Question

Montague Inc. is a publicly accountable enterprise that reports its financial results in

accordance with IFRS. Montague manufactures and installs high-quality, commercial grade

appliances in restaurants. To gain market share in an increasingly competitive

market, on July 1, 20x5, Montague introduced an expense-type warranty against defects

for 12 months from the date of installation.

When the plan was implemented, Montague estimated that the cost would be 2% of net

sales. Due to an oversight, it neglected to provide for this expense on its December 31,

20x5 financial statements. The 20x5 audit did not find this error, which was

understandable given that no warranty claims were actually received in the initial six

months that the plan was offered. In 20x6, Montague again neglected to provide for the

estimated warranty expense in its financial statements. Instead, Montague simply charged

the $425,000 cost of the warranty claims to miscellaneous expense.

In February 20x7, when examining Montague’s 20x6 financial records, the auditors

noticed the $425,000 miscellaneous expense. Through inquiry, the auditors determined

that the $425,000 was related to the warranty plan and that the company should have

accrued for the expected warranty costs in either the 20x5 or the 20x6 fiscal years.

Montague’s net sales for the 20x5 fiscal year were $41 million, $25 million of which was

made after the warranty plan was introduced. Net sales for the 20x6 fiscal year were $45

million. The company’s tax rate for the 20x5 and 20x6 fiscal years is 30%. The draft

financial statements for Montague’s December 31, 20x6, fiscal year end have been

completed (including adjusting entries pertaining to income tax expense), but they have

not yet been approved by the directors and issued to the shareholders.

Required -

a) Prepare the adjusting journal entry/entries at December 31, 20x6, to account for

the correction of a prior period error as it affects the December 31, 20x5 financial

statements. Show all supporting calculations in your answer.

b) Prepare the adjusting journal entries at December 31, 20x6, to account for the

correction of a prior period error as it affects the December 31, 20x6 financial

statements. Show all supporting calculations in your answer.

Answer 1

(a)Disclosures in the financial statement as on Dec 31, 20x6 pretaining to errors in the financial statement of Dec 31,20x5:

As per IAS 8 the financial statement of Dec 31,20x6 shall have the following Disclosures as following;

The Profit of the year will decrease for the amount $ 0.5 million.(25*2%) and will include an item Provision for Warranty for $500,000.

The Journal Entry:

No Journal only Disclosure is required.

(b)Disclosures in the financial statement as on Dec 31, 20x6 pretaining to errors in the financial statement of Dec 31,20x6:

The financial statements shall be corrected and the following Journal Entries shall be passed

Profit and Loss a/c  Dr $900,000

To Provision for Warranty a/c $900,000

[Being the prior period item rectified]

Warranty Expense a/c Dr $425,000

To Miscellanious Expenses a/c   $425,000

[Being miscellanious Expense error rectified]