Chapter 12, Problem 11P

1.

To determine

Prepare the necessary correcting entries of Company B.

Explanation of Solution

Research and development costs: It refers to the expenditures spent on research, development, improvement or introduction of new products, processes, a new patent or even a copyright, that a company expects to get benefits. It is reported under the intangible asset in the balance sheet.

Intangible assets: These are the long-term assets which are not physical in nature, but possess value. The intangible assets would be amortized over their definite useful life or limited useful life, and those with indefinite or unlimited lives are not amortized.

Prepare the necessary correcting entries of Company B as follows:

Date		Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	a.	Software development costs		5,000
		Software development expense			5,000
		(To record the capitalization of computer software costs)
	b.	Allowance for doubtful accounts (1)		23,000
		Bad debt expense			23,000
		(To record the allowance for doubtful account)
	c.	Inventories		12,000
		Cost of goods sold			12,000
		(To record the inventory held by outside processor)
	d.	Prepaid insurance		3,000
		Insurance expense			3,000
		(To record the payment made for insurance in advance)
	e.	Property, plant, and equipment		24,000
		Depreciation expense (2)		2,400
		Repair & maintenance expense			24,000
		Accumulated depreciation			2,400
		(To record the repairs and maintenance of machine purchased and its depreciation)
	f.	Research and development expense (3)		120,000
		Research and development costs			120,000
		(To record the write off research and development costs in accordance with GAAP)
	g.	Loss from litigation		50,000
		Estimated liability from lawsuit			50,000
		(To record the loss from litigation)
	h.	Income taxes payable (4)		72,534
		Income tax expense			72,534
		(To record the provision for income taxes)

Table (1)

Working note (1):

Compute the allowance for doubtful accounts:

$\begin{array}{c}\begin{array}{l}\begin{array}{l}\text{Allowance for }\\ \text{Doubtful Accounts}\end{array}\hfill \end{array}\}=\begin{array}{l}\text{Allowance for Doubtful Accounts}\hfill \end{array}-\text{Accounts receivable}\\ =\$59,000-\$36,000\\ =\$23,000\end{array}$

Working note (2):

Compute the depreciation expense:

$\begin{array}{c}\begin{array}{l}\begin{array}{l}\text{Depreciation}\\ \text{expenses}\end{array}\hfill \end{array}\}=\left[\begin{array}{c}\frac{\text{Acquisition costs}-\text{Salvage value}}{\text{Estimated life}}\times \\ \frac{\text{June 1, 2019}-\text{December 31, 2019}}{\text{months in a year}}\end{array}\right]\\ =\frac{\$24,000-\$0}{5\text{ years}}\times \frac{\text{6}}{12}\\ =\$2,400\end{array}$

Working note (3):

Compute the research and development expense:

$\begin{array}{c}\begin{array}{l}\begin{array}{l}\text{Research and }\\ \text{development}\\ \text{expenses}\end{array}\hfill \end{array}\}=\left[\begin{array}{l}\text{Research and development costs}-\\ \left(\frac{\text{Research and development costs}}{\text{Estimated life}}\right)\end{array}\right]\\ =\text{\$150,000}-\left(\frac{\$150,000}{5\text{ years}}\right)\\ =\$120,000\end{array}$

Working note (4):

Prepare a schedule showing the amount of income tax expense to be adjusted:

Particulars	Amount ($)	Amount ($)
Unadjusted income before income taxes		560,000
Add: Adjustments increasing income
Recognition of computer software	5,000
Allowance for doubtful accounts	23,000
Inventory at outside processor	12,000
Prepaid insurance	3,000
Repairs and maintenance expenses	24,000	67,000
		627,000
Less: Adjustments decreasing income
Depreciation expense	2,400
Research and development expense	120,000
Estimated loss from lawsuit	50,000	172,400
Adjusted income before income taxes (A)		454,600
Effective income tax rate (B)		21%
Adjusted income tax expense $\left(\text{A}\times \text{B}\right)$		95,466
Income tax expense per books		168,000
Adjustment to reduce income tax expense		(72,534)

Table (2)

2.

To determine

Prepare a corrected balance sheet and a corrected income statement of Company B for the year ended November 30, 2019.

Explanation of Solution

Balance sheet: This financial statement reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources. The resources of the company are assets which include money contributed by stockholders and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and stockholders’ equity.

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Prepare a corrected balance sheet of Company B for the year ended November 30, 2019

Corporation B
Balance Sheet
November 30, 2019
Assets
Current Assets:
Cash	180,000
Accounts receivable	480,000
Less: Allowance for doubtful accounts	(36,000)
Inventories	442,000
Prepaid insurance	18,000
Total current assets	1,084,000
Property, plant, and equipment	450,000
Less: Accumulated depreciation	(42,400)
Software development costs	5,000
Total Assets	1,496,600
Liabilities and Shareholders’ Equity
Current Liabilities
Accounts payable and accrued expenses	592,000
Estimated liability from lawsuit	50,000
Income taxes payable	95,466
Total current liabilities (a)	737,466
Shareholders’ Equity
Common stock	400,000
Retained earnings $\left(\text{\$392,000}+\text{\$67,000}-\$172,400+\$72,534\right)$	359,134
Total shareholders’ equity (b)	759,134
Total Liabilities and Shareholders’ Equity	1,496,600

Table (3)

Prepare a corrected income statement of Company B for the year ended November 30, 2019 as follows:

Corporation B
Balance Sheet
For the year ended November 30, 2019
Particulars	Amount ($)	Amount ($)
Net sales		2,950,000
Operating expenses:
Less: Cost of goods sold	1,634,000
Selling and administrative	619,000
Depreciation	42,400
Research and development	150,000
Total expenses		2,445,400
Operating income		504,600
Less: Loss from litigation		(50,000)
Income before income taxes		454,600
Less:  Income tax expense		95,466
Net income		359,134

Table (4)