Comprehensive Accounting Change and Error Analysis Problem Botti

Comprehensive Accounting Change and Error Analysis Problem Botticelli Inc. were organized in late 2008 to manufacture and sell hosiery. At the end of its fourth year of operation, the company has been fairly successful, as indicated by the following reported net incomes. 

2008    $140,000a        2010    $205,000

2009      160,000b        2011      276,000

a Includes a $10,000 increase because of change in bad debt experience rate.

b Includes extraordinary gain of $30,000.

The company has decided to expand operations and has applied for a sizable bank loan. The bank officer has indicated that the records should be audited and presented in comparative statements to facilitate analysis by the bank. Botticelli Inc. therefore hired the auditing firm of Check & Double-check Co. and has provided the following additional information. 

1. In early 2009, Botticelli Inc. changed its estimate from 2% to 1% on the amount of bad debt expense to be charged to operations. Bad debt expense for 2008, if a 1% rate had been used, would have been $10,000. The company therefore restated its net income for 2008.

2. In 2011, the auditor discovered that the company had changed its method of inventory pricing from LIFO to FIFO. The effect on the income statements for the previous years is as follows.

                                                                            2008             2009                 2010                2011

Net income unadjusted—LIFO basis       $140,000      $160,000         $205,000         $276,000

Net income unadjusted—FIFO basis         155,000         165,000          215,000            260,000

                                                                        $ 15,000          $ 5,000         $ 10,000         ($ 16,000)

3. In 2011 the auditor discovered that:

a. The company incorrectly overstated the ending inventory by $14,000 in 2010.

b. A dispute developed in 2009 with the Internal Revenue Service over the deductibility of entertainment expenses. In 2008, the company was not permitted these deductions, but a tax settlement was reached in 2011 that allowed these expenses. As a result of the court’s finding, tax expenses in 2011 were reduced by $60,000. 

(a) Indicate how each of these changes or corrections should be handled in the accounting records. Ignore income tax considerations.

(b) Present comparative income statements for the years 2008 to 2011, starting with income before extraordinary items. Ignore income tax considerations.


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