9-C
25. A company has included in its consolidated financial statements this year a subsidiary acquired several years ago that was appropriately excluded from consolidation last year. This should be reported as a. An accounting change that should be reported prospectively. b. An accounting change that should be reported retrospectively. c. A correction of an error. d. Neither an accounting change nor a correction of an error.
Correct Answer: B) An accounting change that should be reported retrospectively. Notes (b) An accounting change that is a change in reporting entity is given retrospective application to the earliest period presented, if practicable. The term "restatement" refers only to correction of errors in previously issued financial statements.
23. Oak Co. offers a three-year warranty on its products. Oak previously estimated warranty costs to be 2% of sales. Due to a technological advance in production at the beginning of year 3, Oak now believes 1% of sales to be a better estimate of warranty costs. Warranty costs of $80,000 and $96,000 were reported in year 1 and year 2, respectively. Sales for year 3 were $5,000,000. What amount should be presented in Oak's year 3 financial statements as warranty expense? a. $50,000 b. $88,000 c. $100,000 d. $138,000
Correct Answer: A) $50,000 Notes (a) A change in estimated warranty costs due to technological advances in production qualifies as a change in accounting estimate. Changes in estimate are treated prospectively; there is no retroactive restatement, and the new estimate is used in current and future years. Therefore, in year 3, Oak should use the new estimate of 1% and report warranty expense of $50,000 ($5,000,000 × 1%).
24. For year 1, Pac Co. estimated its two-year equipment warranty costs based on $100 per unit sold in year 1. Experience during year 2 indicated that the estimate should have been based on $110 per unit. The effect of this $10 difference from the estimate is reported a. In year 2 income from continuing operations. b. As an accounting change, net of tax, below year 2 income from continuing operations. c. As an accounting change requiring year 1 financial statements to be restated. d. As a correction of an error requiring year 1 financial statements to be restated.
Correct Answer: A) In year 2 income from continuing operations. Notes (a) A change in equipment warranty costs based on additional information obtained through experience qualifies as a change in accounting estimate. Changes in estimate should be accounted for in the period of change as a component of income from continuing operations and in future periods if necessary. No restatement is required for a change in estimate.
20. On January 1, year 1, Flax Co. purchased a machine for $528,000 and depreciated it by the straight-line method using an estimated useful life of eight years with no salvage value. On January 1, year 4, Flax determined that the machine had a useful life of six years from the date of acquisition and will have a salvage value of $48,000. An accounting change was made in year 4 to reflect these additional data. The accumulated depreciation for this machine should have a balance at December 31, year 4, of a. $292,000 b. $308,000 c. $320,000 d. $352,000
Correct Answer: A) $292,000 Notes (a) From 1/1/01 to 12/31/Y3, depreciation was recorded using an eight-year life. Yearly depreciation was $66,000 ($528,000 ÷ 8), and accumulated depreciation at 12/31/Y1 was $198,000 (3 × $66,000). In year 4, the estimated useful life was changed to six years total with a salvage value of $48,000. Therefore, the 12/31/Y3 book value ($528,000 - $198,000 = $330,000) is depreciated down to the $48,000 salvage value over a remaining useful life of three years (six years total - three years already recorded). Depreciation expense for year 4 is $94,000 [($330,000 - $48,000) ÷ 3], increasing accumulated depreciation to $292,000 ($198,000 + $94,000).
13. On January 1, year 3, Poe Construction, Inc. changed to the percentage-of-completion method of income recognition for financial statement reporting but not for income tax reporting. Poe can justify this change in accounting principle. As of December 31, year 2, Poe compiled data showing that income under the completed-contract method aggregated $700,000. If the percentage-of-completion method had been used, the accumulated income through December 31, year 2, would have been $880,000. Assuming an income tax rate of 40% for all years, the cumulative effect of this accounting change should be reported by Poe as a. An increase in construction-in-progress for $180,000 in the year 2 balance sheet. b. A decrease in the beginning balance of retained earnings for $108,000 in year 3. c. A cumulative effect adjustment of $108,000 on the year 3 income statement. d. An increase in ending retained earnings of $180,000 in year 2.
Correct Answer: A) An increase in construction-in-progress for $180,000 in the year 2 balance sheet. Notes (a) The requirement is to indicate how a change in accounting principle from the completed-contract method to the percentage-of-completion method should be reported. A change in the method of accounting for long-term contracts requires retrospective application to the earliest year practicable. This results in a $180,000 increase in income for year 2. The assets would be adjusted for the earliest period affected, and construction-in-progress would increase by $180,000. Net income for year 2 would increase by $108,000 ($180,000 less 40% tax effects), and the deferred tax liability account would increase in year 2 by $72,000.
9. On January 1, year 3, Roem Corp. changed its inventory method to FIFO from LIFO for both financial and income tax reporting purposes. The change resulted in a $500,000 increase in the January 1, year 3 inventory, which is the only change that could be calculated from the accounting records. Assume that the income tax rate for all years is 30%. Retrospective application would result in a. An increase in ending inventory in the year 2 balance sheet. b. A decrease in ending inventory in the year 3 balance sheet. c. A decrease in net income in year 2. d. A gain from cumulative effect of change on the income statement in year 3.
Correct Answer: A) An increase in ending inventory in the year 2 balance sheet. Notes (a) Retrospective application requires applying the new principle to the earliest period presented if practicable. Because year 3 beginning inventory is the previous year's ending inventory, the new principle can be applied to the year 2 financial statements. This would result in an increase in ending inventory in the balance sheet for year 2, a decrease in cost of goods sold in year 2, and an increase in the beginning inventory, which would result in a higher cost of goods sold and a lower net income for year 3.
15. Which of the following is considered a direct effect of a change in accounting principle? a. Deferred taxes. b. Profit sharing. c. Royalty payments. d. None of the above.
Correct Answer: A) Deferred taxes. Notes (a) Deferred taxes is a direct effect from the change in accounting principle, and its effects should be recorded in the earliest period presented, if practicable. Profit sharing and royalty payments are indirect effects and should be reported in the period of the change.
6. When a company changes from the straight-line method of depreciation for previously recorded assets to the double-declining balance method, which of the following should be used? I. Cumulative effects of change in accounting principle II. Retrospective application a. Neither I nor II b. II only c. Both I and II d. I only
Correct Answer: A) Neither I nor II Notes (a) The requirement is to determine whether a change in depreciation method from straight-line to double-declining balance should be reported as a cumulative effect of a change in accounting principle and receive retrospective application. A change in depreciation method is a change in method that is not distinguishable from a change in estimate, and is accounted for as a change in estimate. The change is reported on a prospective basis in the current year and future years. Therefore, it does not receive cumulative effect treatment or retrospective treatment.
28. Under IFRS, changes in accounting policies are a. Permitted if the change will result in a more reliable and more relevant presentation of the financial statements. b. Permitted if the entity encounters new transactions, events, or conditions that are substantively different from existing or previous transactions. c. Required for material transactions, if the entity had previously accounted for similar, though immaterial, transactions under an unacceptable accounting method. d. Required if an alternate accounting policy gives rise to a material change in assets, liabilities, or the current year net income.
Correct Answer: A) Permitted if the change will result in a more reliable and more relevant presentation of the financial statements. Notes (a) The requirement is to select the item that describes when changes in accounting policies are permitted or required. Answer (a) is correct because changes are permitted if it will result in a more reliable and more relevant presentation of the financial statements.
1. On January 1, year 1, Bray Company purchased for $240,000 a machine with a useful life of ten years and no salvage value. The machine was depreciated by the double-declining balance method and the carrying amount of the machine was $153,600 on December 31, year 2. Bray changed to the straight-line method on January 1, year 3. Bray can justify the change. What should be the depreciation expense on this machine for the year ended December 31, year 3? a. $15,360 b. $19,200 c. $24,000 d. $30,720
Correct Answer: B) $19,200 Notes (b) A change in depreciation method is a change in method that is not distinguishable from a change in estimate, and is accounted for as a change in estimate. The change is reported on a prospective basis in the current year and future years. Book value as of 1/1/Y3 = $153,600/8 years remaining = $19,200 depreciation expense in year 3.
19. On January 1, year 1, Taft Co. purchased a patent for $714,000. The patent is being amortized over its remaining legal life of fifteen years expiring on January 1, year 16. During year 4, Taft determined that the economic benefits of the patent would not last longer than ten years from the date of acquisition. What amount should be reported in the balance sheet for the patent, net of accumulated amortization, at December 31, year 4? a. $428,400 b. $489,600 c. $504,000 d. $523,600
Correct Answer: B) $489,600 Notes (b) This situation is a change in accounting estimate and should be accounted for currently and prospectively. From 1/1/Y1 to 12/31/Y3, patent amortization was recorded using a fifteen-year life. Yearly amortization was $47,600 ($714,000 ÷ 15), accumulated amortization at 12/31/Y3 was $142,800 ($47,600 × 3), and the book value of the patent at 12/31/Y3 was $571,200 ($714,000 - $142,800). Beginning in year 4, this book value must be amortized over its remaining useful life of 7 years (10 years - 3 years). Therefore, year 4 amortization is $81,600 ($571,200 ÷ 7) and the 12/31/Y4 book value is $489,600 ($571,200 - $81,600).
4. On January 2, year 3, to better reflect the variable use of its only machine, Holly, Inc. elected to change its method of depreciation from the straight-line method to the units of production method. The original cost of the machine on January 2, year 1, was $50,000, and its estimated life was ten years. Holly estimates that the machine's total life is 50,000 machine hours. Machine hours usage was 8,500 during year 1 and 3,500 during year 2. Holly's income tax rate is 30%. Holly should report the accounting change in its year 3 financial statements as a(n) a. Cumulative effect of a change in accounting principle of $2,000 in its income statement. b. Entry for current year depreciation expense on the income statement and treated on a prospective basis. c. Cumulative effect of a change in accounting principle of $1,400 in its income statement. d. Adjustment to beginning retained earnings of $1,400.
Correct Answer: B) Entry for current year depreciation expense on the income statement and treated on a prospective basis. Notes (b) A change in depreciation method is a change in method that is not distinguishable from a change in estimate, and is accounted for as a change in estimate. The change is reported on a prospective basis in the current year and future years.
17. If it is impracticable to determine the cumulative effect of an accounting change to any of the prior periods, the accounting change should be accounted for a. As a prior period adjustment. b. On a prospective basis. c. As a cumulative effect change on the income statement. d. As an adjustment to retained earnings in the first period presented.
Correct Answer: B) On a prospective basis. Notes (b) If it is impracticable to determine the cumulative effect of an accounting change to any of the prior periods, the accounting change should be accounted for on a prospective basis. Answer (a) is incorrect because accounting changes are no longer treated as prior period adjustments. Answer (c) is incorrect because accounting changes are no longer treated as cumulative effect changes on the income statement. Answer (d) is incorrect because the change would not be to retained earnings in the first period presented.
27. IFRS requires changes in accounting principles to be reported a. On a prospective basis. b. On a retrospective basis. c. By restating the financial statements. d. By a cumulative adjustment on the income statement.
Correct Answer: B) On a retrospective basis. Notes (b) The requirement is to identify the item that describes how changes in accounting principles are reported under IFRS. Answer (b) is correct because IFRS requires changes in accounting principles to be reported by giving retrospective application to the earliest period presented. Answer (a) is incorrect because a change in accounting estimate is accounted for on a prospective basis in the current and future periods. Answer (c) is incorrect because restatement is required for errors in the financial statements. Answer (d) is incorrect because cumulative adjustments on the income statement are not permitted.
5. The effects of a change in accounting principle should be recorded on a prospective basis when the change is from the a. Cash basis of accounting for vacation pay to the accrual basis. b. Straight-line method of depreciation for previously recorded assets to the double-declining balance method. c. Presentation of statements of individual companies to their inclusion in consolidated statements. d. Completed-contract method of accounting for longterm construction-type contracts to the percentage-of-completion method.
Correct Answer: B) Straight-line method of depreciation for previously recorded assets to the double-declining balance method. Notes (b) The requirement is to determine which accounting change should be reported on a prospective basis. A change in depreciation method is a change in principle that is not distinguishable from a change in estimate, and is accounted for as a change in estimate. The change is reported on a prospective basis in the current year and future years. A change from the cash basis to the accrual basis of accounting is a change from non-GAAP to GAAP accounted for as the correction of an error. A change in reporting entity requires retrospective application to the earliest year presented if practicable. A change in the method of accounting for long-term contracts requires retrospective application to the earliest year presented if practicable.
14. The effect of a change in accounting principle that is inseparable from the effect of a change in accounting estimate should be reported a. By restating the financial statements of all prior periods presented. b. As a correction of an error. c. As a component of income from continuing operations, in the period of change and future periods if the change affects both. d. As a separate disclosure after income from continuing operations, in the period of change and future periods if the change affects both.
Correct Answer: C) As a component of income from continuing operations, in the period of change and future periods if the change affects both. Notes (c) The effect of a change in accounting principle which is inseparable from the effect of a change in accounting estimate should be accounted for as a change in accounting estimate. Changes in estimate should be accounted for in the period of change and also in any affected future periods as a component of income from continuing operations. Financial statements are only restated for changes due to an error. Errors include mathematical mistakes, mistakes in applying accounting principles, oversights or misuse of available facts, and changes from unacceptable accounting principles to GAAP. The situation described in this question does not meet the description of an error.
16. Indirect effects from a change in accounting principle should be reported a. Retrospectively to the earliest period presented. b. As a cumulative change in accounting principle in the current period. c. In the period in which the accounting change occurs. d. As a prior period adjustment.
Correct Answer: C) In the period in which the accounting change occurs. Notes (c) Indirect effects of a change in accounting principle should be reported in the period in which the accounting change occurs. Direct effects are reported retrospectively to the earliest period presented, if practicable. Answers (b) and (d) are incorrect since accounting changes are no longer treated as cumulative effect changes or prior period adjustments.
10. Which of the following would receive treatment as a cumulative effect on an accounting change on the income statement? I. LIFO to weighted-average II. FIFO to weighted-average a. Both I and II b. I only c. Neither I nor II d. II only
Correct Answer: C) Neither I nor II Notes (c) A change in inventory method is given retrospective application to the earliest period presented, if practicable.
22. During year 2, Krey Co. increased the estimated quantity of copper recoverable from its mine. Krey uses the units of production depletion method. As a result of the change, which of the following should be reported in Krey's year 2 financial statements? I. Cumulative effect of a change in accounting principle II. Pro forma effects of retroactive application of new depletion base a. Both I and II b. I only c. Neither I nor II d. II only
Correct Answer: C) Neither I nor II Notes (c) The effect of a change in accounting estimate should be accounted for in (a) the period of change if the change affects that period only, or (b) the period of change and future periods if the change affects both. The Codification further states that a change in an estimate should not be accounted for by restating amounts reported in financial statements of prior periods or by reporting pro forma amounts for prior periods.
8. During year 3, Orca Corp. decided to change from the FIFO method of inventory valuation to the weighted-average method. Inventory balances under each method were as follows: FIFO: 1/1/Y3: $71,000 12/31/Y3: $79,000 Weighted-Avg. 1/1/Y3: $77,000 12/31/Y3: $83,000 Orca's income tax rate is 30%. In accordance with the Codification, Orca should report the effect of this accounting change as a(n) a. Prior period adjustment. b. Component of income from continuing operations. c. Retrospective application to previous year's financial statements. d. Component of income after extraordinary items.
Correct Answer: C) Retrospective application to previous year's financial statements. Notes (c) A change in inventory method no longer receives cumulative effect treatment on the income statement. Instead, the accounting change is given retrospective application to the earliest period presented, if practicable.
12. In year 3, Brighton Co. changed from the individual item approach to the aggregate approach in applying the lower of FIFO cost or market to inventories. The change should be reported in Brighton's financial statements as a a. Change in estimate on a prospective basis. b. Cumulative effect of change in accounting principle on the current year income statement. c. Retrospective application to the earliest period presented if practicable. d. Prior period adjustment with a separate disclosure.
Correct Answer: C) Retrospective application to the earliest period presented if practicable. Notes (c) A change in inventory method no longer receives cumulative effect treatment on the income statement. The accounting change is given retrospective application to the earliest period presented, if practicable.
29. Under IFRS, a voluntary change in accounting method may only be made by a company if a. A new standard mandates the change in method. b. Management prefers the new method. c. The new method provides reliable and more relevant information. d. There is no prohibition of the method in the standards.
Correct Answer: C) The new method provides reliable and more relevant information. Notes (c) The requirement is to identify the circumstances that may justify a voluntary change in accounting method. Answer (c) is correct because the new method must provide reliable and more relevant information.
7. During year 3, Orca Corp. decided to change from the FIFO method of inventory valuation to the weighted-average method. Inventory balances under each method were as follows: FIFO: 1/1/Y3: $71,000 12/31/Y3: $79,000 Weighted-Avg. 1/1/Y3: $77,000 12/31/Y3: $83,000 Orca's income tax rate is 30%. In its year 3 financial statements, what amount should Orca report as the gain or loss on the cumulative effect of this accounting change? a. $2,800 b. $4,000 c. $4,200 d. $0
Correct Answer: D) $0 Notes (d) A change in inventory method no longer receives cumulative effect treatment on the income statement. Instead, the accounting change is given retrospective application to the earliest period presented, if practicable. Therefore, the answer is zero.
2. On January 1, year 1, Warren Co. purchased a $600,000 machine, with a five-year useful life and no salvage value. The machine was depreciated by an accelerated method for book and tax purposes. The machine's carrying amount was $240,000 on December 31, year 2. On January 1, year 3, Warren changed to the straight-line method for financial reporting purposes. Warren can justify the change. Warren's income tax rate is 30%. In its year 3 income statement, what amount should Warren report as the cumulative effect of this change? a. $120,000 b. $84,000 c. $36,000 d. $0
Correct Answer: D) $0 Notes (d) Zero. A change in depreciation method is a change in method that is not distinguishable from a change in estimate, and is accounted for as a change in estimate. The change is reported on a prospective basis in the current year and future years. A change in depreciation method is no longer given cumulative effect treatment on the income statement.
3. On January 1, year 1, Warren Co. purchased a $600,000 machine, with a five-year useful life and no salvage value. The machine was depreciated by an accelerated method for book and tax purposes. The machine's carrying amount was $240,000 on December 31, year 2. On January 1, year 3, Warren changed to the straight-line method for financial reporting purposes. Warren can justify the change. Warren's income tax rate is 30%. On January 1, year 3, what amount should Warren report as deferred income tax liability as a result of the change? a. $120,000 b. $72,000 c. $36,000 d. $0
Correct Answer: D) $0 Notes (d) Zero. A change in depreciation method is a change in method that is not distinguishable from a change in estimate, and is accounted for as a change in estimate. The change is reported on a prospective basis in the current year and future years. Because a change in depreciation method is no longer given cumulative effect treatment on the income statement, there are no deferred income tax liability effects.
11. On August 31, year 3, Harvey Co. decided to change from the FIFO periodic inventory system to the weighted-average periodic inventory system. Harvey is on a calendar year basis. The cumulative effect of the change is determined a. As of January 1, year 3. b. As of August 31, year 3. c. During the eight months ending August 31, year 3, by a weighted-average of the purchases. d. As of the earliest period presented if practicable.
Correct Answer: D) As of the earliest period presented if practicable. Notes (d) Retrospective application requires the change to be calculated for the earliest period presented if practicable.
21. How should the effect of a change in accounting estimate be accounted for? a. By restating amounts reported in financial statements of prior periods. b. By reporting pro forma amounts for prior periods. c. As a prior period adjustment to beginning retained earnings. d. In the period of change and future periods if the change affects both.
Correct Answer: D) In the period of change and future periods if the change affects both. Notes (d) Changes in accounting estimate are to be accounted for in the period of change and in future periods if the change affects both (i.e., prospectively). Pro forma amounts are presented for changes in accounting principle accounted for using the current (cumulative effect) approach. Answers (a) and (c) are incorrect because they apply to retroactive-type changes in principle and error correction, respectively.
18. If the cumulative effect of applying an accounting change can be determined but the period-specific effects on all periods cannot be determined, the cumulative effect of the change should be applied to a. The end balance of retained earnings of the earliest period presented. b. Net income of the current year. c. Retained earnings of the current year. d. The carrying value of the assets and liabilities at the beginning of the earliest period to which it can be applied.
Correct Answer: D) The carrying value of the assets and liabilities at the beginning of the earliest period to which it can be applied. Notes (d) If the cumulative effect of applying an accounting change can be determined, but the period-specific effects on all periods cannot be determined, the cumulative effect of the change should be applied to the carrying value of the assets and liabilities at the beginning of the earliest period to which it can be determined.
26. Which of the following statements is correct regarding accounting changes that result in financial statements that are, in effect, the statements of a different reporting entity? a. Cumulative-effect adjustments should be reported as separate items on the financial statements pertaining to the year of change. b. No restatements or adjustments are required if the changes involve consolidated methods of accounting for subsidiaries. c. No restatements or adjustments are required if the changes involve the cost or equity methods of accounting for investments. d. The financial statements of all prior periods presented are adjusted retrospectively.
Correct Answer: D) The financial statements of all prior periods presented are adjusted retrospectively. Notes (d) An accounting change that is a change in reporting entity is given retrospective application to the earliest period presented, if practicable. The term "restatement" refers only to correction of errors in previously issued financial statements.
