EXERCISE 22.

3 (25–30 minutes)

(a) RAMIREZ CO.

Income Statement
For the Year Ended December 31

Average Cost
2020 2021 2022
Sales ........................................................ $4,000 $4,000 $4,000
Cost of goods sold ................................. 800 1,000 1,130
Operating expenses ............................... 1,000 1,000 1,000
Net income ....................................... $2,200 $2,000 $1,870

Income Statement
For the Year Ended December 31

FIFO
2020 2021 2022
Sales ....................................................... $4,000 $4,000 $4,000
Cost of goods sold ................................ 820 940 1,100
Operating expenses .............................. 1,000 1,000 1,000
Net income ...................................... $2,180 $2,060^^ $1,900^

(b) RAMIREZ CO.

Income Statement
For the Year Ended December 31

2022 2021
As adjusted (Note A*)
Sales ....................................................... $4,000 $4,000
Cost of goods sold ................................ 1,100 940
Operating expenses .............................. 1,000 1,000
Net income ...................................... $1,900^ $2,060^^

(Note A* can be found in part c of this exercise)

[^ and ^^ amounts are used in parts (c) and (d) of this exercise]
EXERCISE 22.3 (Continued)

(c) Note A:

Change in Method of Accounting for Inventory Valuation

On January 1, 2022, Ramirez elected to change its method of valuing

its inventory to the FIFO method, whereas in all prior years inventory
was valued using the Average Cost method. The new method of
accounting for inventory was adopted because it better reflects the
current cost of the inventory on the statement of financial position.
Comparative financial statements of prior years have been adjusted to
apply the new method retrospectively. The following financial
statement line items for fiscal years 2022 and 2021 were affected by
the change in accounting policy.

2022 2021

Statement of Financial
Position Average FIFO Difference Average FIFO Difference
Inventory $ 320 $ 390 $70 $ 200 $ 240 $40
Retained Earnings 6,070 6,140** 70 4,200 4,240*** 40

Income Statement

Cost of Goods Sold $1,130 $1,100 $30 $1,000 $ 940 $60

Net Income 1,870 1,900^ 30 2,000 2,060^^ 60

Statement of Cash Flows (No Effect)

(** and ***) - Refer to part (d) below for detailed computations
[^ and ^^ refer to amounts from parts (a) and (b) of this exercise]

(d) Retained earnings statements after retrospective application.

2022 2021
Retained earnings, January 1, as reported $2,200
Less: Adjustment for cumulative effect
of applying new accounting
method (FIFO) ($820 $800) 20
Retained earnings, January 1, as adjusted $4,240*** 2,180
Net Income 1,900^ 2,060^^
Retained earnings, December 31 $6,140** $4,240***
LO: 1, Bloom: AN, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, AICPA BC: None, AICPA FC: Reporting, AICPA PC: None
EXERCISE 22.21 (10–15 minutes)

2021 2022
Item Over- Under- No Over- Under- No
statement statement Effect statement statement Effect
(1) X X
(2) X X
(3) X X
(4) X X
(5) X X

LO: 3, 4, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, AICPA BC: None, AICPA FC: Reporting, AICPA PC: None
 PROBLEM 22.1

(a) 1. Cost of equipment ................................................ $85,000

Less: Residual value ............................................ 5,000
Depreciable cost ................................................... $80,000

Depreciation to 2022
2019 ($80,000 ÷ 10) ........................................ $ 8,000
2020 ($80,000 ÷ 10) ........................................ 8,000
2021 ($80,000 ÷ 10) ........................................ 8,000
Depreciation to 2022……...…………………... $24,000

Depreciation for 2022

Cost of equipment......................................... $85,000
Less: Depreciation to 2022.......................... 24,000
Book value (January 1, 2022) ....................... 61,000
Less: Residual value..................................... 3,000
Depreciable cost ........................................... $58,000

Depreciation Expense .......................................... 14,500*

Accumulated Depreciation—Equipment ..... 14,500
*$58,000 ÷ 4 = $14,500

2. Cost of Building .................................................... $300,000

Less: Depreciation to 2022
2020 ............................................................ 60,000
2021 ............................................................ 48,000
Book value (January 1, 2022) ................... 192,000
Less: Residual value ................................ 30,000
Depreciable cost ........................................ $162,000

Depreciation Expense .......................................... 20,250**

Accumulated Depreciation—Building ......... 20,250
*$162,000 ÷ (10 – 2)
PROBLEM 22.1 (Continued)

3. Depreciation Expense ($120,000(g) – $16,000) ÷ 8 .. 13,000

Accumulated Depreciation—Machine ............. 13,000
Accumulated Depreciation—Machine..................... 3,000
Retained Earnings ............................................. 3,000

Depreciation recorded in 2020:

($120,000(g) ÷ 8) × 1/2 = $7,500
Depreciation that should be recorded in 2020:
([$120,000(g) – $16,000] ÷ 8) × 1/2 = 6,500
Depreciation recorded in 2021:
($120,000 ÷ 8) = $15,000
Depreciation that should be recorded in 2021:
($120,000 – $16,000) ÷ 8 = $13,000

Depreciation Depreciation (corr

(actual) ect) Difference
2020 $ 7,500 $ 6,500 $1,000
2021 15,000 13,000 2,000
$22,500 $19,500 $3,000

(b) HOLTZMAN COMPANY

Comparative Income Statements
For the Years 2022 and 2021
2022 2021
Income before depreciation expense .... $300,000 $310,000
Depreciation expense* ............................ 47,750 69,000
Net income ............................................... $252,250 $241,000

*Depreciation Expense 2022 2021

Equipment ......................................... $14,500 $ 8,000
Building ............................................. 20,250 48,000
Machine ............................................. 13,000 13,000
$47,750 $69,000
LO: 2, 3, Bloom: AP, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, AICPA BC: None, AICPA FC: Reporting, AICPA PC: None
 PROBLEM 22.8

Net Income for 2021 Retained Earnings 12/31/22

Item Understated Overstated Understated Overstated
1. £14,100 0 0 0
2. £ 3,500 0 £ 2,500 0
3. 0 £22,000 0 £11,000
4. £28,000 0 £28,000 0
5. 0 £24,000 0 £12,000
6. £18,200 0 0 0

Although explanations were not required in answering the question, they

are included below.

Explanations:

1. The net income would be understated in 2021 because interest income

is understated. The net income would be overstated in 2022 because
interest income is overstated. The errors, however, would counter-
balance (wash) so that the statement of financial position (Retained
Earnings) would be correct at the end of 2022.

2. The depreciation expense in 2021 should be £500 for this machine.

Since the machine was bought on July 1, 2021, only one-half of a year’s
depreciation should be taken in 2021 (£4,000/4 × 1/2 = £500). The
company expensed £4,000 instead of £500 so net income is
understated by £3,500 in 2022. An additional £1,000 of depreciation
expense should have been taken in 2022. At the end of 2022, retained
earnings would be understated by £2,500 (£3,500 – £1,000).

3. IFRS requires that all research costs should be expensed when

incurred. Net income in 2021 is overstated £22,000 (£33,000 research
costs capitalized less £11,000 amortized). By the end of 2022, only
£11,000 of the research costs would remain as an asset. Therefore,
retained earnings would be overstated by £11,000 (£33,000 research
costs – £22,000 amortized).
PROBLEM 22.8 (Continued)

4. The security deposit of £20,000 should be a long-term asset, called

refundable deposits. The £8,000 of the last month’s rent is also an
asset, called prepaid rent. The net income of 2021 is understated by
£28,000 (£20,000 + £8,000) because these amounts were expensed.
Retained earnings will continue to be understated by £28,000 until the
last year of the lease. The security deposit will then be refunded, and
the last month’s rent should be expensed.

5. £12,000 or one-third of £36,000 should be reported as income each

year. In 2021, £36,000 was reported as income when only £12,000
should have been reported. Because £24,000 (£36,000 - £12,000) too
much was reported as revenue, the net income of 2021 is overstated.
At the end of 2022, £24,000 should have been reported as income, so
retained earnings is still overstated by £12,000 (£36,000 – £24,000).

6. The ending inventory would be understated since the merchandise

was omitted. Because ending inventory and net income have a direct
relationship, net income in 2021 would be understated. The ending
inventory of 2021 becomes the beginning inventory of 2022. If
beginning inventory of 2022 is understated, then net income of 2022 is
overstated (inverse relationship). The omission in inventory over the
two-year period will counterbalance and retained earnings at the end
of 2022 will be correct.
LO: 3, 4, Bloom: AP, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, AICPA BC: None, AICPA FC: Reporting, AICPA PC: None
 (a) ROBERTS COMPANY
Schedule of Revised Net Income
For the Years Ended March 31, 2020, 2021, and 2022
SUMMARY
COMPUTATIONS Increases (Decreases) in Income
2020 2021 2022 2020 2021 2022

1. Net income as reported $71,600 $111,400 $103,580

2. Elimination of profit on consignments:
Billed $ 6,500 $ 5,590
at 125% of cost ÷ 1.25 ÷ 1.25
Cost 5,200 4,472
Profit error $ 1,300 $ 1,300 $ 1,118 (1,300) 1,300 (1,118)
3. To correct C.O.D. sale 6,100 (6,100)
4. Adjustment of warranty expense:
Sales per books $940,000 $1,010,000 $1,795,000

PROBLEM 22-10
Correction for consignments (6,500) 6,500 (5,590)
Correction for C.O.D. sale 6,100 (6,100)
Corrected sales $933,500 $1,022,600 $1,783,310
Normal warranty expense, one-half of 1% $ 4,668 $ 5,113 $ 8,917
Less costs charged to expense 760 1,670 3,850
Additional expense $ 3,908 $ 3,443 $ 5,067 (3,908) (3,443) (5,067)
5. Bad debt adjustments:
Normal bad debt expense, one-quarter of
1% of sales $ 2,334 $ 2,557 $ 4,458
Less previous write-offs 750 1,320 3,850
Additional expense $ 1,584 $ 1,237 $ 608 (1,584) (1,237) (608)
6. Adjustment for contract financing 3,000 3,900 5,100
7. Adjustment for commissions (1,400) 500* (220) **
66,408 118,520 95,567
8. Adjustment for bonus, 1%
of income before taxes and bonus (664) (1,185) (956)

Income before income taxes $65,744 $117,335 $ 94,611

* $1,400 – $900
** $900 – $1,120
PROBLEM 22.10 (Continued)

(b) ROBERTS COMPANY

Journal Entries
March 31, 2022

Sales ............................................................................ 5,590

Inventory on Consignment ........................................ 4,472
Cost of Goods Sold ............................................ 4,472
Accounts Receivable .......................................... 5,590
(To adjust for consignments treated
as sales, 3/31/22)

Sales Revenue ............................................................ 6,100

Retained Earnings .............................................. 6,100
(To adjust for C.O.D. sales not
recorded, 3/31/21)

Warranty Expense ...................................................... 5,067

Retained Earnings ($3,908 + $3,443) ......................... 7,351
Estimated Liability Under Warranties ............... 12,418
($5,067 + $7,351)
(To set up allowance for warranty
expense)

Retained Earnings ($1,584 + $1,237) ......................... 2,821

Bad Debt Expense ...................................................... 608
Allowance for Doubtful Accounts ($2,821+$608) 3,429
(To set up allowance for uncollectible
accounts)

Dealers’ Fund Reserve (held by bank)...................... 12,000

($5,100 + $6,900)
Finance Expense................................................. 5,100
Retained Earnings ($3,000 + $3,900) ................. 6,900
(To record finance charge reserve
held by bank)
PROBLEM 22.10 (Continued)

Commissions Expense .................................................... 220

Retained Earnings ($1,400 – $500) .................................. 900
Commissions Payable ($220 + $900) ...................... 1,120
(To adjust for accrued commissions)

Retained Earnings ($664 + $1,185) ............................ 1,849

Salaries and Wages Expense .................................... 956
Salaries and Wages Payable ($1,849 + $956) ... 2,805
(To set up accrued bonus payable
to manager)

LO: 3, 4, Bloom: AN, Difficulty: Moderate, Time: 50-60, AACSB: Analytic, AICPA BC: None, AICPA FC: Reporting, AICPA PC: None