McNally Co. is a flooring manufacturer and retailer who operates mainly in the Carolinas. A partialtrial balance showing McNallys equity, revenue and expense balances as of its December 31, 2018 year-end follows:

Debits Credits

Dividends $ 207,650

Retained earnings (1/1/18) $ 746,315

Unrealized holding gain GED bonds (1/1/18) 31,980

Interest revenue 26,170

Sales revenue 7,094,460

Bad debts expense 81,210

Cost of goods sold 4,358,125

Depreciation expense 162,595

Interest expense 94,835

Salaries and wages expense 1,613,790

Utilities expense 176,615

In addition, the following information is available for the company for 2018. Unless indicated otherwise, this information has notyet been reflected in the companys accounts. All of the dollar amounts are stated on a before-taxbasis.

1) In 2013, McNally purchased bonds issued by GED Co., which it continues to hold as an available-for-sale investment. The fair value of McNallys investment decreased in 2018, from $416,230 to $343,675.

Note The $32,980 Unrealized holding gain GED bonds (1/1/18) in the partial trial balance above relates to this item and, of course, is stated net of income taxes.

2) In preparing the 2018 financial statements, McNally determines that it must write down certain patents for impairment. The amount of the write-down is $118,720.

3) In 2016, McNally purchased certain equipment and began using it. In the process of preparing the adjusting entries at year-end 2018, McNally discovered that it had ignored estimated salvage value in the depreciation calculations for 2016 and 2017. The total amount of overstatement of depreciation expense for these two years was $21,280.

Note The discovery and correction of the 2016 and 2017 errors will not change the depreciation expense for 2018. The $162,595 figure in the partial trial balance above is correct.

4) In January 2018, McNally shifted its business strategy, resulting in the July 2018 sale of a component of the company considered a separate major line of business. The sale produced a gain on disposal of $94,505. The operations of the component, prior to the sale in July, produced a loss of $35,160.

5) In September 2018, as a result of a major flooding event, a substantial amount of the companys finished goods inventory was destroyed. The amount of McNallys loss, net of the salvage proceeds and insurance settlement, was $57,245. Flooding is a rare occurrence in the area where the companys storage facility is located. Assume this flooding event satisfies the conditions of unusual and infrequent.

6) At year-end 2018, McNally decided to change its inventory cost flow method from LIFO to FIFO. The effect of the change on 2018 and prior years is as follows:

2018 Prior Years

Cost of goods sold LIFO $4,318,125 $18,140,000

Cost of goods sold FIFO 4,179,810 17,621,000

Note The cost of goods sold figure in McNallys partial trial balance above reflects use of the old method (LIFO) for 2018.

7) In December 2018, McNally sold land it was holding as an investment. McNally received $162,500 from the sale of the land. At the time of the sale, the land had a book value of $73,925.

8) At year-end 2018, McNally determined it must change the percentage it uses to estimate bad debts. With collections deteriorating some, the company is increasing the percentage it uses to estimate bad debts from 5.65% to 7.15%. The effect of this change on 2018 income is as follows:

Bad debts expense based on a 5.65% rate (old rate) $81,210

Bad debts expense based on a 7.15% rate (new rate) 96,530

Note The bad debts expense figure in the partial trial balance above reflects use of the old rate (5.65%) for 2018.

Assume the above amounts are material. Also, assume the income tax rate applicable to all years and all income items is 25%. Finally, note that McNally uses the multiple-stepformat for the reporting of income items and the one-income statementapproach for the display of other comprehensive income items.

Instructions

Prepare the financial statements for the year ended December 31, 2018 to show the proper reporting of McNallys:

income and changes in retained earnings.

Prepare these statements in good form, according to GAAP requirements.