Embed Size (px)
Citation preview
22-1
5. Describe the accounting for changes in estimates.
6. Identify changes in a reporting entity.
7. Describe the accounting for correction of errors.
8. Identify economic motives for changing accounting methods.
9. Analyze the effect of errors.
After studying this chapter, you should be able to:
LEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVES
1. Identify the types of accounting changes.
2. Describe the accounting for changes in accounting principles.
3. Understand how to account for retrospective accounting changes.
4. Understand how to account for impracticable changes.
Accounting Changes Accounting Changes and Error Analysisand Error Analysis2222
22-2
Types of Accounting Changes:
1. Change in Accounting Policy.
2. Changes in Accounting Estimate.
3. Change in Reporting Entity.
Errors are not considered an accounting change.
Accounting Alternatives:
Diminish the comparability of financial information.
Obscure useful historical trend data.
Accounting Changes
LO 1
22-3
Average cost to LIFO.
Completed-contract to percentage-of-completion method.
Change from one accepted accounting policy to another.
Examples include:
Changes in Accounting Principle
Adoption of a new principle in recognition of events that have occurred
for the first time or that were previously immaterial is not an accounting
change.
LO 2
22-4
Three approaches for reporting changes:
1) Currently.
2) Retrospectively.
3) Prospectively (in the future).
FASB requires use of the retrospective approach.
Rationale - Users can then better compare results from one period to
the next.
LO 2
Changes in Accounting Principle
22-5
Illustration: Denson Company has accounted for its income from
long-term construction contracts using the completed-contract
method. In 2014, 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 completed-contract method and
plans to continue doing so in the future. (Assume a 40 percent
enacted tax rate.)
Retrospective Accounting Change: Long-Term Contracts
Changes in Accounting Principle
LO 3
22-6
Illustration 22-1
Changes in Accounting Principle
LO 3
22-7
Data for Retrospective ChangeIllustration 22-2
Construction in Process 220,000
Deferred Tax Liability
88,000
Retained Earnings
132,000
Journal entry beginning of
2014
Changes in Accounting Principle
LO 3
22-8
Illustration 22-3Reporting a Change in policy
Changes in Accounting Principle
LO 3
22-9
Retained Earnings Adjustment
Illustration 22-4
Retained earnings balance is $1,360,000 at the beginning of 2012.
Before Change
Changes in Accounting Principle
LO 3
22-10
Illustration 22-5 After Change
Changes in Accounting Principle
LO 3
Retained Earnings Adjustment
22-11
Impracticability
Companies should not use retrospective application if one of the
following conditions exists:
1. Company cannot determine the effects of the retrospective
application.
2. Retrospective application requires assumptions about
management’s intent in a prior period.
3. Retrospective application requires significant estimates that
the company cannot develop.
If any of the above conditions exists, the company prospectively applies the new accounting principle.
Changes in Accounting Principle
LO 4
22-12
Changes in Accounting Estimate
Examples of Estimates
1. Uncollectible receivables.
2. Inventory obsolescence.
3. Useful lives and salvage 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 methods.
LO 5
22-13
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.
FASB views changes in estimates as normal recurring
corrections and adjustments and prohibits retrospective
treatment.
Changes in Accounting Estimate
LO 5
22-14
Illustration: Arcadia High School 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 2014 (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 2014.
No Entry Required
Changes in Accounting Estimate
LO 5
22-15
Equipment $510,000
Fixed Assets:
Accumulated depreciation 350,000
Net book value (NBV) $160,000
Balance Sheet (Dec. 31, 2013)
After 7 years
Equipment cost $510,000
Salvage value - 10,000
Depreciable base 500,000
Useful life (original) 10 years
Annual depreciation $ 50,000 x 7 years = $350,000
First, establish NBV at date of change in
estimate.
First, establish NBV at date of change in
estimate.
Changes in Accounting Estimate
LO 5
22-16
Net book value $160,000
Salvage value (if any) 5,000
Depreciable base 155,000
Useful life 8 years
Annual depreciation $ 19,375
Second, calculate Second, calculate depreciation expense depreciation expense
for 2014.for 2014.
Second, calculate Second, calculate depreciation expense depreciation expense
for 2014.for 2014.
Depreciation expense 19,375
Accumulated depreciation 19,375
Journal entry for 2014
Changes in Accounting Estimate
LO 5Advance slide in presentation
mode to reveal answers.
22-17
Change in Reporting Entity
Examples of a change in reporting entity are:
1. Presenting consolidated statements in place of statements of individual companies.
2. Changing specific subsidiaries that constitute the group of companies for which the entity presents consolidated financial statements.
3. Changing the companies included in combined financial statements.
4. Changing the cost, equity, or consolidation method of accounting for subsidiaries and investments.
Reported by changing the financial statements of all prior periods presented.
LO 6
22-18
Accounting Errors
Accounting Category Type of Restatement
Expense recognition Recording expenses in the incorrect period or for an incorrect amount.
Revenue recognition Instances in which revenue was improperly recognized, questionable revenues were recognized, or any other number of related errors that led to misreported revenue.
Misclassification Include restatements due to misclassification of short- or long-term accounts or those that impact cash flows from operations.
Equity—other Improper accounting for EPS, restricted stock, warrants, and other equity instruments.
Reserves/Contingencies Errors involving accounts receivables’ bad debts, inventory reserves, income tax allowances, and loss contingencies.
Long-lived assets Asset impairments of property, plant, and equipment; goodwill; or other related items.
LO 7
Illustration 22-18Accounting-Error Types
22-19
Accounting Errors
Accounting Category
LO 7
Type of Restatement
Taxes Includes instances in which revenue was improperly recognized, questionable revenues were recognized, or any other number of related errors that led to misreported revenue.
Equity—other comprehensive income
Improper accounting for comprehensive income equity transactions including foreign currency items, minimum pension liability adjustments, unrealized gains and losses on certain investments in debt, equity securities, and derivatives.
Inventory Inventory costing valuations, quantity issues, and cost of sales adjustments.
Equity—stock options Improper accounting for employee stock options.
Other Any restatement not covered by the listed categories.
Illustration 22-18Accounting-Error Types
Source: T. Baldwin and D. Yoo, “Restatements—Traversing Shaky Ground,” Trend Alert, Glass Lewis & Co. (June 2, 2005), p. 8.
22-20
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 7
Accounting Errors
22-21
Illustration: In 2015 the bookkeeper for Selectro Company
discovered an error. In 2014 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 7
Example of Error Correction
22-22
Selectro’s income statement for 2014 with and without the error.
Illustration 22-19
LO 7
Example of Error Correction
What are the entries that Selectro should have made and did make
for recording depreciation expense and income taxes?
22-23
Entries that Selectro should have made and did make for recording
depreciation expense and income taxes.
Illustration 22-20
Example of Error CorrectionIllustration 22-19
22-24
Illustration 22-20
LO 7
Example of Error Correction
Advance slide in
presentation mode to reveal
complete illustration.
22-25
Retained Earnings 12,000Correcting Entry in
2015
Illustration 22-20
LO 7
Example of Error Correction
Prepare the proper correcting entry in 2015, that should be made
by Selectro.
22-26
Retained Earnings 12,000Correcting Entry in
2015
Reversal
LO 7
Example of Error Correction
Prepare the proper correcting entry in 2015, that should be made
by Selectro.Illustration 22-20
Deferred Tax Liability 8,000
22-27
Retained Earnings 12,000Correcting Entry in
2015
LO 7
Example of Error Correction
Prepare the proper correcting entry in 2015, that should be made
by Selectro.Illustration 22-20
Accumulated Depreciation—Buildings
20,000
Deferred Tax Liability 8,000
22-28
Illustration 22-23
LO 7
Accounting Errors
Summary of Accounting Changes and Correction of Errors
22-29
Illustration 22-23
LO 7
Summary of Changes and Errors
22-30
Counterbalancing Errors
Will be offset or corrected over two periods.
1. If company has closed the books:
a. If the error is already counterbalanced, no entry is
necessary.
b. If the error is not yet counterbalanced, make entry to adjust
the present balance of retained earnings.For comparative purposes, restatement is necessary even if a correcting journal entry is not required.
LO 9
Error Analysis
Balance Sheet and Income Statement Errors
22-31
Will be offset or corrected over two periods.
2. If company has not closed the books:
a. If error already counterbalanced, make entry to correct the
error in the current period and to adjust the beginning
balance of Retained Earnings.
b. If error not yet counterbalanced, make entry to adjust the
beginning balance of Retained Earnings.
LO 9
Counterbalancing Errors
Error Analysis
Balance Sheet and Income Statement Errors
