Correction of Errors
Hiatt Textile Corporation is planning to expand its current plant facilities and is in the process of obtaining a loan at City Bank. The bank has requested audited financial statements. Hiatt has never been audited before. It has prepared the following comparative financial statements for the years ended December 31, 2008 and 2007.
|
Hiatt Textile Corporation |
||
|
Comparative Balance Sheets |
||
|
December 31, 2008 and 2007 |
||
|
|
2008 |
2007 |
|
Assets |
|
|
|
Current assets: |
|
|
|
Cash |
$ 602,500 |
$ 400,000 |
|
Accounts receivable |
980,000 |
740,000 |
|
Allowance for bad debts |
(92,500) |
(45,000) |
|
Inventory |
517,500 |
505,000 |
|
Total current assets |
$2,007,500 |
$1,600,000 |
|
Plant assets: |
|
|
|
Property, plant, and equipment |
$ 417,500 |
$ 423,750 |
|
Accumulated depreciation |
(304,000) |
(266,000) |
|
Total plant assets |
$ 113,500 |
$ 157,750 |
|
Total assets |
$2,121,000 |
$1,757,750 |
|
Liabilities and Stockholders’ Equity |
|
|
|
Liabilities: |
|
|
|
Accounts payable |
$ 303,500 |
$ 490,250 |
|
Stockholders’ equity: |
|
|
|
Common stock, par value $25; authorized, 30,000 shares; |
|
|
|
issued and outstanding, 26,000 shares |
$ 650,000 |
$ 650,000 |
|
Retained earnings |
1,167,500 |
617,500 |
|
Total stockholders’ equity |
$1,817,500 |
$1,267,500 |
|
Total liabilities and stockholders’ equity |
$2,121,000 |
$1,757,750 |
|
Hiatt Textile Corporation |
||
|
Comparative Income Statements |
||
|
For the Years Ended December 31, 2008 and 2007 |
||
|
|
2008 |
2007 |
|
Sales |
$2,500,000 |
$2,250,000 |
|
Cost of goods sold |
1,075,000 |
987,500 |
|
Gross margin |
$1,425,000 |
$1,262,500 |
|
Operating expenses |
$ 575,000 |
$ 512,500 |
|
General and administrative expenses |
300,000 |
262,500 |
|
|
$ 875,000 |
$ 775,000 |
|
Net income |
$ 550,000 |
$ 487,500 |
The following facts were uncovered during the audit.
(a) On January 20, 2007, Hiatt had charged a 5-year fire insurance premium to expense.
The total premium amounted to $15,500.
(b) Over the last two years, the amount of loss due to bad debts has steadily decreased.
Hiatt has decided to reduce the amount of bad debt expense from 2% to 1.5% of sales, beginning with 2008. (A charge of 2% has already been made for 2008.)
(c) The inventory account (maintained on a periodic basis) has been in error the last two years. The errors were as follows:
2007: Ending inventory overstated by $37,750
2008: Ending inventory overstated by $49,500
(d) A machine costing $75,000, purchased on January 4, 2007, was incorrectly charged to operating expense. The machine has a useful life of 10 years and a residual value of $12,500. The straight-line depreciation method is used by Hiatt.
Instructions:
1. Prepare the journal entries to correct the books at December 31, 2008. The books for
2008 have not been closed. (Ignore income taxes.)
2. Prepare a schedule showing the computation of corrected net income for the years ended December 31, 2007 and 2008, assuming that any adjustments are to be reported on the comparative statements for the two years. Begin your schedule with the net income for each year. (Ignore income taxes.)