Question 1

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:
A)Report a prior period adjustment decreasing retained earnings by $600,000.
B)Report a prior period adjustment decreasing retained earnings by $1,400,000.
C)Report a current period charge decreasing net income by $600,000.
D)Report a current period charge decreasing net income by $1,400,000.

Accepted Answer

The switch from the cash basis to accrual basis for recognizing warranty expense will require a change in accounting estimate. The unrecorded liability of $2 million at the beginning of the year would need to be recorded as a prior period adjustment, which would decrease the opening balance of retained earnings. The year-end warranty liability of $3 million would be recognized as an expense in the current period.

The calculation for the prior period adjustment is: 
Unrecorded liability x Tax rate = Prior period adjustment 
$2 million x 30% = $600,000

Therefore, the company would report a prior period adjustment decreasing retained earnings by $600,000 and a current period charge decreasing net income by $1,400,000 ($3 million warranty liability - $600,000 tax benefit). The correct choice is B.

Question 2

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:
A)Understated by $14 million.
B)Understated by $7 million.
C)Understated by $20 million
D)UnaffecteD.Unrealized gains on trading securities are included in earnings, so retained earnings would be increased by the after-tax amount: $20,000,000 x (1 - 30%) = $14,000,000.

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 x (1 - 30%) = $14,000,000. Therefore, total shareholders' equity would be understated by $14 million.

Question 3

During 2013, P Company discovered that the ending inventories reported on its financial statements were incorrect by the following amounts: 2011 $120,000 understated
2012 150,000 overstated
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, 2013, would be:
A)Correct.
B)$30,000 overstated.
C)$150,000 overstated.
D)$270,000 overstateD.The $120,000 understated ending inventory would cause the 2011 COGS to be overstated, understating NI and RE.That same error would cause 2012 beginning inventory to be understated, overstating NI and RE by the same amount, effectively correcting the RE balance.The $150,000 overstated ending inventory would cause the 2012 COGS to be understated, overstating NI and RE.

Accepted Answer

The answer of During 2013, P Company discovered that the...

Question 4

Powell Company had the following errors over the last two years: 2011: Ending inventory was overstated by $30,000 while depreciation expense was overstated by $24,000.
2012: 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, 2013? (Ignore taxes)
A)Increase by $15,000.
B)Decrease by $25,000.
C)Decrease by $6,000.
D)Increase by $25,000.

Accepted Answer

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

Question 5

Popeye Company purchased a machine for $300,000 on January 1, 2012. 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 2012. Popeye discovered the error in 2013. What amount should Popeye record as depreciation expense for 2013? The tax rate is 40%.
A)$120,000.
B)$60,000.
C)$36,000.
D)$72,000.

Accepted Answer

The machine should be depreciated over 5 years with no salvage value, so the annual depreciation is $300,000 / 5 = $60,000. Since no depreciation was recorded in 2012, Popeye should record $60,000 as depreciation expense for 2013.

Question 6

Due to an error in computing depreciation expense, Prewitt Corporation overstated accumulated depreciation by $20 million as of December 31, 2013. Prewitt has a tax rate of 30%. Prewitt's retained earnings as of December 31, 2013, would be:
A)Overstated by $14 million.
B)Understated by $14 million.
C)Overstated by $6 million.
D)Understated by $6 million.

Accepted Answer

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

Question 7

If undetected, what is the effect of this error on Berkshire's 12/31/2012 balance sheet?
A)Assets understated by $600,000 and shareholders' equity understated by $600,000.
B)Assets understated by $420,000 and shareholders' equity understated by $420,000.
C)Assets understated by $600,000, liabilities understated by $180,000, and shareholders' equity understated by $420,000.
D)None of the above is correct.

Accepted Answer

If assets are understated by $600,000 and liabilities are understated by $180,000, the net effect on shareholders' equity would be an understatement of $420,000.

Question 8

In 2013, 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 2013 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, 2013, would be:
A)Overstated by $7 million.
B)Overstated by $3 million.
C)Overstated by $10 million.
D)UnaffecteD.This is a change in estimate.No prior period adjustment is needed.

Accepted Answer

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

Question 9

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:
A)Overstated by $108,000.
B)Overstated by $12,000.
C)Understated by $108,000.
D)Understated by $12,000.

Accepted Answer

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

Question 10

Moonland Company's income statement contained the following errors: Ending inventory, December 31, 2013, understated by $6,000
Depreciation expense for 2013 overstated by $1,000
What is the effect of the errors on 2013 net income before taxes?
A)Overstated by $5,000.
B)Understated by $5,000.
C)Understated by $7,000.
D)Overstated by $7,000.

Accepted Answer

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

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:
A)Understated by $14 million.
B)Understated by $6 million.
C)Understated by $20 million
D)UnaffecteD.Unrealized gains on securities available for sale are reported net of tax in other comprehensive income.

Accepted Answer

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

Question 12

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:
A)Understated by $70,000.
B)Overstated by $70,000.
C)Understated by $30,000.
D)Overstated by $30,000.

Accepted Answer

The answer of After issuing its financial statements, a company...

Question 13

What is the effect of the error on Berkshire's 2013 income statement?
A)Net income is understated by $420,000.
B)Cost of goods sold is understated by $420,000.
C)There are no errors in the 2013 income statement.
D)None of the above is correct.

Accepted Answer

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

Question 14

What is the effect of the error on Berkshire's 12/31/2013 balance sheet?
A)There are no errors in the 12/31/2013 balance sheet.
B)Assets understated by $600,000 and shareholders' equity understated by $600,000.
C)Assets understated by $420,000 and shareholders' equity understated by $420,000.
D)Liabilities understated by $180,000 and shareholders' equity overstated by $420,000.

Accepted Answer

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

Question 15

Washburn Co. spent $10 million to purchase a new patented technology, debiting an intangible asset and crediting cash. Washburn uses SYD depreciation on its depreciable assets and plans to amortize the intangible asset on a straight-line basis.
A)Washburn is not required to make any accounting adjustments.
B)Washburn is required to adjust a change in accounting estimate prospectively.
C)Washburn has made a change in accounting principle, requiring retrospective adjustment.
D)Washburn needs to correct an accounting error.

Accepted Answer

The answer of Washburn Co. spent $10 million to purchase...

Question 16

In December 2013, Kojak Insurance Co. received $500,000 in premiums for a two-year property insurance policy. The company recorded the transaction by debiting cash and crediting insurance premium revenue for the full amount. An internal audit conducted in early 2014 flagged this transaction.
A)Kojak needs to correct an accounting error.
B)Kojak has made a change in accounting principle, requiring retrospective adjustment.
C)Kojak is required to adjust a change in accounting estimate prospectively.
D)Kojak is not required to make any accounting adjustments.

Accepted Answer

The transaction where Kojak Insurance Co. recorded the full $500,000 in insurance premium revenue as soon as they received the premiums is an accounting error. Insurance companies are required to recognize revenue over the coverage period rather than recognizing it all at once. Therefore, Kojak needs to correct this error by adjusting their accounting records to recognize revenue over the policy period.

Question 17

C Co. reported a retained earnings balance of $200,000 at December 31, 2012. In September 2013, C determined that insurance premiums of $30,000 for the three-year period beginning January 1, 2012, had been paid and fully expensed in 2012. C has a 30% income tax rate. What amount should C report as adjusted beginning retained earnings in its 2013 statement of retained earnings?
A)$210,000.
B)$214,000.
C)$220,000.
D)$221,000.

Accepted Answer

The insurance premium should have been expensed over three years, not fully in 2012. The error correction increases 2012 income by $20,000 ($30,000/3 * 2 years), and after tax ($20,000 * (1 - 0.30) = $14,000), the adjusted retained earnings is $200,000 + $14,000 = $214,000.

Question 18

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:
A)Unaffected.
B)Overstated by $60,000.
C)Understated by $60,000.
D)Understated by $140,000.

Accepted Answer

When the company overstated its liability for warranties, it would have recognized a higher expense and a higher liability on its financial statements. However, this error is not recognized for tax purposes until the actual warranty claims are paid, which would result in a lower expense and liability. This will result in a lower taxable income and income tax expense, which is understated by $60,000 (30% of $200,000).

Question 19

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:
A)Unaffected.
B)Overstated by $600,000.
C)Overstated by $420,000.
D)Overstated by $180,000.

Accepted Answer

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

Question 20

Due to an error in computing depreciation expense, Crote Corporation understated accumulated depreciation by $60 million as of December 31, 2013. Crote has a tax rate of 40%. Crote's retained earnings as of December 31, 2013, would be:
A)Overstated by $36 million.
B)Understated by $36 million.
C)Overstated by $24 million.
D)Understated by $24 million.

Accepted Answer

The understatement of accumulated depreciation by $60 million means that net income was overstated by $60 million. After accounting for taxes (40% of $60 million = $24 million), the overstatement of retained earnings is $36 million.

Quiz 20: Accounting Changes and Error Corrections

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:

Due to an error in computing depreciation expense, Prewitt Corporation overstated accumulated depreciation by $20 million as of December 31, 2013. Prewitt has a tax rate of 30%. Prewitt's retained earnings as of December 31, 2013, would be:

If undetected, what is the effect of this error on Berkshire's 12/31/2012 balance sheet?

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:

Moonland Company's income statement contained the following errors: Ending inventory, December 31, 2013, understated by $6,000 Depreciation expense for 2013 overstated by $1,000 What is the effect of the errors on 2013 net income before taxes?

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:

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:

What is the effect of the error on Berkshire's 2013 income statement?

What is the effect of the error on Berkshire's 12/31/2013 balance sheet?

Washburn Co. spent $10 million to purchase a new patented technology, debiting an intangible asset and crediting cash. Washburn uses SYD depreciation on its depreciable assets and plans to amortize the intangible asset on a straight-line basis.

In December 2013, Kojak Insurance Co. received $500,000 in premiums for a two-year property insurance policy. The company recorded the transaction by debiting cash and crediting insurance premium revenue for the full amount. An internal audit conducted in early 2014 flagged this transaction.

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:

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:

Due to an error in computing depreciation expense, Crote Corporation understated accumulated depreciation by $60 million as of December 31, 2013. Crote has a tax rate of 40%. Crote's retained earnings as of December 31, 2013, would be: