In 2018, 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 2017 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 2017 tax return and reduce its income by $240,000.
B) The company should change its accounting method in 2018, with a $60,000 negative § 481 adjustment which decreases its 2018 taxable income.
C) The company should change its accounting method in 2018, and increase its 2018 income by $60,000, the amount of the positive § 481 adjustment to income.
D) The company should change its accounting method in 2018 and recognize a $60,000 negative § 481 adjustment that will be spread equally over 2018-21.
E) None of the above.

Question

Quizplus · Accepted Answer

The company has been capitalizing administrative expenses as production costs, which is incorrect. Therefore, it needs to change its accounting method going forward. The negative § 481 adjustment of $60,000 (the amount that was included in ending inventory in 2017) will decrease its 2018 taxable income. The company does not need to amend its 2017 tax return because the $240,000 deduction for cost of goods sold was correct, and it cannot be changed now. Option C is incorrect because the positive § 481 adjustment of $60,000 would increase the company's 2018 income, which is the opposite of what is desired. Option D is incorrect because there is no need to spread the adjustment over multiple years. Option E is incorrect as the correct option is B.

In 2018, Swan Company Discovered That It Had for the Past