Accounting midterm Quiz help

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Types of Accounting Changes:

1. Change in Accounting Policy.

2. Changes in Accounting Estimate.

Errors are not considered an accounting change.

Accounting Alternatives:

 Diminish the comparability of financial information.

 Obscure useful historical trend data.

Chapter 22: Accounting Changes and Error Analysis

LO 1

LEARNING OBJECTIVE 1

Discuss the types of accounting

changes and the accounting for

changes in accounting policies.

Background

22-2

Three approaches for reporting changes:

1) Currently.

2) Retrospectively.

3) Prospectively (in the future).

IASB (IAS 8) requires use of the retrospective approach.

Rationale - Users can then better compare results from one

period to the next.

LO 1

Changes In Accounting Policy

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 Average-cost to LIFO.

 Cost-recovery to percentage-of-completion method.

Change from one accepted accounting policy to another.

Examples include:

Changes In Accounting Policy

Adoption of a new policy in recognition of events that have

occurred for the first time or that were previously immaterial is

not an accounting change.

LO 1

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Retrospective Accounting Change Approach

Company reporting the change

1) Adjusts its financial statements for each prior period

presented to the same basis as the new accounting

policy.

2) Adjusts the carrying amounts of assets and liabilities as

of the beginning of the first year presented.

3) Makes an offsetting adjustment to the opening balance of

retained earnings or other appropriate component of

equity or net assets as of the beginning of the first year

presented. LO 1

Changes In Accounting Policy

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Illustration: Denson SA has accounted for its income from long-

term construction contracts using the cost-recovery (zero-profit)

method. In 2019, the company changed to the percentage-of-

completion method.

Management believes this approach provides a more appropriate

measure of the income earned.

For tax purposes, the company uses the cost-recovery method and

plans to continue doing so in the future. (Assume a 40 percent

enacted tax rate.)

Retrospective Accounting Change: Long-Term

Contracts

LO 1

Changes In Accounting Policy

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Changes In Accounting Policy ILLUSTRATION 22.1

Comparative Income

Statements for Cost-

Recovery versus

Percentage-of-Completion

Methods

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Data for Retrospective Change Example ILLUSTRATION 22.2

Construction in Process 220,000

Deferred Tax Liability 88,000

Retained Earnings 132,000

Journal entry

beginning of

2019

LO 1

Changes In Accounting Policy

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Retained Earnings Adjustment

Retained earnings balance is €1,360,000 at the beginning of 2017.

Before Change

LO 1

ILLUSTRATION 22.4

Changes In Accounting Policy

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Retained Earnings Adjustment

After Change ILLUSTRATION 22.5

Changes In Accounting Policy

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Illustration: Cherokee Construction Company changed from the cost-

recovery to the percentage-of-completion method of accounting for

long-term construction contracts during 2019. For tax purposes, the

company employs the cost-recovery method and will continue this

approach in the future. (Hint: Adjust all tax consequences through the

Deferred Tax Liability account.) The appropriate information related to

this change is as follows.

LO 1

Changes In Accounting Policy

2018 2019

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Instructions: (assume a tax rate of 35%)

(a) What entry(ies) are necessary to adjust the accounting records

for the change in accounting principle?

(b) What is the amount of net income and retained earnings that

would be reported in 2019? Assume beginning retained earnings

for 2018 to be $100,000.

LO 1

Changes In Accounting Policy

2018 2019

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35%

Percentage- Cost- Tax Net of

Date of-Completion Recovery Difference Effect Tax

2018 780,000$ 610,000$ 170,000 59,500 110,500$

2019 700,000 480,000 220,000 77,000 143,000

Pre-Tax Income from Long-Term Contracts

LO 1

Journal entry (recorded in 2019)

Construction in Process 170,000

Deferred Tax Liability 59,500

Retained Earnings 110,500

Changes In Accounting Policy

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Restated Previous

2019 2018 2018

Pre-tax income 700,000$ 780,000$ 610,000$

Income tax (35%) 245,000 273,000 213,500

Net income 455,000$ 507,000$ 396,500$

Beg. Retained earnings 496,500$ 100,000$ 100,000$

Accounting change 123,500

Beg. R/Es restated 607,000 100,000 100,000

Net income 455,000 507,000 396,500

End. Retained earnings 1,062,000$ 607,000$ 496,500$

Income

Statement

Statement

of Retained

Earnings

Comparative Statements

LO 1

Changes In Accounting Policy

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Changes in Accounting

Estimates

Examples of Estimates

1. Bad debts.

2. Inventory obsolescence.

3. Useful lives and residual values of assets.

4. Periods benefited by deferred costs.

5. Liabilities for warranty costs and income taxes.

6. Recoverable mineral reserves.

7. Change in depreciation estimates.

8. Fair value of financial assets or financial liabilities.

LO 2

LEARNING OBJECTIVE 2

Describe the accounting and

reporting for changes in

estimates.

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Prospective Reporting

Changes in accounting estimates are reported prospectively.

Account for changes in estimates in

1. the period of change if the change affects that period only,

or

2. the period of change and future periods if the change

affects both.

IASB views changes in estimates as normal recurring corrections

and adjustments and prohibits retrospective treatment.

LO 2

Changes in Accounting Estimates

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Illustration: Arcadia HS purchased equipment for $510,000 which

was estimated to have a useful life of 10 years with a salvage

value of $10,000 at the end of that time. Depreciation has been

recorded for 7 years on a straight-line basis. In 2019 (year 8), it is

determined that the total estimated life should be 15 years with a

salvage value of $5,000 at the end of that time.

Required:

 What is the journal entry to correct

prior years’ depreciation expense?

 Calculate depreciation expense for 2019.

No Entry Required

LO 2

Changes in Accounting Estimates

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Equipment $510,000

Property, Plant, and Equipment:

Accumulated depreciation 350,000

Book value (BV) $160,000

Statement of Financial Position (Dec. 31, 2018)

After 7 years

Equipment cost $510,000

Residual value - 10,000

Depreciable base 500,000

Useful life (original) 10 years

Annual depreciation $ 50,000 x 7 years = $350,000

First, establish book

value at date of

change in estimate.

LO 2

Changes in Accounting Estimates

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Book value $160,000

Residual value (if any) 5,000

Depreciable base 155,000

Useful life 8 years

Annual depreciation $ 19,375

Second, calculate

depreciation expense

for 2019.

Depreciation expense 19,375

Accumulated depreciation 19,375

Journal entry for 2019

LO 2

Changes in Accounting Estimates

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Accounting Errors

Types of Accounting Errors:

1. A change from an accounting principle that is not generally

accepted to an accounting policy that is acceptable.

2. Mathematical mistakes.

3. Changes in estimates that occur because a company did

not prepare the estimates in good faith.

4. Failure to accrue or defer certain expenses or revenues.

5. Misuse of facts.

6. Incorrect classification of a cost as an expense instead of

an asset, and vice versa.

LO 3

LEARNING OBJECTIVE 3

Describe the accounting for

correction of errors.

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 All material errors must be corrected.

 Record corrections of errors from prior periods as an

adjustment to the beginning balance of retained earnings in

the current period.

 Such corrections are called prior period adjustments.

 For comparative statements, a company should restate the

prior statements affected, to correct for the error.

LO 3

Accounting Errors

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Illustration: In 2020 the bookkeeper for Selectro plc discovered

an error. In 2019 the company failed to record £20,000 of

depreciation expense on a newly constructed building. This

building is the only depreciable asset Selectro owns. The

company correctly included the depreciation expense in its tax

return and correctly reported its income taxes payable.

LO 3

Example of Error Correction

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Selectro’s income statement for 2019 with and without the error.

LO 3

Example of Error Correction

What are the entries that Selectro should have made and did make

for recording depreciation expense and income taxes?

ILLUSTRATION 22.17

ILLUSTRATION 22.17

Error Correction Comparison

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ILLUSTRATION 22.17

ILLUSTRATION 22.18

Error Entries

LO 3

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Example of Error Correction ILLUSTRATION 22.18

The £20,000 omission error in 2019 results in the following effects.

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Retained Earnings 12,000Correcting

Entry in

2020

ILLUSTRATION 22.18

LO 3

Example of Error Correction

Prepare the proper correcting entry in 2020, that should be made

by Selectro.

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ILLUSTRATION 22.18

Prepare the proper correcting entry in 2020, that should be made

by Selectro.

Retained Earnings 12,000Correcting

Entry in

2020

Reversal

LO 3

Example of Error Correction

Deferred Tax Liability 8,000

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ILLUSTRATION 22.18

Prepare the proper correcting entry in 2020, that should be made

by Selectro.

Retained Earnings 12,000Correcting

Entry in

2020

LO 3

Example of Error Correction

Accumulated Depreciation—Buildings 20,000

Deferred Tax Liability 8,000

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Illustration: Selectro Company has a beginning retained earnings

balance at January 1, 2020, of £350,000. The company reports net

income of £400,000 in 2020.

LO 3

Example of Error Correction

Single-Period Statements

ILLUSTRATION 22.19

Reporting an Error—

Single-Period Financial

Statement