Chapter 20 The Effect The Change Each Line Item

Chapter 20 Accounting Changes and Error Corrections

QUESTIONS FOR REVIEW OF KEY TOPICS

Question 20-1

Accounting changes are categorized as:

1. Changes in principle (when companies switch from one acceptable accounting

method to another)

Question 20-2

Accounting changes can be accounted for:

Question 20-3

In general, we report voluntary changes in accounting principles retrospectively.

This means revising all previous periods’ financial statements as if the new method

were used in those periods. In other words, for each year in the comparative

20–2 Intermediate Accounting, 8/e

Answers to Questions (continued)

Question 20-4

Lynch should report its change in depreciation method as a change in estimate,

rather than as a change in accounting principle. This is because a change in

depreciation method is considered a change in accounting estimate reflected by a

Question 20-5

In general, we report voluntary changes in accounting principles retrospectively.

This means Sugarbaker will revise all previous period’s financial statements,

Answers to Questions (continued)

The company also will revise deferred taxes. Income tax effect is reflected in the

Question 20-6

Voluntary changes in accounting principles usually are reported retrospectively.

We don’t report changes in depreciation method that way, though, because such

changes are considered to be changes in estimate and thus reported prospectively.

Also, it’s not practicable to report some changes in principle retrospectively

20–4 Intermediate Accounting, 8/e

Answers to Questions (continued)

Question 20-7

Accounting records of prior years usually are inadequate to determine the

cumulative income effect of the change for prior years when a company changes to

Question 20-8

A change in estimate is accounted for prospectively. When a company revises an

Question 20-9

When it’s not possible to distinguish between a change in principle and a change in

estimate, the change should be treated as a change in estimate.

Question 20–10

The situations deemed to constitute a change in reporting entity are (1) presenting

Answers to Questions (continued)

Question 20–11

Ford reported the situation as a change in reporting entity. This means that Ford

Question 20–12

When an error is discovered, previous years’ financial statements that were

incorrect as a result of the error are retrospectively restated to reflect the correction.

Question 20–13

If merchandise inventory is understated at the end of 2015, that year’s cost of

Question 20–14

The error would have caused the previous year’s expenses to be overstated, and

20–6 Intermediate Accounting, 8/e

Answers to Questions (continued)

Question 20–15

During the two-year period, insurance expense would have been overstated by

$30,000, so net income during the period was understated by $30,000. This means

beginning retained earnings is currently understated by that amount. During the two–

Question 20–16

If the error in the previous question is not discovered until the insurance coverage

has expired, no correcting entry at all would be needed. By then, the sum of the

Question 20-17

When correcting errors in previously issued financial statements, IFRS (IAS No. 8)

BRIEF EXERCISES

Brief Exercise 20-1

To record the change: ($ in millions)

Retained earnings ………………………………………………………………………………. 8.2

Inventory ($32 million – 23.8 million) ………………………………. 8.2

B & B applies the average cost method retrospectively; that is, to all prior periods

as if it always had used that method. In other words, all financial statement amounts

for individual periods that are included for comparison with the current financial

Brief Exercise 20-2

To record the change: ($ in millions)

20–8 Intermediate Accounting, 8/e

Brief Exercise 20-3

When a company changes to the LIFO inventory method from another inventory

method, accounting records of prior years often are inadequate to determine the

cumulative income effect of the change for prior years. For instance, it would be

Brief Exercise 20-4

A change in depreciation method is considered a change in accounting estimate

resulting from a change in accounting principle. In other words, a change in the

depreciation method is similar to changing the economic useful life of a depreciable

Calculation of SYD depreciation

(10 + 9 + 8) x [$35 – 2] million) = $16.2 million

55*

Adjusting entry (2016 depreciation):

($ in millions)

20–10 Intermediate Accounting, 8/e

Brief Exercise 20-5

A change in depreciation method is considered a change in accounting estimate

resulting from a change in accounting principle. In other words, a change in the

depreciation method is similar to changing the economic useful life of a depreciable

Calculation of straight-line depreciation to date

($35 – 2)  10 years = $3.3 x 3 years = $9.9

Adjusting entry (2016 depreciation):

Calculation of SYD depreciation

Brief Exercise 20-6

The fact that more royalty revenue was received in February than anticipated

in December represents a change in estimate. No adjustments are made to any

Brief Exercise 20-7

The fact that claims were less than expected represents a change in estimate.

As a result, no adjustments are made to any 2015 financial statements, and the

20–12 Intermediate Accounting, 8/e

Brief Exercise 20-8

When an estimate is revised as new information comes to light, accounting for the

change in estimate is quite straightforward. We do not recast prior years’ financial

($ in millions)

Amortization expense (determined below) . 5

Patent …………………………………………… 5

Calculation of annual amortization after the estimate change:

($ in millions)

$18 Cost

Brief Exercise 20-9

To correct the error:

Other step(s) that would be taken in connection with the error:

When comparative balance sheets are reported that include 2015, the 2015

20–14 Intermediate Accounting, 8/e

Brief Exercise 20-10

Analysis:

Correct Incorrect

(Should Have Been Recorded) (As Recorded)

2013 Equipment 350,000 Expense 350,000

Cash 350,000 Cash 350,000

During the three-year period, depreciation expense was understated by

$210,000, but other expenses were overstated by $350,000, so net income

during the period was understated by $140,000, which means retained

earnings is currently understated by that amount.

To correct incorrect accounts

Equipment …………………………………………………. 350,000

Accumulated depreciation ($70,000 x 3 years) 210,000

Retained earnings ($350,000 – 140,000) …….. 140,000

Brief Exercise 20-11

Brief Exercise 20-12

Error a

1.

2. The 2015 financial statements that were incorrect as a result of the error would be

retrospectively restated to reflect the correct wages expense, (income tax expense

if taxes are considered), net income, and retained earnings when those statements

are reported again for comparative purposes in the 2016 annual report.

3. Because retained earnings is one of the accounts incorrectly stated accounts, the

4. Also, a disclosure note should describe the nature of the error and the impact of

Brief Exercise 20-12 (concluded)

Error b

1. To include the $3 million in year 2016 purchases and increase retained earnings

to what it would have been if 2015 cost of goods sold had not included the $3

million purchases.

Analysis:

2015 2016

Beginning inventory Beginning inventory

Purchases O Purchases U

2. The 2015 financial statements that were incorrect as a result of the error would be

3. Because retained earnings is one of the accounts incorrectly stated, the correction

4. Also, a disclosure note should describe the nature of the error and the impact of

EXERCISES

Exercise 20-1

Requirement 1

January 1, 2016 ($ in millions)

Retained earnings ……………………………………………………………….. 30

Inventory (cumulative effect) * ………………………………………….. 30

Requirement 2

COMPARATIVE INCOME STATEMENTS

($ in millions) 2016 2015

Revenues $420 $390

20–18 Intermediate Accounting, 8/e

Exercise 20-1 (continued)

Requirement 3

Calculations ($ in millions):

2014

Revenues $380

Exercise 20-1 (concluded)

Requirement 4

Calculations ($ in millions): 2014

FIFO Average Difference

Revenues $380 $380

Comparative Statements of Shareholders’ Equity

(not required)

($ in millions)

Common

Stock

Additional

Paid-in

Capital

Retained

Earnings

Total

Shareholders’

Equity

Jan. 1, 2015*

66

Jan. 1, 2016

* Decreased from $80 million to $66 million to reflect the effect of the

change in inventory methods.

**Calculations ($ in millions):

2016 2015

Revenues $420 $390

Exercise 20-2

Requirement 1

Balance at January 1, 2016, using LIFO $780,000

Prior to 2016, using FIFO:

Inventory would have been higher by $60,000, so

Requirement 2

January 1, 2016

Inventory (additional inventory if FIFO had been used) …………………. 60,000