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CHAPTER
22
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Learning Objectives
1. 2. Identify the two types of accounting changes. Describe the accounting for changes in accounting policies.
3.
4. 5.
6.
7. 8.
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Accounting Changes
Error Analysis
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Accounting Changes
Accounting Alternatives:
Diminish the comparability of financial information. Obscure useful historical trend data.
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Completed-contract to percentage-of-completion.
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.
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Rationale - Users can then better compare results from one period to the next.
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2.
4.
Amount of the adjustment relating to periods before those presented, to the extent practicable.
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LO 3
Before Change
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Illustration 22-5
After Change
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Instructions: (assume a tax rate of 35%) (b) What entry(ies) are necessary to adjust the accounting records for the change in accounting policy? (a) What is the amount of net income and retained earnings that would be reported in 2010? Assume beginning retained earnings for 2009 to be $100,000.
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Journal entry 2010 Construction in progress Deferred tax liability Retained earnings 170,000 59,500 110,500
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2010
Income Statement
Pre-tax income Income tax (35%) Net income Beg. Retained earnings Accounting change Beg. R/Es restated Net income End. Retained earnings
$ $ $ $
$ 1,062,000
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Direct Effects - IASB takes the position that companies should retrospectively apply the direct effects of a
Indirect Effect is any change to current or future cash flows of a company that result from making a change in accounting policy that is applied retrospectively.
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What is the journal entry to correct prior years depreciation expense? Calculate depreciation expense for 2010.
No Entry Required
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After 7 years
$510,000 First, establish NBV - 10,000 at date of change in 500,000 estimate. 10 years $ 50,000 x 7 years = $350,000
Balance Sheet (Dec. 31, 2009) Fixed Assets: Equipment Accumulated depreciation Net book value (NBV)
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Journal entry for 2010 Depreciation expense Accumulated depreciation 19,375 19,375
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Correction of Errors
Types of Accounting Errors:
1. A change from an accounting policy 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.
Correction of Errors
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Correction of Errors
Illustration: In 2012 the bookkeeper for Selectro Company discovered an error: In 2011 the company failed to record 20,000of 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.
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Correction of Errors
Illustration: Selectros income statement for 2011 with and without the error.
Illustration 22-17
Show the entries that Selectro should have made and did make for
recording depreciation expense and income taxes.
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Correction of Errors
Illustration: Show the entries that Selectro should have made and did make for recording depreciation expense and income taxes.
Illustration 22-18
Correction of Errors
Illustration: Show the entries that Selectro should have made and did make for recording depreciation expense and income taxes.
Illustration 22-18
Retained Earnings
12,000
Correction of Errors
Illustration: Show the entries that Selectro should have made and did make for recording depreciation expense and income taxes.
Illustration 22-18
Retained Earnings
Deferred Tax Liability
12,000
8,000
Reversal
Correction of Errors
Illustration: Show the entries that Selectro should have made and did make for recording depreciation expense and income taxes.
Illustration 22-18
Retained Earnings
Deferred Tax Liability
12,000
8,000 Record 20,000
Accumulated DepreciationBuildings
Correction of Errors
Illustration (Single-Period Statement): Assume that Selectro Company has a beginning retained earnings balance at January 1, 2012, of $350,000. The company reports net income of $400,000 in 2012.
Illustration 22-21
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Correction of Errors
Comparative Statements
Company should
1. make adjustments to correct the amounts for all affected accounts reported in the statements for all periods reported. 2. restate the data to the correct basis for each year
presented.
3. show any catch-up adjustment as a prior period adjustment to retained earnings for the earliest period it
reported.
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Correction of Errors
Woods, Inc. Statement of Retained Earnings For the Year Ended December 31, 2010 Balance, January 1 Net income Dividends Balance, December 31 $ 1,050,000 360,000 (300,000) 1,110,000
Before issuing the report for the year ended December 31, 2010, you discover a $62,500 error that caused the 2009 inventory to be overstated (overstated inventory caused COGS to be lower and thus net income to be higher in 2009). Would this discovery have any impact on the reporting of the Statement of Retained Earnings for 2010? Assume a 20% tax rate.
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Correction of Errors
Woods, Inc. Statement of Retained Earnings For the Year Ended December 31, 2010 Balance, January 1, as previously reported Prior period adjustment, net of tax Balance, January 1, as restated Net income Dividends Balance, December 31 $ 1,050,000 (50,000) 1,000,000 360,000 (300,000) 1,060,000
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LO 6
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Error Analysis
Companies must answer three questions:
1. What type of error is involved? 2. What entries are needed to correct for the error? 3. After discovery of the error, how are financial statements to
be restated? Companies treat errors as prior-period adjustments and report them in the current year as adjustments to the beginning balance of Retained Earnings.
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Current year error - reclassify item to its proper position. Prior year error - restate the statement of financial position of the prior year for comparative purposes.
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Current year error - reclassify item to its proper position. Prior year error - restate the income statement of the prior year for comparative purposes.
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Dr. Supplies on hand Accured salaries and wages Interest receivable Prepaid insurance Unearned rent Accured interest payable 5,100 90,000 $ 2,500 $
Cr. 1,500
0 15,000
Instructions: (a) Assuming that the books have not been closed, what are the adjusting entries necessary at December 31, 2010?
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1.
2.
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3.
4.
The unexpired portions of the insurance policies totaled $65,000 as of December 31, 2010.
Insurance expense Prepaid insurance 25,000 25,000
LO 8 Analyze the effect of errors.
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5.
$24,000 was received on January 1, 2010 for the rent of a building for both 2010 and 2011. The entire amount was credited to rental income.
Rental income Unearned rent 12,000 12,000
6.
Depreciation for the year was erroneously recorded as $5,000 rather than the correct figure of $50,000.
Depreciation expense Accumulated depreciation 45,000 45,000
LO 8 Analyze the effect of errors.
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Dr. Supplies on hand Accured salaries and wages Interest receivable Prepaid insurance Unearned rent Accured interest payable 5,100 90,000 $ 2,500 $
Cr. 1,500
0 15,000
Instructions: (b) Assuming that the books have been closed, what are the adjusting entries necessary at December 31, 2010?
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1.
2.
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3.
4.
The unexpired portions of the insurance policies totaled $65,000 as of December 31, 2010.
Retained earnings Prepaid insurance 25,000 25,000
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5.
$24,000 was received on January 1, 2010 for the rent of a building for both 2010 and 2011. The entire amount was credited to rental income.
Retained earnings Unearned rent 12,000 12,000
6.
Depreciation for the year was erroneously recorded as $5,000 rather than the correct figure of $50,000.
Retained earnings Accumulated depreciation 45,000 45,000
LO 8 Analyze the effect of errors.
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One area in which U.S. GAAP and IFRS differ is the reporting of error corrections in previously issued financial statements. While both sets of standards require restatement, U.S. GAAP is an absolute standard that is, there is no exception to this rule.
The accounting for changes in estimates is similar between U.S. GAAP and IFRS.
Under U.S. GAAP and IFRS, if determining the effect of a change in accounting policy is considered impracticable, then a company should report the effect of the change in the period in which it believes it practicable to do so, which may be the current period.
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Under IFRS, the impracticality exception applies both to changes in accounting policies and to the correction of errors. Under U.S. GAAP, this exception applies only to changes in accounting policy. IAS 8 does not specifically address the accounting and reporting for indirect effects of changes in accounting policies. As indicated in the chapter, U.S. GAAP has detailed guidance on the accounting and reporting of indirect effects.
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Copyright
Copyright 2011 John Wiley & Sons, Inc. All rights reserved.
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