Question

A client's previous two years financial statements understated estimated warranty payable by $30,000 and $50,000 respectively, immaterial amounts. This year the auditors estimate that the accrual is understated by an additional $60,000. In this year's audit $55,000 represents a material amount. Assuming that the entire understatement is to be recorded, following SEC SAB 108 the decrease in this year's income due to these understatements is:

A. $0
B. $60,000
C. $110,000
D. $140,000

Answer 1

The decrease in this year's income due to understatement of the accrued warranty payable identified in the audit is $60,000, with prior year immaterial amounts not needing adjustment.

Step-by-step explanation:

The client's financial statements understated estimated warranty payable by $30,000 and $50,000 in the previous two years, which were considered immaterial amounts. However, in this year's audit, an additional understatement of $60,000 is identified, with $55,000 being a material amount. If the entire understatement needs to be recorded in accordance with SEC SAB 108, the decrease in this year's income due to these understatements would be $60,000. The prior period adjustments of $30,000 and $50,000 are not considered since they were immaterial for their respective years and would not be adjusted in the current year.

According to SEC SAB 108, if previous financial statements have understated estimated warranty payable, the entire understatement must be recorded in the current year. In this case, the previous two years understated the amount by $30,000 and $50,000, which were considered immaterial. However, this year's auditors estimate that the accrual is understated by an additional $60,000 and $55,000 of this represents a material amount. Therefore, the decrease in this year's income due to these understatements is $55,000, which is option B.