Question

A company switched from the cash basis to the accrual basis for recognizing warranty expense. The unrecorded liability for warranties was $2 million at the beginning of the year. Its tax rate is 30%. The company booked a year-end warranty liability of $3 million.
1. As a result of this change, the firm would ___________.

Answer 1

Answer:

Report a prior period adjustment decreasing retained earnings by $1,365,000.

Explanation:

Going by the question we can derive that $2,100,000 is the prior period's warranty. Consequently, it will be charged to the current year's earnings following the deduction of tax, 35%.

(2,100,000 *65) /100 = $1,365,000

This above calculation is so because Under the accrual basis of accounting...operating expense are reported on the income statement in the particular period when they took place or when they expire

Answer 2

Answer:

B.Report a prior period adjustment decreasing retained earnings by $1,400,000

Explanation:

Unrecorded liability for warranties was $2 million at the beginning of the year × Its tax rate is 30%.

$2,000,000 ×30%

=$600,000

$ 2,000,000-$600,000

=$1,400,000

Therefore a result of this change, the firm would report a prior period adjustment decreasing retained earnings by $1,400,000 because net income often increases Retained Earnings, while net losses and dividends decrease Retained Earnings due to the fact that any items that push net income higher or lower will ultimately affect retained earnings.