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P2-14. Correcting errors
1) Correcting entries in 2017 for equipment improperly expensed in
2016:
To capitalize equipment purchased in 2016 and improperly expensed.
To record 2017 depreciation on equipment ($5,000 ÷ 4 = $1,250)
2) To capitalize vehicle improperly expensed in 2017:
To properly capitalize vehicle that was expensed when purchased.
3) To correct prepaid rent improperly charged to “Buildings” account:
To correctly record rent prepayment.
2017 adjusting entry to record use of warehouse for 6 months.
4) To correct error in accounting for receivables:
To correct overstatement of revenue in 2016 and record collection of
account receivable
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To reverse improper write-off of account receivable in 2017.
5) To correct error in recording prepaid insurance:
To correct overstatement of expense in 2016 and record 2017 insurance expense.
6) To record adjustment for failure to accrue interest expense in 2016:
Financial Reporting and Analysis (7th Ed.)
Chapter 2 Solutions
Accrual Accounting and Income Determination
Cases
Cases
C2-1. Conducting financial reporting research: Discontinued
operations
Requirement 1:
FASB ASC Paragraph 360-10-45-9 specifies the following criteria to
be met in order to classify assets as held for sale:
a. Management commits to a plan to sell the assets.
c. An active program to locate a buyer and other actions required to
complete the plan to sell the assets have been initiated.
e. The assets are being actively marketed for sale at a price that is
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f. Actions required to complete the plan indicate that it is unlikely that
Requirement 2:
At issue is whether the regulatory approval delay violates the
requirement that assets be transferred within one year to qualify for
“held for sale” treatment. FASB ASC Paragraph 360-10-45-11 lists
several exceptions to the “one-year” requirement for completing the
Requirement 3:
The scenario for this requirement implies that management’s plans
have changed since the original disposal plan was adopted. Clearly,
the unit in question is no longer available for immediate sale. While it
is permissible to continue to classify assets as held for sale when
Requirement 4:
Corrpro’s net income would not be affected by denying discontinued
operations treatment to these business units. However, Corrpro has
suffered losses from continuing operations in each of the last three
C2-2. Retrospectively applying a change in accounting principle
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Requirement 1:
Requirement 2:
On January 1, 2017, Neville Company changed its method of valuing
its inventory to the FIFO method; in all prior years the LIFO method
was used to value inventory. The new method of accounting was
C2-3. Channel stuffing
Requirement 1
The Securities and Exchange Commission alleged that ClearOne improperly
recognized revenue, thus inflating net income and accounts receivable,
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distributors did not have to pay for these products until the distributors resold
Physically transferring inventory to a distributor, but not requiring the
distributor to pay until the goods are resold, does not meet the criteria for
revenue recognition. This case pre-dates the new revenue recognition rules,
so the guiding principle would have been that the earnings process is
Requirement 2
Following are the fiscal 2002 and 2001 income statements as originally
Impact on Consolidated Statements of Operations
As of June 30, 2002 As of June 30, 2001
As
Previously
Reported Restated
As
Previously
Reported Restated
Revenue:
Cost of goods sold:
Operating expenses:
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Purchased in-process research and development - - - 728
Income (loss) from continuing operations before
Discontinued operations:
Income from discontinued operations, net of
income taxes - - 737 737
Gain on disposal of a component of our business,
ClearOne had overstated revenue by $11.2 million ($54,543,000 – $43,362,000) and $5.7
million ($39,879,000 – $34,137,000) in $scal 2002 and 2001, respectively. However, cost of
goods sold was misstated by relatively small amounts in those years, resulting in restatements
C2-4. Earnings management
The ethical issues involved are integrity and honesty in financial
reporting, full disclosure, and the accountant’s professionalism. In
violating GAAP, the Chief Accounting Officer also violated the AICPA’s
Code of Professional Conduct. Various parties were affected by the
conduct of the Chief Accounting Officer (and others in Mystery
Technologies management).
Honesty in financial reporting: Although estimates are pervasive in the
preparation of financial statements, accounts are expected to use their
best expectations in making those estimates, and are not permitted to
base estimates on desired reporting outcomes rather than beliefs
about the underlying economics.
Full disclosure: Accountants are expected to provide disclosures that
are sufficient to make the financial statements not misleading. Thus,
failing to disclose the over-reserve was a violation of securities laws.
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Professionalism: Accountants are expected to act in the interests of
the financial statement users in order to provide faithful representation
of the firm’s economic situation. This requirement is inconsistent with
over-reserving in order to prop up subsequent period earnings
artificially.
Note to the instructor: Details of the SEC’s complaint against the
company this case is based on can be found at:
www.sec.gov/litigation/complaints/comp18194.htm
The Chief Accounting Officer pleaded guilty to criminal
charges based on his conduct at Mystery Technologies, the result
of which was various monetary penalties and the loss of future
employment opportunities.
Mystery Technologies, after an SEC investigation, was
charged with filing false and misleading financial statements.
Mystery Technologies’ auditors were named in shareholder
lawsuits filed as a result of the false and misleading financial
statements. The firm’s professional reputation cannot be enhanced
by the fact that the firm did not detect earnings management
schemes involving millions of dollars.
Investors in Mystery Technologies’ stock suffered. Note to
the instructor: By Year 0, Mystery Technologies’ stock had
climbed to over $40 per share where it more or less remained
before falling rapidly to the low teens in June of Year 1—about the
time that it became public that the SEC was investigating Mystery
Technologies’ reported earnings. (While this drop in share price
may have been purely the result of a down market at the time, suits
were filed that allege otherwise.)
The accounting profession suffers in the eyes of the public
whenever one of its members acts unprofessionally.
Employees of Mystery Technologies were placed in a
position where their superiors were pressuring them to engage in
unethical and/or illegal practices.
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