Comprehensive – The financial statements of the Gray Company showed income before income taxes of $4,030,000 for the year ended December 31, 2008, and $3,330,000 for the year ended December 31, 2007. Additional information is as follows:
Capital expenditures were $2,800,000 in 2008 and $4,000,000 in 2007. Included in the 2008 capital expenditures is equipment purchased for $1,000,000 on January 1, 2008, with no salvage value. Gray used straight-line depreciation based on a 10-year estimated life in its financial statements. As a result of additional information now available, it is estimated that this equipment should have only an eight-year life.
Gray made an error in its financial statements that should be regarded as material. A payment of $180,000 was made in January 2008 and charged to expense in 2008 for insurance premiums applicable to policies commencing and expiring in 2007. No liability had been recorded for this item at December 31, 2007.
The allowance for doubtful accounts reflected in Gray’s financial statements was $7,000 at December 31, 2008, and $97,000 at December 31, 2007. During 2008, $90,000 of uncollectible receivables were written off against the allowance for doubtful accounts. In 2007, the provision for doubtful accounts was based on a percentage of net sales. The 2008 provision has not yet been recorded. Net sales were $58,500,000 for the year ended December 31, 2008, and $49,230,000 for the year ended December 31, 2007. Based on the latest available facts, the 2008 provision for doubtful accounts is estimated to be 0.2% of net sales.
A review of the estimated warranty liability at December 31, 2008, which is included in “other liabilities’ in Gray’s financial statements, has disclosed that this estimated liability should be increased $170,000.
Gray has two large blast furnaces that it uses in its manufacturing process. These furnaces must be periodically relined. Furnace A was relined in January 2002 at a cost of $230,000 and in January 2007 at a cost of $280,000. Furnace B was relined for the first time in January 2008 at a cost of $300,000. In Gray’s financial statements, these costs were expensed as incurred.
Since a relining will last for five years, a more appropriate matching of revenues and costs would result if the cost of the relining were capitalized and depreciated over the productive life of the relining. Gray has decided to make a change in accounting principle from expensing relining costs as incurred to capitalizing them and depreciating them over their productive life on a straight-line basis with a full year’s depreciation in the year of relining. This change meets the requirements for a change in accounting principle under FASB Statement No. 154, “Accounting Changes and Error Corrections.”
For the years ended December 31, 2008 and 2007, prepare a worksheet reconciling income before income taxes as given previously with income before income taxes, as adjusted for the preceding additional information. Show supporting computations in good form. Ignore income taxes and deferred tax considerations in your answer. The worksheet should have the following format:
Year Ended December 31
Income before income taxes, before adjustments
Income before income taxes, after adjustments
As of January 1, 2008, compute the retrospective adjustment of retained earnings for the cumulative effect of the change in accounting principle from expensing to capitalizing relining costs. Ignore income taxes and deferred tax considerations in your answer.