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Discussion Questions. Q20
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1. Chapter 20 ACCOUNTING CHANGES AND ERROR CORRECTIONS Sommers – ACCT 3311 Chapter 1: Environment and Theoretical Structure of Financial Accounting.Chapter 1: Environment and Theoretical Structure of Financial Accounting.
2. Discussion Questions Q20–1 For accounting purposes, we classify accounting changes into three categories. What are they? Provide a short description of each.
3. Change in Accounting Principle Change from one GAAP to another
Adopt a new FASB standard
Change methods of inventory costing
Change from cost method to equity method, or vice versa
Change from completed contract to percentage-of-completion, or vice versa
4. Change in Accounting Principle Qualitative Characteristics
Consistency and Comparability – Although these are desirable, changing to a new method sometimes is appropriate
Motivations for Change
Changing Conditions
Effect on Compensation
Effect on Debt Agreements
Effect on Union Negotiations
New Standard Issued
Effect on Income Taxes
Two of the qualitative characteristics of accounting information are consistency and comparability. While accountants make every effort to achieve these financial reporting attributes, they cannot ignore the normal changes that continually occur in a dynamic business environment. The accounting profession’s response to these changes often involves the development of new or modified reporting standards that are more appropriate for the changed environment.Two of the qualitative characteristics of accounting information are consistency and comparability. While accountants make every effort to achieve these financial reporting attributes, they cannot ignore the normal changes that continually occur in a dynamic business environment. The accounting profession’s response to these changes often involves the development of new or modified reporting standards that are more appropriate for the changed environment.
5. Change in Accounting Estimate Revision of an estimate because of new information or new experience
Change depreciation methods (considered a change in estimate achieved by a change in accounting principle)
Change estimate of useful life of depreciable asset
Change estimate of bad debt percentage
Change estimate of periods benefited by intangible assets
Change actuarial estimates pertaining to a pension plan
6. Change in Reporting Entity Change from reporting as one type of entity to another type of entity
Consolidate a subsidiary not previously included in consolidated financial statements
Report consolidated financial statements in place of individual financial statements
7. Discussion Questions Q20–3 We report most changes in accounting principle retrospectively. Describe this general way of recording and reporting changes in accounting principle.
8. Retrospective Approach Revise prior years’ statements (that are presented for comparative purposes) to reflect the impact of the change.
The balance in each account affected is revised to appear as if the newly adopted accounted method had been applied all along or that the error had never occurred.
Adjust the beginning balance of retained earnings for the earliest period reported.
In the first set of financial statements after the change is made, a disclosure note is needed to:
Provide justification for the change.
Point out that comparative information has been revised.
Report any per share amounts affected for the current and all prior periods.
In the first set of financial statements after the change is made, a disclosure note is needed to:
Provide justification for the change.
Point out that comparative information has been revised.
Report any per share amounts affected for the current and all prior periods presented.
In the first set of financial statements after the change is made, a disclosure note is needed to:
Provide justification for the change.
Point out that comparative information has been revised.
Report any per share amounts affected for the current and all prior periods presented.
9. Change in Reporting Entity Summary of the Retrospective Approach for Changes in Reporting Entity
Recast all previous periods’ financial statements as if the new reporting entity existed in those periods.
In the first financial statements after the change:
A disclosure note should describe the nature of and the reason for the change.
The effect of the change on net income, income before extraordinary items, and related per share amounts should be shown for all periods presented.
A change in reporting entity requires that financial statements of prior periods be retrospectively revised to report the financial information for the new reporting entity in all periods presented. All previous periods’ financial statements that are presented are recasted as if the new reporting entity existed in those periods.
In the first financial statements after the change:
? A disclosure note should describe the nature of and the reason for the change.
? The effect of the change on net income, income before extraordinary items, and related per share amounts should be shown for all periods presented.
These two disclosures are not necessary in subsequent financial statements.
A change in reporting entity requires that financial statements of prior periods be retrospectively revised to report the financial information for the new reporting entity in all periods presented. All previous periods’ financial statements that are presented are recasted as if the new reporting entity existed in those periods.
In the first financial statements after the change:
? A disclosure note should describe the nature of and the reason for the change.
? The effect of the change on net income, income before extraordinary items, and related per share amounts should be shown for all periods presented.
These two disclosures are not necessary in subsequent financial statements.
10. Discussion Questions Q20–6 Most accounting principles are recorded and reported retrospectively. In a few situations, though, the changes should be reported prospectively. When is prospective application appropriate?
11. Prospective Approach The change is implemented in the current period, and its effects are reflected in the financial statements of the current and future years only.
Prior years’ statements are not revised.
Account balances are not revised.
Most changes in principle are reported by the retrospective approach, but the prospective approach is used for changes in principle when:
It is impracticable to determine some period-specific effects.
It is impracticable to determine the cumulative effect of prior years.
The change is mandated by authoritative pronouncements.
Change in Accounting Estimate
A change in depreciation method is considered to be a change in accounting estimate that is achieved by a change in accounting principle. It is accounted for prospectively as a change in accounting estimate.
The prospective approach is used instead of the retrospective approach when it is:
? Impracticable to determine some period-specific effects.
? Impracticable to determine the cumulative effect of prior years.
? Mandated by Financial Accounting Standards Board or other authoritative pronouncements.
The prospective approach is used instead of the retrospective approach when it is:
? Impracticable to determine some period-specific effects.
? Impracticable to determine the cumulative effect of prior years.
? Mandated by Financial Accounting Standards Board or other authoritative pronouncements.
12. Discussion Questions Q20–9 It’s not easy sometimes to distinguish between a change in principle and a change in estimate. In these cases, how should the change be accounted for?
13. E20-18 Indicate with the appropriate letter the nature of each situation described below:
PR Change in principle reported retrospectively
PP Change in principle reported prospectively
E Change in estimate
EP Change in estimate resulting from a change in principle
R Change in reporting entity
N Not an accounting change
Change from declining balance depreciation to straight-line.
Change in the estimated useful life of office equipment.
Technological advance that renders worthless a patent with an unamortized cost of $ 45,000.
Change from determining lower of cost or market for the inventories by the individual item approach to the aggregate approach.
14. E20-18 Indicate with the appropriate letter the nature of each situation described below:
PR Change in principle reported retrospectively
PP Change in principle reported prospectively
E Change in estimate
EP Change in estimate resulting from a change in principle
R Change in reporting entity
N Not an accounting change
Change from LIFO inventory costing to the weighted-average inventory costing.
Settling a lawsuit for less than the amount accrued previously as a loss contingency.
Including in the consolidated financial statements a subsidiary acquired several years earlier that was appropriately not included in previous years.
15. E20-18 Indicate with the appropriate letter the nature of each situation described below:
PR Change in principle reported retrospectively
PP Change in principle reported prospectively
E Change in estimate
EP Change in estimate resulting from a change in principle
R Change in reporting entity
N Not an accounting change
Change by a retail store from reporting bad debt expense on a pay-as-you-go basis to the allowance method.
A shift of certain manufacturing overhead costs to inventory that previously were expensed as incurred to more accurately measure cost of goods sold. (Either method is generally acceptable.)
Pension plan assets for a defined benefit pension plan achieving a rate of return in excess of the amount anticipated.
16. P9-12 Rockwell Corporation uses a periodic inventory system and has used the FIFO cost method since inception of the company in 1976. In 2011, the company decided to switch to the average cost method. Data for 2011 are as follows:
Beginning inventory, FIFO (5,000 units @ $30) $150,000
Purchases: 5,000 units @ $ 36 $180,000
5,000 units @ $ 40 200,000 380,000
Cost of goods available for sale $530,000
Sales for 2011 (8,000 units @ $70) $560,000
Additional Information:
The company’s effective income tax rate is 40% for all years.
If the company had used the average cost method prior to 2011, ending inventory for 2010 would have been $130,000.
7,000 units remained in inventory at the end of 2011.
Ignoring income taxes, prepare the 2011 journal entry to adjust the accounts to reflect the average cost method.
What is the effect of the change in methods on 2011 net income?
17. P9-12
18. E20-16 The Peridot Company purchased machinery on January 2, 2009, for $800,000. A five-year life was estimated and no residual value was anticipated. Peridot decided to use the straight-line depreciation method and recorded $160,000 in depreciation in 2009 and 2010. Early in 2011, the company revised the total estimated life of the machinery to eight years.
What type of change is this?
Briefly describe the accounting treatment for this change.
Determine depreciation for 2011.
19. E20-16 What type of change is this?
Briefly describe the accounting treatment for this change.
20. E20-16 The Peridot Company purchased machinery on January 2, 2009, for $800,000. A five-year life was estimated and no residual value was anticipated. Peridot decided to use the straight-line depreciation method and recorded $160,000 in depreciation in 2009 and 2010. Early in 2011, the company revised the total estimated life of the machinery to eight years.
Determine depreciation for 2011.
21. P20-8 Described below are six independent and unrelated situations involving accounting changes. Each change occurs during 2011 before any adjusting entries or closing entries were prepared. Assume the tax rate for each company is 40% in all years.
Fleming Home Products introduced a new line of commercial awnings in 2010 that carry a one-year warranty against manufacturer’s defects. Based on industry experience, warranty costs were expected to approximate 3% of sales. Sales of the awnings in 2010 were $3,500,000. Accordingly, warranty expense and a warranty liability of $105,000 were recorded in 2010. In late 2011, the company’s claims experience was evaluated and it was determined that claims were far fewer than expected: 2% of sales rather than 3%. Sales of the awnings in 2011 were $4,000,000 and warranty expenditures in 2011 totaled $91,000.
Identify the type of change. Prepare any journal entry necessary as a direct result of the change as well as any adjusting entry for 2011 related to the situation described. Briefly describe any other steps that should be taken to appropriately report the situation.
22. P20-8
23. P20-8 Each change occurs during 2011 before any adjusting entries or closing entries were prepared. Assume the tax rate for each company is 40% in all years.
On December 30, 2007, Rival Industries acquired its office building at a cost of $1,000,000. It was depreciated on a straight- line basis assuming a useful life of 40 years and no salvage value. However, plans were finalized in 2011 to relocate the company headquarters at the end of 2015. The vacated office building will have a salvage value at that time of $700,000.
Identify the type of change. Prepare any journal entry necessary as a direct result of the change as well as any adjusting entry for 2011 related to the situation described. Briefly describe any other steps that should be taken to appropriately report the situation.
24. P20-8
25. P20-8 Each change occurs during 2011 before any adjusting entries or closing entries were prepared. Assume the tax rate for each company is 40% in all years.
Hobbs- Barto Merchandising, Inc., changed inventory cost methods to LIFO from FIFO at the end of 2011 for both financial statement and income tax purposes. Under FIFO, the inventory at January 1, 2012, is $690,000.
Identify the type of change. Prepare any journal entry necessary as a direct result of the change as well as any adjusting entry for 2011 related to the situation described. Briefly describe any other steps that should be taken to appropriately report the situation.
26. P20-8
27. P20-8 Each change occurs during 2011 before any adjusting entries or closing entries were prepared. Assume the tax rate for each company is 40% in all years.
At the beginning of 2008, the Hoffman Group purchased office equipment at a cost of $330,000. Its useful life was estimated to be 10 years with no salvage value. The equipment was depreciated by the sum-of-the-years’-digits method. On January 1, 2011, the company changed to the straight-line method.
Identify the type of change. Describe all journal entry(s) necessary as a direct result of the change as well as any adjusting entry for 2011 related to the situation described. Briefly describe any other steps that should be taken to appropriately report the situation.
28. P20-8
29. P20-8 Each change occurs during 2011 before any adjusting entries or closing entries were prepared. Assume the tax rate for each company is 40% in all years.
In November 2009, the State of Minnesota filed suit against Huggins Manufacturing Company, seeking penalties for violations of clean air laws. When the financial statements were issued in 2010, Huggins had not reached a settlement with state authorities, but legal counsel advised Huggins that it was probable the company would have to pay $200,000 in penalties. Accordingly, the following entry was recorded: Loss— litigation .................................. 200,000 Liability— litigation .............................. 200,000 Late in 2011, a settlement was reached with state authorities to pay a total of $350,000 in penalties.
Identify the type of change. Prepare any journal entry necessary as a direct result of the change as well as any adjusting entry for 2011 related to the situation described. Briefly describe any other steps that should be taken to appropriately report the situation.
30. P20-8
31. P20-8 Each change occurs during 2011 before any adjusting entries or closing entries were prepared. Assume the tax rate for each company is 40% in all years.
At the beginning of 2011, Jantzen Specialties, which uses the sum-of-the-years’-digits method, changed to the straight-line method for newly acquired buildings and equipment. The change increased current year net earnings by $445,000.
Identify the type of change. Prepare any journal entry necessary as a direct result of the change as well as any adjusting entry for 2011 related to the situation described. Briefly describe any other steps that should be taken to appropriately report the situation.
32. P20-8
