4,000.
By how much should retained earnings be adjusted on January 1, 2009? (Ignore taxes)

Accepted Answer

The answer of Powell Company had the following errors over...

Question 3

A company uses the aging method to estimate bad debt expense. Its tax rate is 30%. After issuing its 2009 financial statements, the firm discovered that it failed to write off $50,000 in receivables that were determined to be uncollectible in 2009. As a result of this error, net income was:

Accepted Answer

Since the $50,000 in uncollectible receivables were not written off in 2009, the aging method used to estimate bad debt expense would have overstated the amount of bad debt expense and thus understated net income. Therefore, the error resulted in net income being understated, and the amount by which it was understated cannot be determined without additional information. The tax rate is not relevant to the calculation of the effect on net income.

Question 4

Moonland Company's income statement contained the following errors: Ending inventory, December 31, 2009, understated by $6,000
Depreciation expense for 2009 overstated by $1,000
What is the effect of the errors on 2009 net income before taxes?

Accepted Answer

The answer of Moonland Company's income statement contained the following...

Question 5

A company failed to record unrealized gains of $20 million on its trading security investments. Its tax rate is 30%. As a result of this error, total shareholders' equity would be:

Accepted Answer

Unrealized gains on trading securities are included in earnings, so retained earnings would be increased by the after-tax amount: $20,000,000 * (1 - 0.30) = $14,000,000.

Question 6

At the end of the current year, a company overstated prepaid insurance by $80,000 and understated supplies expense by $100,000. Its effective tax rate is 40%. As a result of this error, net income is:

Accepted Answer

The answer of At the end of the current year,...

Question 7

Popeye Company purchased a machine for $300,000 on January 1, 2008. Popeye depreciates machines of this type by the straight-line method over a five-year period using no salvage value. Due to an error, no depreciation was taken on this machine in 2008. Popeye discovered the error in 2009. What amount should Popeye record as depreciation expense for 2009? The tax rate is 40%.

Accepted Answer

The correct depreciation expense for 2009 is $60,000, calculated as $300,000 divided by 5 years. The error from 2008 should be corrected as a prior period adjustment, but it does not affect the 2009 depreciation expense calculation.

Question 8

After issuing its financial statements, a company discovered that its beginning inventory was overstated by $100,000. Its tax rate is 30%. As a result of this error, net income was:

Accepted Answer

Beginning inventory is overstated, COGS is overstated and net income is understated: $100,000 (1 30%) = $70,000.

Question 9

A company switched from the cash basis to the accrual basis for recognizing warranty expense. The unrecorded liability for warranties was $2 million at the beginning of the year. Its tax rate is 30%. The company booked a year-end warranty liability of $3 million. As a result of this change, the firm would:

Accepted Answer

When switching from cash basis to accrual basis, the company needs to recognize previously unrecorded liabilities. In this case, the unrecorded liability for warranties was $2 million at the beginning of the year. Therefore, the company needs to book a prior period adjustment decreasing retained earnings by $2 million. In addition to that, since the company booked a year-end warranty liability of $3 million, it will also decrease retained earnings by $900,000 ($3 million x 30% tax rate). Therefore, the total prior period adjustment to decrease retained earnings will be $2 million + $900,000 = $2.9 million or $1.4 million after tax.

Question 10

Due to an error in computing depreciation expense, Prewitt Corporation overstated accumulated depreciation by $20 million as of December 31, 2009. Prewitt has a tax rate of 30%. Prewitt's retained earnings as of December 31, 2009, would be:

Accepted Answer

The answer of Due to an error in computing depreciation...

Question 11

A company failed to record unrealized gains of $20 million on its available for sale security investments. Its tax rate is 30%. As a result of this error, comprehensive income would be:

Accepted Answer

Unrealized gains on available-for-sale securities are reported in other comprehensive income net of tax. The after-tax effect of the $20 million gain is $20 million * (1 - 0.30) = $14 million. Therefore, comprehensive income is understated by $14 million.

Question 12

C Co. reported a retained earnings balance of $200,000 at December 31, 2008. In September 2009, C determined that insurance premiums of $30,000 for the three-year period beginning January 1, 2008, had been paid and fully expensed in 2008. C has a 30% income tax rate. What amount should C report as adjusted beginning retained earnings in its 2009 statement of retained earnings?

Accepted Answer

The correct amount for adjusted beginning retained earnings is $214,000. This is because the insurance premiums of $30,000 were charged to the wrong year, and should have been allocated equally at $10,000 per year for 2008, 2009, and 2010. Therefore, the beginning retained earnings at 2009 are understated by $14,000 (the effect of the error), which is reduced to $9,800 ($14,000 x 0.7) due to the 30% income tax rate. The corrected retained earnings would be the beginning balance plus the correction of the error ($200,000 + $9,800 = $214,000).

Question 13

In 2009, due to a change in marketing forecasts, Barney Corporation reduced the projected life of its patent for producing round dice. The cumulative patent amortization prior to 2009 would have been $10 million higher had the new life been used. Barney's tax rate is 30%. Barney's retained earnings as of December 31, 2009, would be:

Accepted Answer

This is a change in estimate. No prior period adjustment is needed.

Question 14

What is the effect of the error on Berkshire's 12/31/09 balance sheet?

Accepted Answer

The answer of What is the effect of the error...

Question 15

A company overstated its liability for warranties by $200,000. Its tax rate is 30%. As a result of this error, income tax expense is:

Accepted Answer

Since the company overstated its liability for warranties by $200,000, its expenses will be overstated by the same amount. This means that the company's taxable income will be reduced by $200,000, resulting in a tax reduction of $60,000 ($200,000 x 0.3). Therefore, income tax expense will be understated by $60,000.

Question 16

Due to an error in computing depreciation expense, Crote Corporation understated accumulated depreciation by $60 million as of December 31, 2009. Crote has a tax rate of 40%. Crote's retained earnings as of December 31, 2009, would be:

Accepted Answer

The understatement of accumulated depreciation by $60 million means that expenses were understated, leading to an overstatement of net income. After accounting for taxes (40% of $60 million = $24 million), the net overstatement of retained earnings is $36 million.

Question 17

A company failed to report the $600,000 additional liability for its underfunded pension plan. Its tax rate is 30%. As result of this error, retained earnings would be:

Accepted Answer

The answer of A company failed to report the $600,000...

Question 18

What is the effect of the error on Berkshire's 2009 income statement?

Accepted Answer

The error affects the beginning inventory, which causes the cost of goods sold to be understated by $600,000, leading to an overstatement of net income by $420,000.

Question 19

During 2009, P Company discovered that the ending inventories reported on its financial statements were incorrect by the following amounts: P uses the periodic inventory system to ascertain year-end quantities that are converted to dollar amounts using the FIFO cost method. Prior to any adjustments for these errors and ignoring income taxes, P's retained earnings at January 1, 2009 would be

Accepted Answer

The ending inventory is overstated by $60,000 on December 31, 2008, and by an additional $90,000 on December 31, 2009. This means that the cost of goods sold (COGS) is understated by $150,000 for the year 2009. Since net income is calculated as revenues minus expenses (including COGS), an understatement of COGS causes an overstatement of net income. Retained earnings is calculated by adding net income to the beginning balance of retained earnings and subtracting any dividends declared. Therefore, an overstatement of net income causes an overstatement of retained earnings. Since the amount of the overstatement of net income is $150,000, the answer is C) $150,000 overstated.

Question 20

A company uses the percentage of sales method to estimate bad debt expense. Its tax rate is 30%. After issuing its 2009 financial statements, the firm discovered that it failed to write off $50,000 in receivables that were determined to be uncollectible in 2009. As a result of this error, net income was:

Accepted Answer

The actual write-off of receivables has no effect on net income when the percentage of sales method is used. Because bad debt expense was based on sales and not a specific receivable, net income will not be affected by correcting the error.

Quiz 20: Accounting Changes