The Ingalls Corporation is in the process of negotiating a loan for expansion purposes.
The books
and records have never been audited, and the bank has requested that an audit be performed.
Ingalls has prepared the following comparative financial statements for the years ended
December 31, 2008 and 2007:
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During the course of the audit, the following additional facts were determined:
1. An analysis of collections and losses on accounts receivable during the past two years
indicates a drop in anticipated losses because of bad debts. After consultation with management,
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it was agreed that the loss experience rate on sales should be reduced from the recorded 2% to
1%, beginning with the year ended December 31, 2008.
2. An analysis of the available-for-sale securities revealed that this portfolio consisted entirely of
short-term investments in marketable equity securities that were acquired in 2007. The total
market valuation for these investments as of the end of each year was as follows: December 31,
2007—$81,000; December 31, 2008—$62,000.
3. The merchandise inventory at December 31, 2007 was overstated by $4,000 and the
merchandise inventory at December 31, 2008 was overstated by $6,100.
4. On January 2, 2007, equipment costing $12,000 (estimated useful life of 10 years and residual
value of $1,000) was incorrectly charged to Operating Expenses. Ingalls records depreciation via
the straight-line method. In 2008, fully depreciated equipment (with no residual value) that
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originally cost $17,500 was sold as scrap for $2,500. Noble credited the proceeds of $2,500 to
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Property and Equipment.
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5. An analysis of 2007 operating expenses revealed that Ingalls charged to expense a three-year
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insurance premium of $2,700 on January 15, 2007.
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Required
1. Prepare the journal entries to correct the books at December 31, 2008. The books for 2008
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have not been closed. Ignore income taxes.
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2. Prepare a schedule showing the computation of corrected net income for the years ended
December 31, 2008 and 2007, assuming that any adjustments are to be reported on comparative
statements for the two years. The first items on your schedule should be the net income for each
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year. Ignore income taxes. (Do not prepare financial statements.)
SOLUTION:
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1. (1) Allowance for Uncollectible Accounts 10,000
Administrative Expenses 10,000
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To reflect reduction in loss experience
rate.
(2) Unrealized Decline in Value of
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Securities Available for Sale 16,000
Allowance for Change in Value
of Investment 16,000
To reduce securities available
for sale to market valuation.
(3) Retained Earnings 4,000
Cost of Sales 2,100
Merchandise Inventory 6,100
To adjust for overstatements in
opening and closing inventories.
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(4) Equipment 12,000
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Operating Expenses 1,100
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Retained Earnings 10,900
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Accumulated Depreciation: Equipment 2,200
To adjust for misposting of equipment
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purchase in 2007.
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(5) Accumulated Depreciation: Equipment 17,500
Equipment 15,000
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Other Income 2,500
To adjust for misposting of equipment sale.
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(6) Prepaid Expenses 900
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Operating Expenses 900
Retained Earnings 1,800
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To adjust for nonrecognition of
prepaid expense in 2007.
(7) Common Stock 60,000
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Capital in Excess of Par 60,000
To adjust for capital contributed in
excess of par value.
2. INGALLS CORPORATION
Computation of Corrected Net Income
For Years Ended December 31, 2008 and 2007
2008 2007
Reported income $220,000 $195,000
Change in accounts receivable loss
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experience rate from 2% to 1% 10,000 ---
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Ending merchandise inventories overstated:
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December 31, 2007 4,000 (4,000)
December 31, 2008 rs e (6,100)
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Misposting of equipment purchase:
Decrease in operating expenses - 2007 10,900
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Increase in operating expenses - 2008 (1,100)
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Misposting of proceeds of equipment sold 2,500
Recognition of prepaid insurance (900) 1,800
Corrected net income $228,400 $203,700
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