Question

Problem 22-03

Larkspur Inc. was organized in late 2018 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.

2018		$141,000a		2020		$204,000
2019		160,000b		2021		273,000

^a Includes a $11,000 increase because of change in bad debt experience rate.
^b Includes a 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. Larkspur Inc. therefore hired the auditing firm of Check & Doublecheck Co. and has provided the following additional information.

1.		In early 2019, Larkspur Inc. changed its estimate from 2% of receivables to 1% on the amount of bad debt expense to be charged to operations. Bad debt expense for 2018, if a 1% rate had been used, would have been $11,000. The company therefore restated its net income for 2018.
2.		In 2021, 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.

		2018		2019		2020		2021
Net income unadjusted—LIFO basis		$141,000		$160,000		$204,000		$273,000
Net income unadjusted—FIFO basis		155,000		164,000		215,000		259,000
		$14,000		$4,000		$11,000		$(14,000)

3. In 2021, the auditor discovered that:

(a)		The company incorrectly overstated the ending inventory (under both LIFO and FIFO) by $15,000 in 2020.
(b)		A dispute developed in 2019 with the Internal Revenue Service over the deductibility of entertainment expenses. In 2018, the company was not permitted these deductions, but a tax settlement was reached in 2021 that allowed these expenses. As a result of the court’s finding, tax expenses in 2021 were reduced by $59,000.

(b) Present net income as reported in comparative income statements for the years 2018 to 2021. (Ignore income tax considerations.) (Enter amounts that decrease net income using either a negative sign preceding the number e.g. -15,000 or parentheses e.g. (15,000).)

LARKSPUR INC. Comparative Income Statements For the Years 2018 through 2021
		2018		2019		2020		2021
Net income (unadjusted)		$		$		$		$
1. Bad debt expense adjustment
2. Inventory adjustment (FIFO)
3. Inventory overstatement
Net income (adjusted)		$		$		$		$

Answer 1