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AccountingChangesandErrorAnalysis Chapter14 IntermediateAccounting12thEditionKieso Weygandt andWarfield PreparedbyCobyHarmon UniversityofCalifornia SantaBarbara Identifythetypesofaccountingchanges Describetheaccountingforchangesinaccountingprinciples Understandhowtoaccountforretrospectiveaccountingchanges Understandhowtoaccountforimpracticablechanges Describetheaccountingforchangesinestimates Identifychangesinareportingentity Describetheaccountingforcorrectionoferrors Identifyeconomicmotivesforchangingaccountingmethods Analyzetheeffectoferrors LearningObjectives Whyareaccountingchangesmade NewFASBpronouncementsChangingeconomicconditionsChanginginternalcircumstances AccountingChangesReportingIssues Approaches Essentialissuesinreportingaccountingchanges Whetheranaccountingchangeisallowed Whethertorestateprioryears financialstatements Whethertorecognizetheeffectofthechangeinthecurrentyear snetincomeorinthebeginningretainedearningsbalance AccountingChangesReportingIssues Approaches AccountingChanges Errorcorrections Arenotclassifiedasaccountingchanges Doaffecttheincomeofpriorperiodsandrequirespecialtreatment AccountingChanges Relevance Consistency PublicConfidence ObjectivesofReportingAccountingChanges AccountingPrincipleChanges Thefollowingarenotaccountingprinciplechanges InitialadoptionofanaccountingprincipleAdoptinganaccountingprincipleforanewgroupofassetsorliabilitiesChangefrominappropriateaccountingprincipletoGAAPPlannedchangetostraight linedepreciationChangeinaccountingprinciplethatcannotbedistinguishedfromachangeinaccountingestimate AccountingPrincipleChanges Threeapproachesforreportingchanges Currently cumulativeeffect Retrospectively Prospectively inthefuture FASBrequiresuseoftheretrospectiveapproach ChangesinAccountingPrinciple Achangeinanaccountingprincipleisaccountedforbytheretrospectiveapplicationofthenewaccountingprinciple Achangeinanaccountingestimateisaccountedforprospectively Achangeinareportingentityisaccountedforbytheretrospectiveapplicationofthenewaccountingprinciple Amaterialerrorisaccountedforbypriorperiodrestatement adjustment AccordingtotheprovisionsofFASBNo 154 BasicPrinciples Acompanyaccountsforachangeinprinciplebytheretrospectiveapplicationofthenewaccountingprincipleasfollows Thecompanycomputesthecumulativeeffectofthechangetothenewaccountingprincipleasofthebeginningofthefirstperiodpresented Thatis itcomputestheamountsthatwouldhavebeeninthefinancialstatementsifithadalwaysusedthenewprinciple Continued RetrospectiveAdjustmentMethod Thecompanyadjuststhecarryingvaluesofthoseassetsandliabilities includingincometaxes thatareaffectedbythechange Thecompanymakesanoffsettingadjustmenttothebeginningbalanceofretainedearningstoreportthecumulativeeffectofthechange netoftaxes foreachperiodpresented Continued RetrospectiveAdjustmentMethod Thecompanyadjuststhefinancialstatementsofeachpriorperiodtoreflectthespecificeffectsofapplyingthenewaccountingprinciple Thatis eachitemineachfinancialstatementthatisaffectedbythechangeisrestatedtotheappropriateamountunderthenewaccountingprinciple Thecompanyusesthenewaccountingprincipleinitscurrentfinancialstatements Continued RetrospectiveAdjustmentMethod Thecompany sdisclosuresinclude a thenatureandreasonforthechangeinaccountingprinciple includinganexplanationofwhythenewprincipleispreferable b adescriptionoftheprior periodinformationthathasbeenretrospectivelyadjusted c theeffectofthechangeonincome earningspershare andanyotherfinancialstatementlineitemforthecurrentperiodandthepriorperiodsretrospectivelyadjusted and d thecumulativeeffectofthechangeonretainedearnings orotherappropriatecomponentofequity atthebeginningoftheearliestperiodpresented RetrospectiveAdjustmentMethod Thefollowingaccountingprinciplechangesaresubjecttotheretroactiveapproach ChangefromLIFOtoanotherinventorymethodChangeinthemethodofaccountingforlong termconstructioncontractsChangetoorfromfull costmethodinextractiveindustriesChangesinaccountingprinciplemadeinconjunctionwithaninitialpublicofferingofequitysecurities exemptionavailableonlyonce RetrospectiveAdjustmentMethod Thefollowingaccountingprinciplechangesaresubjecttotheretroactiveapproach Changefromretirement replacementaccountingtodepreciationaccountingforrailroadtrackstructuresChangetoaprinciplerequiredbyanewpronouncementrecognizedasGAAPthatrequiresretroactiveapplicationChangetotheequitymethodofaccountingforinvestmentsincommonstock sometimesclassifiedasachangeinreportingentity RetrospectiveAdjustmentMethod Example RetrospectiveChange BuildmoreConstructionCompanyusedthecompletedcontractmethodtoaccountforlong termconstructioncontractsforfinancialaccountingandtaxpurposesin2007 itsfirstyearofoperations In2008 thecompanydecidedtochangetothepercentage of completionmethodforfinancialaccountingpurposes Incomebeforelong termcontractsandtaxesin2007and2008was 80 000and 100 000 Thetaxrateis40 andthecompanywillcontinuetousethecompletedcontractmethodfortaxpurposes RetrospectiveChangeExample ExampleIncomefromLong TermContracts RetrospectiveChangeExample ExampleComparativeIncomeStatements RetrospectiveChangeExample ExampleRetainedEarningsStatement RetrospectiveChangeExample Impracticability ChangesinAccountingPrinciple Companiesshouldnotuseretrospectiveapplicationifoneofthefollowingconditionsexists Companycannotdeterminetheeffectsoftheretrospectiveapplication Retrospectiveapplicationrequiresassumptionsaboutmanagement sintentinapriorperiod Retrospectiveapplicationrequiressignificantestimatesthatthecompanycannotdevelop Ifanyoftheaboveconditionsexists thecompanyprospectivelyappliesthenewaccountingprinciple Nocumulativeadjustmentismade Prioryears resultsremainunchanged Newestimatesareappliedprospectively SummaryoftheApproachforChangesinAccountingEstimates ProspectiveApproach ChangesinAccountingEstimate Thefollowingitemsrequireestimates Uncollectiblereceivables Inventoryobsolescence Usefullivesandsalvagevaluesofassets Periodsbenefitedbydeferredcosts Liabilitiesforwarrantycostsandincometaxes Recoverablemineralreserves Changeindepreciationmethods Companiesreportprospectivelychangesinaccountingestimates ArcadiaHS purchasedequipmentfor 510 000whichwasestimatedtohaveausefullifeof10yearswithasalvagevalueof 10 000attheendofthattime Depreciationhasbeenrecordedfor7yearsonastraight linebasis In2005 year8 itisdeterminedthatthetotalestimatedlifeshouldbe15yearswithasalvagevalueof 5 000attheendofthattime Required Whatisthejournalentrytocorrecttheprioryears depreciation Calculatethedepreciationexpensefor2005 NoEntryRequired ChangeinEstimateExample Equipment 510 000 FixedAssets Accumulateddepreciation 350 000 Netbookvalue NBV 160 000 BalanceSheet Dec 31 2004 ChangeinEstimateExample After7years Equipmentcost 510 000Salvagevalue 10 000Depreciablebase500 000Usefullife original 10yearsAnnualdepreciation 50 000 x7years 350 000 First establishNBVatdateofchangeinestimate ChangeinEstimateExample After7years Netbookvalue 160 000Salvagevalue new 5 000Depreciablebase155 000Usefulliferemaining8yearsAnnualdepreciation 19 375 Second calculatedepreciationexpensefor2005 Depreciationexpense19 375Accumulateddepreciation19 375 Journalentryfor2005 ReportingaChangeinEntity Examplesofachangeinreportingentityare Presentingconsolidatedstatementsinplaceofstatementsofindividualcompanies Changingspecificsubsidiariesthatconstitutethegroupofcompaniesforwhichtheentitypresentsconsolidatedfinancialstatements Changingthecompaniesincludedincombinedfinancialstatements Changingthecost equity orconsolidationmethodofaccountingforsubsidiariesandinvestments Reportedbychangingthefinancialstatementsofallpriorperiodspresented Nocumulativeadjustmentismade Prioryears resultsarerestated SummaryoftheApproachforChangesinReportingEntity ReportingaChangeinEntity Newprinciplemustbepreferable Natureofchangeandjustificationdisclosedinnotes JustificationsImprovedmatchingEnhancedassetvaluationNewinformationChangingconditionsCompliancewithnewreportingstandards JustificationforAccountingChanges Iwonderwhycompaniesmakeaccountingchanges Itseemslikealotoftroubletome ReportingaCorrectionofanError Accountingerrorsincludethefollowingtypes Achangefromanaccountingprinciplethatisnotgenerallyacceptedtoanaccountingprinciplethatisacceptable Mathematicalmistakes Changesinestimatesthatoccurbecauseacompanydidnotpreparetheestimatesingoodfaith Failuretoaccrueordefercertainexpensesorrevenues Misuseoffacts Incorrectclassificationofacostasanexpenseinsteadofanasset andviceversa ReportingaCorrectionofanError Allmaterialerrorsmustbecorrected Recordcorrectionsoferrorsfrompriorperiodsasanadjustmenttothebeginningbalanceofretainedearningsinthecurrentperiod Suchcorrectionsarecalledpriorperiodadjustments Forcomparativestatements acompanyshouldrestatethepriorstatementsaffected tocorrectfortheerror Thecompanycomputesthecumulativeeffectoftheerrorcorrectiononpriorperiodfinancialstatements Thatis itcomputestheamountsthatwouldhavebeeninthefinancialstatementsifithadnotmadetheerror Continued Acompanyaccountsforachangeinaccountingprinciplebypriorperiodrestatementasfollows PriorPeriodRestatement Thecompanyadjuststhecarryingvaluesofthoseassetsandliabilities includingincometaxes thatareaffectedbytheerror Thecompanymakesanoffsettingentrytothebeginningbalanceofretainedearningstoreportthecumulativeeffectoftheerrorcorrection netoftaxes foreachperiodpresented Continued PriorPeriodRestatement Thecompanyadjuststhefinancialstatementsofeachpriorperiodtoreflectthespecificeffectsofcorrectingtheerror Thecompany sdisclosuresinclude a thatitspreviouslyissuedfinancialstatementshavebeenrestated alongwithadescriptionofthenatureoftheerror Continued PriorPeriodRestatement b theeffectofthecorrectionofeachfinancialstatementlineitem andanypershareamountsaffectedforeachpriorperiodpresented and c thecumulativeeffectofthechangeonretainedearnings orotherappropriatecomponentofequity atthebeginningoftheearliestperiodpresented PriorPeriodRestatement BeforeissuingthereportfortheyearendedDecember31 2007 youdiscovera 62 500errorthatcausedthe2006inventorytobeoverstated overstatedinventorycausedCOGStobelowerandthusnetincometobehigherin2006 WouldthisdiscoveryhaveanyimpactonthereportingoftheStatementofRetainedEarningsfor2007 Assumea20 taxrate RetainedEarningsStatement RetainedEarningsStatement I Errorsoccurredanddiscoveredinthesameaccountingperiod II Errorsoccurredinpreviousperiod A Errorsdidnotaffectpriorperiodnetincome B Errorsdidaffectpriorperiodnetincome 1 Counterbalancingerrors2 Noncounterbalancingerrors AccountingErrorsClassifications Correctedbyreversingtheincorrectentryandthenrecordingthecorrectentry orbymakinganentrytocorrecttheaccountbalances ErrorsOccurredandDiscoveredinSamePeriod Involvesincorrectclassificationofaccounts Requirescorrectionofpreviouslyissuedstatements retroactiveapproach Isnotclassifiedasapriorperiodadjustmentsinceitdoesnotaffectpriorincome Disclosenatureoferror PreviousPeriodErrorsNotAffectingNetIncome Counterbalancingerrorsdiscoveredaftertwoormoreyearsdonotrequireacorrectingentry Counterbalancingerrorsdiscoveredinthesecondyearofthecyclerequireacorrectingentry Treatedasapriorperiodadjustment netoftax tobeginningRetainedEarningsbalance CounterbalancingErrorsAffectingPriorNetIncome Theseerrorsdonotautomaticallycorrectthemselvesaftertwoyears Correctionofanoncounterbalancingerrorusuallyrequiresapriorperiodadjustment retroactiveapproach NoncounterbalancingErrorsAffectingPriorNetIncome E22 19 ErrorAnalysis CorrectingEntries ApartialtrialbalanceofJulieHartsackCorporationisasfollowsonDecember31 2008 ErrorAnalysisExample Instructions a Assumingthatthebookshavenotbeenclosed whataretheadjustingentriesnecessaryatDecember31 2008 ErrorAnalysisExample 1 AphysicalcountofsuppliesonhandonDecember31 2008 totaled 1 100 2 AccruedsalariesandwagesonDecember31 2008 amountedto 4 400 Assumingthatthebookshavenotbeenclosed whataretheadjustingentriesnecessaryatDecember31 2008 ErrorAnalysisExample 3 Accruedinterestoninvestmentsamountsto 4 350onDecember31 2008 4 Theunexpiredportionsoftheinsurancepoliciestotaled 65 000asofDecember31 2008 Assumingthatthebookshavenotbeenclosed whataretheadjustingentriesnecessaryatDecember31 2008 ErrorAnalysisExample Assumingthatthebookshavenotbeenclosed whataretheadjustingentriesnecessaryatDecember31 2008 5 28 000wasreceivedonJanuary1 2008fortherentofabuildingforboth2008and2009 Theentireamountwascreditedtorentalincome 6 Depreciationfortheyearwaserroneouslyrecordedas 5 000ratherthanthecorrectfigureof 50 000