ACCT CH 20 Accounting changes and error corrections

An addition to or reduction in the beginning retained earnings balance in a statement of shareholders' equity

prior period adjustment

•Effects of a change are reflected in the financial statements of only the current and future years

prospective

•If a new accounting standards update specifically requires prospective accounting, that requirement is followed

prospective approach: when mandated by authoritative literature

the retrospective approach

1 revise comparative F/S 2 adjust accounts for the change 3 disclosure notes

steps to correct an error

Step 1 A journal entry is made to correct any account balances that are incorrect as a result of the error. Step 2 Previous years' financial statements that were incorrect as a result of the error are retrospectively restated to reflect the correction (for all years reported for comparative purposes). Step 3 If retained earnings is one of the accounts incorrect as a result of the error, the correction is reported as a prior period adjustment to the beginning balance in a statement of shareholders' equity. Step 4 A disclosure note should describe the nature of the error and the impact of its correction on each financial statement line item and any per-share amounts affected for each prior period presented.

•Change from reporting as one type of entity to __

another type of entity

A change in accounting principle that usually should not be reported by revising the financial statements of prior periods is a change from: a.The weighted-average method to the FIFO method b.The weighted-average method to the LIFO method c.FIFO method to the weighted-average method d.LIFO method to the weighted-average method

b

The prospective approach usually is required for: a.A change in reporting entity b.A change in estimate c.A change in accounting principle d.A correction of an error

b

note disclose must:

-Explain why the change was needed as well as its effects on items not reported on the face of the primary financial statements -Point out that comparative information has been revised -Report any per share amounts affected for the current period and all prior periods presented

change in reporting entity

-Presenting consolidated financial statements in place of statements of individual companies, -Changing specific companies that constitute the group for which consolidated or combined statements are prepared, -Changes in accounting rules, or -One company acquiring another

change in accounting principle examples

-adopt a new accounting standard -change methods of inventory costing -change from cost method to equity method, or vice versa

change in accounting estimate example

-change depreciation methods -change estimate of residual value of depreciable asset -change estimate of useful life of depreciable asset -change estimate of periods benefited by intangible assets -change actuarial estimates pertaining to a pension plan

change in reporting entity examples

-consolidate a subsidiary not previously included in consolidated financial statements -report consolidated F/S in place of individual statements

correction of errors examples

-math mistakes -inaccurate physical count of inventory -change from cash basis of accounting to the accrual basis -failure to record an adjusting entry -recording an asset as an expense, or vice versa -fraud or gross negligence

change in acct principle: Though accounting choices once made should be consistently followed from year to year->

Changing circumstances might make a new method more appropriate

The effect of most errors is different->

Depending on when the error is discovered

It is significantly more complicated to deal with an error if:

It affected net income in the reporting period in which it occurred PLUS It is not discovered until a later period

If the error in our illustration is not discovered until 2024 or after->

No correcting entry at all would be needed

•Considered to be a change in accounting estimate that is achieved by a change in accounting principle •Accounted for prospectively—precisely the way we account for changes in estimates

The Prospective Approach: Changing Depreciation, Amortization, and Depletion Methods

In 2021, it was discovered that Hines 55 had debited expense for the full cost of an asset purchased on January 1, 2018. The cost was $24 million with no expected residual value. Its useful life was 5 years and straight-line depreciation is used by the company. The correcting entry assuming the error was discovered in 2021 before the adjusting and closing entries includes: a.A credit to accumulated depreciation of $14.4 million b.A debit to accumulated depreciation of $9.6 million c.A debit to retained earnings of $9.6 million d.A credit to an asset of $24 million

a

Which of the following is not a change in accounting principle usually accounted for by restrospectively revising prior financial statements? a.Change from sum-of-the-years'-digits to double-declining balance depreciation method b.Change from FIFO to the average method c.Change from the average method to FIFO d.Change from LIFO to FIFO

a

Which of the following is not a change in accounting principle? a.A change from the LIFO to the average cost inventory costing method b.A change in the useful life of a depreciable asset c.A change to implement a new FASB accounting standard d.A change from the equity method to the cost method to value investments in subsidiaries

b

•Most errors affect net income -When they do, they affect the ___ as well •Both statements must be retrospectively restated •The statement of cash flows sometimes is affected, too •Incorrect account balances must be corrected •Income taxes often are affected by income errors -Amended tax returns are prepared: •Either to pay additional taxes; or •To claim a tax refund for taxes overpaid

balance sheet

Big Merchandisers changed from the FIFO method of costing inventories to the weighted-average method during 2021. When reported in the 2021 comparative financial statements, the 2020 inventory amount will be: a.Increased b.Decreased c.Increased or decreased, depending on how prices changed during 2021 d.Unaffected

c

Which of the following is not true regarding the correction of an error? a.A journal entry is made to correct any account balances that are incorrect as a result of the error b.Prior years' financial statements are restated to reflect the correction of the error (if the error affected those statements) c.The correction is reported prospectively; previous financial statements are not revised A disclosure note should describe the nature of the error and the impact of its correction on each financial statement line item and any per-share amounts affected for each prior period presented

c

revise an estimate because of new information or new experience

change in accounting estimate

•Revision of an estimate may result from new information or new experience •They are accounted for prospectively •Disclosure note should describe the effect of a change in estimate on income from continuing operations, net income, and related per share amounts for the current period

change in accounting estimate

change from one generally accepted accounting principle to another

change in accounting principle

change from reporting as one type of entity to another type of entity

change in reporting entity

correct an error caused by a transaction being recorded incorrectly or not at all

correction of errors

Global Products overstated its inventory by $30 million at the end of 2020. The discovery of this error during 2021, before adjusting or closing entries, would require: a.A debit to inventory of $30 million b.A prospective adjustment in the 2021 income statement c.An increase in retained earnings d.None of the above

d

Lamont Communications has amortized a patent on a straight-line basis since it was acquired at the beginning of 2018 at a cost of $50 million. During 2021, management decided that the benefits from the patent would be received over a total period of 8 years rather than the 20-year legal life being used to amortize the cost. Lamont's 2021 financial statements should include: a.A patent balance of $50 million b.Patent amortization expense of $2.5 million c.Patent amortization expense of $5 million d.A patent balance of $34 million

d

Which of the following constitutes a change in reporting entity? a.Hunt Corporation launches a new product line b.Hunt Corporation reports a net loss after reporting net income for five consecutive years c.Hunt Corporation converts from a simple capital structure to a complex capital structure d.Hunt Corporation acquires ownership of Outdoors Unlimited

d

Must be provided in the first set of financial statements after the change to justify the application of the new method

disclose notes

•Caused by a transaction being recorded incorrectly or not recorded at all •Previous years' financial statements are retrospectively restated

errors

•Most errors

eventually self-correct •Even errors that eventually correct themselves cause financial statements to be misstated in the meantime

•Reported by recasting all previous periods' financial statements as if the new reporting entity ___ in those periods •A disclosure note should describe the nature of the change and the reason it occurred

existed (change in reporting entity)

•New standard applied only to the current period •Adjust retained earnings balance at beginning of year

modified retrospective

FASB sometimes allows a __

modified retrospective approach -Apply the new standard only to the adoption period (the current period) -Adjust the balance of retained earnings at the beginning of the adoption period to capture the cumulative effects of prior periods without actually adjusting the numbers in the prior periods reported

•Financial statements issued in previous years are revised •Statements are made to appear as if the newly adopted accounting method had been applied all along or that the error had never occurred •Then, a journal entry is created to adjust all account balances affected

retrospective

three approaches to reporting accounting changes and error corrections

retrospective, modified retrospective, prospective

most voluntary changes in accounting principles are reported ___

retrospectively -as if method has always been applied all along