Erin Kramer Inc. has recently hired a new independent auditor, Jodie Larson, who says she wants “to get everything straightened out.” Consequently, she has proposed the following accounting changes in connection with Erin Kramer Inc.’s 2008 financial statements.
1. At December 31, 2008, the client had a receivable of $820,000 from Holly Michael Inc. on its balance sheet. Holly Michael Inc. has gone bankrupt, and no recovery is expected. The client proposes to write off the receivable as a prior period item.
2. The client proposes the following changes in depreciation policies.
(a) For office furniture and fixtures it proposes to change from a 10-year useful life to an 8-year life. If this change had been made in prior years, retained earnings at December 31, 2008, would have been $250,000 less. The effect of the change on 2008 income alone is a reduction of $60,000.
(b) For its equipment in the leasing division the client proposes to adopt the sum-of-the-years’-digits depreciation method. The client had never used SYD before. The first year the client operated a leasing division was 2009. If straight-line depreciation were used, 2009 income would be $110,000 greater.
3. In preparing its 2008 statements, one of the client’s bookkeepers overstated ending inventory by $235,000 because of a mathematical error. The client proposes to treat this item as a prior period adjustment.
4. In the past, the client has spread preproduction costs in its furniture division over 5 years. Because its latest furniture is of the “fad” type, it appears that the largest volume of sales will occur during the first 2 years after introduction. Consequently, the client proposes to amortize preproduction costs on a per-unit basis, which will result in expensing most of such costs during the first 2 years after the furniture’s introduction.
If the new accounting method had been used prior to 2008, retained earnings at December 31, 2007, would have been $375,000 less.
5. For the nursery division the client proposes to switch from FIFO to LIFO inventories because it believes that LIFO will provide a better matching of current costs with revenues. The effect of making this change on 2009 earnings will be an increase of $320,000. The client says that the effect of the change on December 31, 2008, retained earnings cannot be determined.
6. To achieve a better matching of revenues and expenses in its building construction division, the client proposes to switch from the completed-contract method of accounting to the percentage-of-completion method.
Had the percentage-of-completion method been employed in all prior years, retained earnings at December 31, 2008, would have been $1,175,000 greater.
Instructions
(a) For each of the changes described above decide whether:
(1) The change involves an accounting principle, accounting estimate, or correction of an error.
(2) Restatement of opening retained earnings is required.
(b) What would be the proper adjustment to the December 31, 2008, retained earnings?