20-1 Intermediate Accounting,17E Stice | Stice | Skousen © 2010 Cengage Learning PowerPoint...

20-1

Intermediate Accounting,17E

Stice | Stice | Skousen

© 2010 Cengage Learning

PowerPoint presented by: Douglas Cloud Professor Emeritus of Accounting, Pepperdine University

Accounting Changes and Error Corrections

20-2

Accounting Changes

• The accounting profession has identified two main categories of accounting changes:1. Change in accounting estimate2. Change in accounting principle

• The basic accounting issue is whether accounting changes should be reported as adjustments of the prior periods’ statements or whether the changes should affect only the current and future years.

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Change in Accounting Estimate

• Contrary to what many people believe, accounting information cannot always be measured precisely.

• To provide information on a timely basis, accounting information often must be based on estimates.

• Estimates may need to be revised to give a better reflection of the company’s activities.

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Examples of areas for which changes in accounting estimates are needed include:1. Uncollectible receivables2. Useful lives of depreciable or

intangible assets3. Residual value of depreciable assets4. Warranty obligations5. Quantities of mineral reserves6. Pensions and postemployment

benefits7. Number of periods benefited by

deferred costs

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• All changes in accounting estimates should be reflected either in the current period or in current and future periods.

• No retroactive adjustments or pro forma statements are to be prepared for a change in estimate.

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Telstar Company

Telstar Company, a high-power telescope sales and manufacturing firm, elected in 2011 to change from the double-declining balance method of depreciation to the straight-line method to make its financial reporting more consistent with the majority of its competitors. (continues)

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Depreciable assets were acquired on January 1, 2008, at a cost of $500,000. They are expected to have a ten-year life and a zero salvage value. The income tax rate is 30%.

Telstar Company

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Telstar Company

The total impact on Telstar’s balance sheet as of January 1, 2011, is as follows:

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20-9

Telstar Company

The table below shows the depreciation amount that would be reported in the books and for income tax purposes after the accounting change.

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Change in Accounting Principle

• A change in accounting principle involves a change from one generally accepted principle or method to another.

• A change from a principle that is not generally accepted to one that is generally accepted is considered to be an error correction rather than a change in accounting principle.

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The effect of the accounting change from one accepted accounting principle to another is reflected by retrospectively adjusting the financial statements for all years reported, and reporting the cumulative effect of the change in the income for all preceding years as an adjustment to the beginning balance. IMPORTANT!


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On January 1, 2011, Forester Company changed from the LIFO inventory costing method to the FIFO method for both financial reporting and income tax purposes. The income tax rate is 30%. The chart in Slide 20-13 shows financial statement data based on LIFO.

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20-13


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Now, let’s examine the financial statements after changing to FIFO compared to the data if Forester had continued using LIFO.

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In addition to the preparation of retrospectively adjusted primary financial statements, a note disclosure is needed to show the impact of the change on each financial statement item in each year reported. Such disclosures are shown on Slides 20-17 and 20-18.

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20-17


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20-18


20-19

Pro Forma Disclosures after a Business Combination

The supplemental disclosure required following a business combination is explained in SFAS No.141(R). The combined company is required to disclose pro forma results for the year of the combination as if the combination had occurred at the beginning of the year.

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On December 31, 2011, Sump Pump Company acquired Rock Wall Company for $500,000. This amount exceeded the recorded value of Rock Wall Company’s net assets by $100,000 on the acquisition date. The entire excess was attributed to a piece of Rock Wall’s equipment that had a remaining useful life of five years as of the acquisition date.

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Sump Pump Company:Revenue $3,500,000 $3,000,000Net income 250,000 200,000

Rock Wall Company:Revenue $250,000 $400,000Net income 40,000 75,000

Sump Pump Company:Revenue $3,500,000 $3,000,000Net income 250,000 200,000

Rock Wall Company:Revenue $250,000 $400,000Net income 40,000 75,000

2011 2010

Information reported on the two companies for 2010 and 2011 was as follows:

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The pro forma information included in the 2011 financial statements notes was as follows:

Revenue $3,500,000 $3,750,000Net income 250,000 270,000


2011 2011 ResultsReported for CombinedResults Companies



2010 2010 ResultsReported for Combined

Results Companies

20-23

Errors Discovered Currently in the Course of Normal Accounting Procedures

• Math errors• Posting to the wrong account• Misstating an account• Omitting an account from the trial

balance

Error Corrections

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Error Corrections

Errors Limited to Balance Sheet Accounts

• Debiting Accounts Receivable instead of Notes Receivable

• Crediting Interest Payable instead of Notes Payable

• Not recording the exchange of convertible bonds for stock

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Errors Limited to Income Statement Accounts

• Debiting Office Salaries instead of Sales Salaries

• Crediting Rent Revenue instead of Commissions Revenue

Error Corrections

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Errors Affecting Both Income Statement Accounts and Balance Sheet Accounts

• Debiting Office Equipment instead of Repairs Expense

• Crediting Depreciation Expense instead of Accumulated Depreciation

• Omission of an adjusting entry

Error Corrections

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• There are errors in net income that, when not detected, are automatically counterbalanced in the following fiscal period.

• There are also errors in net income that, when not detected, are not automatically counterbalanced in the following fiscal period.

Error Corrections

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• If detected in current period, before books are closed: Correct the account through normal

accounting adjustment.• If detected in subsequent period, after

books are closed: Adjust financial records for effect of

material errors. Make adjustment directly to Retained

Earnings.

Error Corrections

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Illustrative Example of Error Corrections

Supply Master, Inc., began operations at the beginning of 2009. Before the accounts are adjusted and closed for 2011, it was discovered that merchandise inventory as of December 31, 2009, was understated by $1,000.

(1) Understatement of Merchandise Inventory(1) Understatement of Merchandise Inventory

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The effects of the misstatement were as follows:

Because this type of error counterbalances after two years, no correcting entry is required in 2011.


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The correcting entry in 2010 would have been as follows:Merchandise Inventory 1,000

Retained Earnings 1,000

The correcting entry is the same whether the company uses a periodic or a perpetual inventory system.


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It is discovered that purchase invoices of December 28, 2009, for $850 had not been recorded until 2010. The goods had been included in the inventory at the end of 2009.

(2) Failure to Record Merchandise Purchases(2) Failure to Record Merchandise Purchases

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Retained Earnings 850Purchases (periodic) or Inventory (perpetual) 850


20-34

It is discovered that sales on account of $1,800 for the last week of December 2010 had not been recorded until 2011. The goods were not included in the inventory at the end of 2010.

(3) Failure to Record Merchandise Sales(3) Failure to Record Merchandise Sales

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When the error is discovered in 2011, the following entry is made:

Sales 1,800Retained Earnings 1,800


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(4) Failure to Record Accrued Expenses(4) Failure to Record Accrued Expenses

Accrued sales salaries of $450 as of December 31, 2009, were overlooked in adjusting the accounts. Sales Salaries is debited for salary payments.

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No entry is required in 2011 to correct the accounts because the misstatement in 2009 has been counterbalanced by the misstatement in 2010.

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If this error had been discovered in 2010 instead of 2011, the following correcting entry would have to be made to correct the account balances.Retained Earnings 450

Sales Salaries 450


20-39

It is discovered that Miscellaneous General Expense for 2009 included taxes of $275 that should have been deferred in adjusting the accounts on December 31, 2009.

(5) Failure to Record Prepaid Expenses(5) Failure to Record Prepaid Expenses

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The effects of the failure to record the prepaid expenses were as follows:

Because this is a counterbalancing error, no entry to correct the accounts is required in 2011.

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If this error had been discovered in 2010 instead of 2011, the following correcting entry would be necessary to correct the accounts.Miscellaneous General Expense 275

Retained Earnings 275


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Accrued interest on notes receivable of $150 was overlooked in adjusting the accounts on December 31, 2009. The revenue was recognized when the interest was collected in 2010.

(6) Failure to Record Accrued Revenue(6) Failure to Record Accrued Revenue

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The effects of the failure to record the accrued revenue were as follows:

Because the balance sheet items at the end of 2010 were correctly stated, no entry is required in 2011.

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If this error had been discovered in 2010 instead of 2011, the following entry would be necessary to correct the account balances:Interest Revenue 150

Retained Earnings 150


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(7) Failure to Record Unearned Revenue(7) Failure to Record Unearned Revenue

Fees of $225 received in advance for miscellaneous services as of December 31, 2010, were overlooked in adjusting the accounts. Miscellaneous Revenue had been credited when fees were received.


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The effects of the failure to record the unearned revenue were as follows:

The following entry is required to correct the accounts:Retained Earnings 225

Miscellaneous Revenue 225


20-47

Delivery equipment was acquired at the beginning of 2009 at a cost of $6,000. The equipment has an estimated five-year life. Depreciation of $1,200 related to this equipment was overlooked at the end of 2009 and 2010.

(8) Failure to Record Depreciation(8) Failure to Record Depreciation


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The effects of the failure to record depreciation for 2009 were as follows:

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The misstatements arising from the failure to record depreciation are not counterbalanced in the succeeding year.


20-49

Failure to record depreciation for 2010 affected the statements as follows:

The correcting entry in 2011 is as follows:Retained Earnings 2,400

Accumulated Depreciation—Delivery Equipment 2,400$1,200 per year $1,200 per year ×× 2 2


20-50

Operating expenses of $2,000 were paid in cash at the beginning of 2009. The payment was incorrectly debited to Equipment. The “equipment” was assumed to have an estimated five-year life and no residual value; thus, depreciation of $400 was recognized at the end of 2009 and 2010.

(9) Incorrectly Capitalizing an Expenditure(9) Incorrectly Capitalizing an Expenditure

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The effects of this incorrect capitalization of an expenditure were as follows:

Retained Earnings 1,200Accumulated Depreciation—Equipment 800 Equipment 2,000

The correcting entry in 2011 is as follows:


20-52

Required Disclosure for Error Restatements

If an error is subsequently discovered that affected a prior period, the nature of the error, its effect on previously issued financial statements, and the effect of its correction on current period’s net income and EPS should be disclosed in the period in which the error is corrected.

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Summary of Accounting Changes and Error Corrections

20-1 Intermediate Accounting,17E Stice | Stice | Skousen © 2010 Cengage Learning PowerPoint...

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