In 2017, 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 2016 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 2016 tax return and reduce its income by $240,000.
B)The company should change its accounting method in 2017, with a $60,000 negative § 481 adjustment which decreases its 2017 taxable income.
C)The company should change its accounting method in 2017, and increase its 2017 income by $60,000, the amount of the positive § 481 adjustment to income.
D)The company should change its accounting method in 2017 and recognize a $60,000 negative § 481 adjustment that will be spread equally over 2017-20.
E)None of the above.

Question

Quizplus · Accepted Answer

The company should change its accounting method in 2017, with a $60,000 negative § 481 adjustment which decreases its 2017 taxable income. This is because the company has been capitalizing expenses that should have been expensed as administrative expenses, and to rectify this error, the accounting method should be changed from capitalizing to expensing the expenses in question. The negative § 481 adjustment accounts for the difference between the amount previously capitalized and the correct amount that should have been expensed. This adjustment will decrease the company's taxable income for the year.

In 2017, Swan Company Discovered That It Had for the Past