Question

You are internal auditor for Shannon Supplies, Inc., and are reviewing the company’s preliminary financial statements. The statements, prepared after making the adjusting entries, but before closing entries for the year ended December 31, 2018, are as follows: SHANNON SUPPLIES, INC. Balance Sheet December 31, 2018 ($ in 000s) Assets Cash $ 2,450 Investments 300 Accounts receivable, net 860 Inventory 1,110 Property, plant, and equipment 1,290 Less: Accumulated depreciation (510 ) Total assets $ 5,500 Liabilities and Shareholders’ Equity Accounts payable and accrued expenses $ 3,370 Income tax payable 270 Common stock, $1 par 250 Additional paid-in capital 800 Retained earnings 810 Total liabilities and shareholders’ equity $ 5,500 SHANNON SUPPLIES, INC. Income Statement For the Year Ended December 31, 2018 ($ in 000s) Sales revenue $ 3,500 Operating expenses: Cost of goods sold $ 1,190 Selling and administrative 901 Depreciation 79 2,170 Income before income tax $ 1,330 Income tax expense (532 ) Net income $ 798 Shannon’s income tax rate was 40% in 2018 and previous years. During the course of the audit, the following additional information (not considered when the above statements were prepared) was obtained: Shannon’s investment portfolio consists of blue chip stocks held for long-term appreciation. To raise working capital, some of the shares with an original cost of $185,000 were sold in May 2018. Shannon accountants debited cash and credited investments for the $230,000 proceeds of the sale. At December 31, 2018, the fair value of the remaining securities in the portfolio was $326,500. The state of Alabama filed suit against Shannon in October 2016, seeking civil penalties and injunctive relief for violations of environmental regulations regulating emissions. Shannon’s legal counsel previously believed that an unfavorable outcome was not probable, but based on negotiations with state attorneys in 2018, now believe eventual payment to the state of $135,000 is probable, most likely to be paid in 2021. The $1,110,000 inventory total, which was based on a physical count at December 31, 2018, was priced at cost. Based on your conversations with company accountants, you determined that the inventory cost was overstated by $137,000. Electronic counters costing $85,000 were added to the equipment on December 29, 2017. The cost was charged to repairs. Shannon’s equipment, on which the counters were installed, had a remaining useful life of four years on December 29, 2017, and is being depreciated by the straight-line method for both financial and tax reporting. A new tax law was enacted in 2018 which will cause Shannon’s income tax rate to change from 40% to 35% beginning in 2019.

Prepare journal entries to record the effects on Shannon’s accounting records at December 31, 2018, for each of the items described above.

Answer 1

a)	Investments ($230,000 - $185,000)	45
	Gain on sale of investment		45
b)	Investments	211.5
	Unrealized Gain on investment		211.5
Unrealized gain = Fair value of remaining securities - Book value of remaining securities => $326,500 - ($300,000 - $185,000) = $211,500
c)	No entry required as payment to be made in 2019
d)	Retained Earnings	137
	Inventory		137
e)	Equipment	85
	Repairs		85
f)	No entry required as deperciation is already charged