Acc 3020 - Exam 3

- Basic EPS: ((150,000 - 77,000) / 40,000) = $1.83 per share - Diluted EPS with Conversion of Preferred Stock: (150,000 / (40,000 + 20,000)) = $2.50 per share - Answer: Antidilutive, because the conversion cause Basic EPS to increase

10,000 shares of 7.7% of $100 par convertible, cumulative preferred stock. Each share may be converted into two common shares

A journal entry is made to correct any incorrect amounts

4 Steps for the Correction of Accounting Errors: (Step 1)

Previous year's financial statements presented for comparison are changed to reflect the correct amounts

4 Steps for the Correction of Accounting Errors: (Step 2)

If retained earnings is one of the incorrect accounts, the correction is reported as a prior period adjustment to beginning retained earnings

4 Steps for the Correction of Accounting Errors: (Step 3)

A disclosure note should describe the error and the impact of its correction

4 Steps for the Correction of Accounting Errors: (Step 4)

- Basic EPS: (150,000 / 40,000) = $3.75 - Diluted EPS with Conversion of Preferred Stock: ((150,000 + (32,000 - (32,000 x 25%))) / (40,000 + 5,000)) = $3.87 per share (Note: 32,000 = (500,000 x 6.4%)) - Answer: Antidilutive, because the conversion cause Basic EPS to increase

6.4% convertible 10-year, $500,000 of bonds, issued at face value. The bonds are convertible to 5,000 shares of common stock

Change in estimate achieved by a change in accounting principle using the Prospective Method

A change in the method of depreciation, amortization, or depletion is considered to be a

Adjust accounts to the correct balances reflecting the new principle as of the beginning of the year of the change

A journal entry needs to be made to

Journal Entry: 1 - Debit Prepaid Insurance: ((72,000 / 3) x 2) = 48,000 - Credit Retained Earnings: (72,000 - (72,000 / 3)) = 48,000 Journal Entry: 2 - Debit Insurance Expense: (72,000 / 3) = 24,000 - Credit Prepaid Insurance: 24,000

A three-year liability insurance policy was purchased at the beginning of 2020 for $72,000. The full premium was debited to insurance expense at the time

A revision in estimate because of new information

Accounting Changes: Changes in Accounting Estimate

A change from one generally accepted accounting principle to another

Accounting Changes: Changes in Accounting Principle

Represents the present value of future expected retirement benefits to be paid based on salaries already earned (accumulated))

Accumulated Benefit Obligation (ABO)

Journal Entry: 1 - Debit Equipment: 45,000 - Credit Accumulated Depreciation: ((45,000 / 5) x 2) = 18,000 - Credit Retained Earnings: (45,000 - (9,000 x 2) = 27,000 Journal Entry: 2 - Debit Depreciation Expense: (45,000 / 5) = 9,000 - Credit Accumulated Depreciation: 9,000

Additional computers were acquired at the beginning of 2019 and added to the company's office network. The $45,000 cost of the computers was inadvertently recorded as maintenance expense. Computers have five-year useful lives and no material salvage value. This class of equipment is depreciated by the straight-line method

1.5% x Number of years x Highest Salary

Annual Retirement Benefit Formula

That item is antidilutive and is not considered for diluted EPS

Antidilutive Convertible Securities: If the incremental effect is higher than basic EPS

Dividing the assumed change to the numerator by the assumed changed to the denominator

Antidilutive Convertible Securities: The earnings per incremental share of any assumed conversion can be calculated by

It would be irrational to think that exercise would have taken place (Note) - Using the treasury stock method would decrease the number of shares assumed outstanding which would be anti-dilutive

Antidilutive Securities Options, Warrants, Rights: If the exercise price > the average market price

No assumed exercise or conversion of potential common shares could reduce EPS (Note) - All options, warrants, rights, convertible bonds, and shares of convertible preferred stock are anti-dilutive, and they are not considered for diluted EPS

Antidilutive Securities: If a company has a basic loss per share

These items are anti-dilutive and are not considered for diluted EPS, but they would be included in the disclosure notes (Note) - All options, warrants, rights, convertible bonds, and shares of convertible preferred stock are anti-dilutive, and they are not considered for diluted EPS

Antidilutive Securities: If the assumed exercise or conversion of potential common shares outstanding would increase the EPS

Beginning Inventory: NE, 0 Plus: Net Purchases: NE, 0 Less: Ending Inventory: U, 6,000 COGS: O, 6,000 Revenues: Less: COGS: O, 6,000 Less: Other Expenses: NE, 0 Net Income: U, 6,000 Retained Earnings: U, 6,000

Assuming that the errors were discovered after the 2020 financial statements were issued, analyze the effect of the errors on 2020 and 2019 cost of goods sold, net income, and retained earnings (Ignore income taxes) "2019"

Beginning Inventory: U, 6,000 Plus: Net Purchases: U, 3,000 Less: Ending Inventory: O, 9,000 COGS: U, 18,000 Revenues: Less: COGS: U, 18,000 Less: Other Expenses: NE, 0 Net Income: O, 18,000 Retained Earnings: O, 12,000

Assuming that the errors were discovered after the 2020 financial statements were issued, analyze the effect of the errors on 2020 and 2019 cost of goods sold, net income, and retained earnings (Ignore income taxes) "2020"

Journal Entry: 1 - Debit Retained Earnings: 104,000 - Credit Interest Expense: 104,000 Journal Entry: 2 - Debit Interest Expense: 104,000 - Credit Interest Payable: 104,000

At the end of 2020, the company failed to accrue $104,000 of interest expense that accrued during the last four months of 2020 on bonds payable. The bonds, which were issued at face value, mature in 2025. The following entry was recorded on March 1, 2021, when the semiannual interest was paid, as well as on September 1 of each year: - Debit Interest Expense: 156,000 - Credit Cash: 156,000

($110,000 - $10,000)/10,000 shares = $10/share

BEPS/DEPS Example: Calculate the BEPS

Earnings Per Incremental Share: - Step 1: (((50,000 x 10%) x 70%) / 2,500) = $1.40 per share

BEPS/DEPS Example: Calculate the DEPS (Convertible Bonds)

Earnings Per Incremental Share: - Step 1: (Assumed New Shares "2,000" - Assumed Treasury Shares Repurchased "1,500") = 500 Step 2: ($0 / 500) = $0 per share (1) (Note: 1,500 = ((2,000 x 15) / 20))

BEPS/DEPS Example: Calculate the DEPS (Options)

Earnings Per Incremental Share: - Step 1: (10,000 / 5,000) = $2.00

BEPS/DEPS Example: Calculate the DEPS (Preferred Stock)

(1) Options (2) Bonds (3) Preferred Stock

BEPS/DEPS Example: Options, Bonds, Preferred Stock Rank

- Is based on what actually happened during the year and is calculated as income available to common shareholders divided by the weighted average number of common shares outstanding during the period (Note) - All companies need to report basic EPS on the face of the income statement

Basic Earnings Per Share (EPS)

The "earnings per incremental share" of dilutive options, warrants, or rights are always $0 (Note) - ($0/assumed change to the denominator)

Because there is an assumed change to the denominator but no assumed change to the numerator

Net Pension Asset: (160,000 - 150,000) = $10,000 Net Pension Liability: (346,000 - 359,000) = $13,000

Calculate each of the following amounts as of both December 31, 2021, and December 31, 2022. (Net Pension Asset or Net Pension Liability)

Pension Expense: $150,000 - Service Cost: 150,000 - Interest Cost: (6% x 0) = 0 - Expected Return on the Plan Assets: (10% x 0) = 0 Balance 12/31/21: (150,000 + 0 - 0) = 150,000 Pension Expense: $193,000 - Service Cost: 200,000 - Interest Cost: (6% x 150,000) = 9,000 - Expected Return on the Plan Assets: (10% x 160,000) = 16,000 - Total: (200,000 + 9,000 - 16,000) = 193,000

Calculate each of the following amounts as of both December 31, 2021, and December 31, 2022. (Pension Expense)

Plan Assets: $160,000 - Balance 1/1/21: 0 - Actual Return on Plan Assets: (10% x 0) = 0 - Contributions in year 2021: 160,000 - Benefits Paid: 0 - Balance 12/31/21: (0 + 0 + 160,000 - 0) = 160,000 Plan Assets: $346,000 - Balance 1/1/21: 160,000 - Actual Return on Plan Assets: (10% x 160,000) = 16,000 - Contributions in year 2022: 170,000 - Benefits Paid: 0 - Total: (160,000 + 16,000 + 170,000 - 0) = 346,000

Calculate each of the following amounts as of both December 31, 2021, and December 31, 2022. (Plan Assets)

PBO: $150,000 - Balance 1/1/21: 0 - Service Cost: 150,000 - Interest Cost: (6% x 0) = 0 - Benefits Paid: 0 - Balance 12/31/22: (0 + 150,000 + 0 - 0) = 150,000 PBO: $359,000 - Balance 1/1/22: 150,000 - Service Cost: 200,000 - Interest Cost: (6% x 150,000) = 9,000 - Balance 12/31/23: (150,000 + 200,000 + 9,000 - 0) = 359,000

Calculate each of the following amounts as of both December 31, 2021, and December 31, 2022. (Projected Benefit Obligation)

- Pension Expense Year 3: (3,487 + 395 - 499) = $3,383 - Pension Expense Year 4: (3,696 + 628 - 779) = $3,545

Calculate pension expense for years 3 and 4, assuming $3,000 contributions to the pension fund at the end of each year and an 8% actual and expected rate of return on the plan assets

- ABO at age 39: $9,793 o Annual Retirement Payments: (1.5% x 5 years x $43,500) = 3,263 o N = 20 o I = 6% o PMT = -3,263 o FV = 0 o PV = 37,421 § N = 23 § I = 6% § PMT = 0 § FV = -37,421 § PV = 9,793

Calculate the ABO at age 39, five years after the employee began working

End Mode: Calculate PV N = 20 I = 6% PMT = (1.5% x (38 - 34) x 87,000) = 5,220 PV = 59,873 CLR TUM: Calculate PV N = 24 I = 6% FV = 59,873 PV = 14,787

Calculate the PBO at age 38, four years after the employee began working

- PBO at age 39: $19,593 o Annual Retirement Payments: (1.5% x 5 years x $87,000) = 6,525 o N = 20 o I = 6% o PMT = -6,525 o FV = 0 o PV = 74,841 § N = 23 § I = 6% § PMT = 0 § FV = -74,841 § PV = 19,593

Calculate the PBO at age 39, five years after the employee began working

- Ending PBO Year 3: (3,104 + (3,104 x 1.06) + (3,104 x 6%)) = $6,580 - Ending PBO Year 4: (6,580 + (3,290 x 1.06) + (6,580 x 6%)) = $10,462

Calculate the PBO balance at the end of years 3 and 4 by accumulating service cost and interest cost over the appropriate years, starting from year 1

End Mode: Calculate PV N = 20 I = 6% PMT = (1.5% x (38 - 34) x 42,000) = 2,520 PV = 28,904 CLR TUM: Calculate PV N = 24 I = 6% FV = 28,904 PV = 7,139

Calculate the accumulated benefit obligation (ABO) at age 38, four years after the employee began working

- Funded Status Year 3: (6,580 - 6,240) = $340 - Funded Status Year 4: (10,462 - 9,739) = $723

Calculate the difference between the plan asset balance and the PBO at the end of year 3 and the end of year4 (this difference is called "funded status").

1.5% x (62 - 34) x 87,000 = 36,540

Calculate the estimated annual retirement benefit at the time of retirement

Year 1 Pension Expense: (3,104 + 0 - 0) = 3,104 Service Cost: 3,104 End Mode: Calculate PV N = 20 I = 6% PMT = (1.5% x 1 x 87,000) = 1,305 PV = 14,968 CLR TUM: Calculate PV N = (62 - 35) = 27 I = 6% FV = 14,968 PV = 3,104 Interest Cost: (0 x 6%) = 0 Expected Return: (0 x 8%) = 0 Year 2 Pension Expense: (3,290 + 186 - 240) = 3,236 Service Cost: (3,104 x 1.06) = 3,290 Interest Cost: (3,104 x 6%) = 186 Expected Return: (3,000 x 8%) = 240

Calculate the pension expense for years 1 and 2, assuming $3,000 contributions to the pension fund at the end of each year. The expected and actual rate of return on the pension fund was 8%

- Planned Asset Year 1: ((0 x 8%) + 3,000) = $3,000 - Planned Asset Year 2: ((3,000 x 8%) + 3,000 + 3,000) = $6,240 - Planned Asset Year 3: ((6,240 x 8%) + 6240 + 3,000) = $9,739 - Planned Asset Year 4: ((9,739 x 8%) + 9,739 + 3,000) = $13,518

Calculate the plan asset balance at the end of years 3 and 4 by accumulating contributions and return on the pension fund over the appropriate years, starting from year 1

End Mode: Calculate PV N = 20 I = 6% PMT = 36,540 PV = 419,111

Calculate the projected benefit obligation (PBO) at the time of retirement

- Year 3 o Service Cost: (3,290 x 1.06) = $3,487 o Interest Cost: ((3,104 +3,290 +186) x 6%) = $395 - Year 4 o Service Cost: (3,487 x 1.06) = $3,696 Interest Cost: ((6,580 + 3,487 + 395) x 6%) = $628

Calculate the service cost and interest cost components of pension expense for years 3 and 4

Prospective Method

Changes in estimate are treated using what method?

Projected Benefit Obligation: (130,603 + 9,982 + 9,142) = $149,727

Combine your answers to requirements 1, 3, and 4 to determine the company's projected benefit obligation at the end of 2021 (after 15 years' service) with respect to Davenport

- Numerator: 520,000,000 - 120,000,000) = 400,000,000 (Note: 120,000,000 = 60,000,000 x 2) - Denominator: 100,000,000 - EPS: (400,000,000 / 100,000,000) = $4.00 per share

Compute Basic EPS for the year end 12/31/21

NOT EPS: - Conversion of Preferred Stock: (120,000,000 / 32,000,000) = $3.75 - Conversion of Bonds: ((72,000,000 - (72,000,000 x 25%)) / 32,000,000) = $4.00 per sahre EPS: - Numerator with Conversion of Preferred Stock: (400,000,000 + 120,000,000) = 520,000,000 - Denominator with Conversion of Preferred Stock: (100,000,000 + 32,000,000) = 132,000,000 - EPS with Conversion of Preferred Stock: (520,000,000 / 132,000,000) = $3.94 (Note) Since $4.00 > $3.94 means that the Conversion of bonds is anti-dilutive, so we won't include them. This also means that are Dilutive EPS is $3.94 as there are no other earnings per share to be exercised or converted

Compute Diluted EPS for the year end 12/31/21

Additional shares of common stock that would have been outstanding if the bonds had been converted

Convertible Bonds: Add back to the denominator the number of

After-tax bond interest that wouldn't have been subtracted in calculating net income if the bonds had instead been converted to stock

Convertible Bonds: Add back to the numerator the

Additional shares of common stock that would have been outstanding if the preferred stocks had been converted

Convertible Preferred Stock: Add back to the denominator the number of

Preferred dividends that wouldn't have been subtracted if the preferred stock had instead been converted to common stock

Convertible Preferred Stock: Add back to the numerator the

Actually dilutive

Convertible securities are only included in diluted EPS if they are

Accounting for similarly using the retrospective approach

Corrections of errors are not accounting changes but are

- Obligation - The plan assets set aside to pay the obligation - The periodic expense of having a pension plan (Note) While the first two of these are not separately reported in the balance sheet, it is important to understand the composition of both, and they are reported in the disclosure notes

Defined Benefit Pension Plan Key Elements

- Total Compensation Cost: (3 x 12,000,000) = $36,000,000

Determine the total compensation cost pertaining to the incentive stock option plan

Is a hypothetical number showing the dilutive effective of all potential common shares

Diluted Earnings Per Share

It has a simple capital structure and only needs to report basic EPS

Diluted Earnings Per Share: If a company has no potential common shares outstanding

It has a complex capital structure and needs to report both basic EPS and diluted EPS

Diluted Earnings Per Share: If it has potential common shares outstanding

Any claim by senior securities such as preferred shareholders

Earnings Available to Common Shareholders: Net income minus

- The preferred stock is cumulative or - The preferred dividends were declared

Earnings Available to Common Shareholders: Preferred dividends were declared if

A single number reported frequently to summarize a company's performance

Earnings Per Share

Annual Retirement Payments: (1.6% x 15 years x $90,000) = $21,600

Estimate by the accumulated benefits approach the amount of Davenport's annual retirement payments earned as of the end of 2021

Annual Retirement Payments: (1.6% x 15 years x $240,000) = $57,600

Estimate by the projected benefits approach the amount of Davenport's annual retirement payments earned as of the end of 2021

Annual Retirement Payments: (1.6% x $240,000) = $3,840

Estimate by the projected benefits approach the portion of Davenport's annual retirement payments attributable to 2021 service

A correcting journal entries and/or restatement of prior years' numbers in comparative statements)

Even if errors affecting a prior year's net income self correct, some errors may need

- Stock Option Plans (We will only cover this on) - Stock Plans - Stock Appreciation Rights Plans

Examples of Share-Based Compensation

Fair Value accounting for employee stock options

Expense - The Great Debate: Led to current GAAP requirement of

Retroactively

How are Stock Dividends and Stock Splits treated at the beginning of the year

Debit: Pension Expense Debit/Credit: Pension-Related Asset/Liability Credit: Cash

How do you account for a Defined Benefit Pension Plan?

Debit: Pension Expense Credit: Cash

How do you account for a Defined Contribution Pension Plan?

- The funded status of the pension plan is the difference between the PBO and the plan asset balance - If PBO < plan asset balance = overfunded amount If PBO > plan asset balance = underfunded amount

How do you report the Funded Status of the Pension Plan?

Accumulated Benefit Obligation 2024: $91,711 o Annual Retirement Payments: (1.6% x 18 years x $100,000) = $28,800 o N = 18 o I = 7% o PMT = -28,800 o FV = 0 o PV = 289,702 § N = 17 § I = 7% § PMT = 0 § FV = -289,702 § PV = 91,711

If no estimates are changed in the meantime, what will be the accumulated benefit obligation at the end of 2024 (three years later), when Davenport's salary is $100,000?

Projected Benefit Obligation 2024: $220,106 o Annual Retirement Payments: (1.6% x 18 years x $240,000) = 69,120 o N = 18 o I = 7% o PMT = -69,120 o FV = 0 o PV = 695,284 § N = 17 § I = 7% § PMT = 0 § FV = -695,284 § PV = 220,106

If no estimates are changed in the meantime, what will be the company's projected benefit obligation at the end of 2024 (three years later) with respect to Davenport?

If-Converted Method

In considering convertible securities for diluted EPS, we use what method?

If additional shares are issued during the year, these shares are included in the denominator, weighted for the fraction of the year they were outstanding

Issuance of New Shares

Debit Cash: (for the amount of the option price received) Debit Paid-in Capital-Stock Options: (for the amount related to the options) Credit Common Stock: (record stock issued) (often) Credit Paid-in Capital-Excess of par: (record stock issued)

Journal Entry for when Options are Exercised

- Options - Warrants - Rights - Convertible bonds - Shares of convertible preferred stock which could be exercised or converted to become more shares of common stock

List of Potential Common Shares

- Journal Entries Year 1: o Debit Pension Expense: (3,104 + 0 - 0) = 3,104 o Credit Cash: 3,000 o Credit Pension Related Asset/Liability: (3,104 - 3,000) = 104 - Journal Entries Year 2: o Debit Pension Expense: (3,290 + 186 - 240) = 3,236 o Credit Cash: 3,000 o Credit Pension Related Asset/Liability: (3,236 - 3,000) = 236 - Journal Entries Year 3: o Debit Pension Expense: (3,487 + 395 - 499) = 3,383 o Credit Cash: 3,000 o Credit Pension Related Asset/Liability: (3,383 - 3,000) = 383 - Journal Entries Year 4: o Debit Pension Expense: (3,696 + 628 - 779) = 3,546 o Credit Cash: 3,000 o Credit Pension Related Asset/Liability: (3,546 - 3,000) = 546

Make the journal entries for years 1-4 to record pension expense and contributions to the pension fund

- When the employees retire - How long they live during retirement - Inflation - Future compensation levels - Interest rates - Employee turnover

Many factors affect the amount of the pension payments

Are not adjusted

Modified Retrospective Method: Numbers reported in comparative statements

Journal Entry: 1 - Debit Inventory: 78,000 - Credit Retained Earnings: 78,000 Journal Entry: 2 - No Entry Required

On December 31, 2020, merchandise inventory was understated by $78,000 due to a mistake in the physical inventory count. The company uses the periodic inventory system

Calculate the earnings per incremental share for each of the potential common shares

Order of Entry for Multiple Convertible Securities: (Step 1)

Assume their exercise or conversion one at a time, starting with the item with the smallest earnings per incremental share (if dilutive), and continue to assume the exercise or conversion of other items with increasing earnings per incremental share, as long as they are still dilutive compared to the prior calculation

Order of Entry for Multiple Convertible Securities: (Step 2)

When we have included all potential common shares or the next item becomes antidilutive, the last calculation becomes the diluted EPS

Order of Entry for Multiple Convertible Securities: (Step 3)

Hypothetical worst case scenario or lowest possible EPS

Order of Entry for Multiple Convertible Securities: For diluted EPS, we want the

Are designed to provide income to individuals during their retirement years

Pension Plan

The employer needs to invest money such that enough will be available to pay the promised benefits

Pension Plan Assets

- Income from Continuing Operations: - Net Income: - Earnings Per Common Share

Prepare the 2021-2020 comparative income statements beginning with income from continuing operations (adjusted for any revisions). Include per share amounts: Income From Continuing Operations (2020)

- Income from Continuing Operations: - Net Income: - Earnings Per Common Share:

Prepare the 2021-2020 comparative income statements beginning with income from continuing operations (adjusted for any revisions). Include per share amounts: Income From Continuing Operations (2021)

12/31/21: - Debit Compensation Expense: (36,000,000 / 3 years) = 12,000,000 - Credit Paid in Capital Stock Options: 12,000,000

Prepare the appropriate journal entries to record compensation expense on December 31, 2021, 2022, and 2023. Record the exercise of the options if all of the options are exercised on May 11, 2025, when the market price is $14 per share. (Entry 1)

12/31/22: - Debit Compensation Expense: (36,000,000 / 3 years) = 12,000,000 - Credit Paid in Capital Stock Options: 12,000,000

Prepare the appropriate journal entries to record compensation expense on December 31, 2021, 2022, and 2023. Record the exercise of the options if all of the options are exercised on May 11, 2025, when the market price is $14 per share. (Entry 2)

12/31/23: - Debit Compensation Expense: (36,000,000 / 3 years) = 12,000,000 - Credit Paid in Capital Stock Options: 12,000,000

Prepare the appropriate journal entries to record compensation expense on December 31, 2021, 2022, and 2023. Record the exercise of the options if all of the options are exercised on May 11, 2025, when the market price is $14 per share. (Entry 3)

05/11/25: - Debit Cash: (11 x 12,000,000) = 132,000,000 - Debit Paid in Capital Stock Options: (12,000000 x 3 years) = 36,000,000 - Credit Common Stock: (12,000,000 x 1) = 12,000,000 - Credit Paid in Capital Excess of Par: (132,000,000 + 36,000,000 - 12,000,000) = 156,000,000

Prepare the appropriate journal entries to record compensation expense on December 31, 2021, 2022, and 2023. Record the exercise of the options if all of the options are exercised on May 11, 2025, when the market price is $14 per share. (Entry 4)

01/01/2021: Debit Inventory: (155,000 - 120,000) = 35,000 Credit: Retained Earnings: 35,000

Prepare the journal entry at January 1, 2021, to record the change in accounting principle (Ignore all taxes)

- Asset's Cost: 21,000 - Accumulated Depreciation (SYD): (6,909) - Undepreciated Cost, 01/01/2021: (21,000 - 6,909) = 14,091 - Estimated Residual Value to be depreciated over remaining 8 years: (1,000) - Annual straight-line depreciation 2021-2028: ((14,091 - 1,000) / 8) = $1,636 (Note) A disclosure note should justify that the change is preferable and describe the effect of a change on any financial statement line items and per share amounts affected for all periods reported ANSWER: Debit Depreciation Expense: 1,636 Credit Accumulated Depreciation: 1,636

Prepare the journal entry that Faulkner will record in 2021 related to the change

- Event: An Error - Type of Change: Not Applicable (NA) Journal Entry: 1 - Debit Prepaid Insurance: ((35,000 / 5) x 3) = 21,000 - Credit Retained Earnings: (35,000 - ((35,000 / 5) x 2)) = 21,000 Journal Entry: 2 - Debit Insurance Expense: (35,000 / 5) = 7,000 - Credit Prepaid Insurance: 7,000

Problem A: A five-year casualty insurance policy was purchased at the beginning of 2019 for $35,000. The full amount was debited to insurance expense at the time - State whether it represents and accounting change or an error - If an accounting change, what type of change - Journal Entry if needed

- Event: An Accounting Change - Type of Change: Change in Estimate Journal Entry: 1 - No Entry Required Journal Entry: 2 - Debit Depreciation Expense: ((600,000 - (12,500 x 10) - 25,000)) / 30) = 15,000 - Credit Accumulated Depreciation: 15,000

Problem B: Effective January 1, 2021, the company changed the salvage value used in calculating depreciation for its office building. The building cost $600,000 on December 29, 2010, and has been depreciated on a straight-line basis assuming a useful life of 40 years and a salvage value of $100,000. Declining real estate values in the area indicate that the salvage value will be no more than $25,000 - State whether it represents and accounting change or an error - If an accounting change, what type of change - Journal Entry if needed

- Event: An Error - Type of Change: NA Journal Entry: 1 - Debit Retained Earnings: 25,000 - Credit Inventory: 25,000 Journal Entry: 2 - No Entry Required

Problem C: On December 31, 2020, merchandise inventory was overstated by $25,000 due to a mistake in the physical inventory count using the periodic inventory system - State whether it represents and accounting change or an error - If an accounting change, what type of change - Journal Entry if needed

- Event: An Accounting Change - Type of Change: Change in Accounting Principle Journal Entry: 1 - Debit Inventory: 960,000 - Credit Retained Earnings: 960,000 Journal Entry: 2 - No Entry Required

Problem D: The company changed inventory cost methods to FIFO from LIFO at the end of 2021 for both financial statement and income tax purposes. The change will cause a $960,000 increase in the beginning inventory at January 1, 2022 - State whether it represents and accounting change or an error - If an accounting change, what type of change - Journal Entry if needed

- Event: An Error - Type of Change: NA Journal Entry: 1 - Debit Retained Earnings: 15,500 - Credit Compensations Expense: 15,500 Journal Entry: 2 - No Entry Required

Problem E: At the end of 2020, the company failed to accrue $15,500 of sales commissions earned by employees during 2020. The expense was recorded when the commissions were paid in early 2021 - State whether it represents and accounting change or an error - If an accounting change, what type of change - Journal Entry if needed

- Event: An Accounting Change - Type of Change: Change in estimate resulting from a change in accounting principle Journal Entry: 1 - No Entry Required Journal Entry: 2 - Debit Depreciation Expense: ((460,800 - 0) / 8) = 57,600 - Credit Accumulated Depreciation: 57,600

Problem F: At the beginning of 2019, the company purchased a machine at a cost of $720,000. Its useful life was estimated to be 10 years with no salvage value. The machine has been depreciated by the double-declining balance method. Its book value on December 31, 2020, was $460,800. On January 1, 2021, the company changed to the straight-line method - State whether it represents and accounting change or an error - If an accounting change, what type of change - Journal Entry if needed

- Event: An Accounting Change - Type of Change: Change in Estimate Journal Entry: 1 - No Entry Required Journal Entry: 2 - Debit Warranty Expense: (4,000,000 x 0.75%) = 30,000 - Credit Warranty Liability: 30,000

Problem G: Warranty expense is determined each year as 1% of sales. Actual payment experience of recent years indicates that 0.75% is a better indication of the actual cost. Management effects the change in 2021. Credit sales for 2021 are $4,000,000; in 2020 they were $3,700,000 - State whether it represents and accounting change or an error - If an accounting change, what type of change - Journal Entry if needed

The present value of the expected future retirement benefits to be paid based on future (projected) salary levels prior to retirement

Projected Benefit Obligation (PBO)

Is simply applied to the current and future periods, and prior-period comparative statements are not restated

Prospective Approach

The prospective method may be used

Prospective Approach: If it is impracticable to use the retrospective method

Reduced by the number of shares repurchased, weighted for the fraction of the year these shares were not outstanding

Reacquired Shares: If shares are reacquired during the year, the weighted average number of shares outstanding is

Used to determine the fair value of the options

Recognizing the Fair Value Options: Option Pricing Model

Over the service/vesting period - Usually the vesting period is several years - The employees must stay with the company for that period to keep their options - As the amount is expensed over the vesting period (Note) - The amount is added to Paid-in Capital-Stock Options

Recognizing the Fair Value Options: The total value of the options is expensed

Grant Date

Recognizing the Fair Value Options: We measure fair value of the options at the

Compensation expense over the service period for which the options are granted

Recognizing the Fair Value Options: We record the fair value of the options as

How well the fund has grown over time

Relating to Defined Contribution Plan: Employee will get retirement income based on

The employer bears no risk once the contributions are made

Relating to Defined Contribution Plan: The employee bears the risk of the investment returns, meaning

Invested (usually with input from the employee choosing among designated funds based on their risk preferences)

Relating to Defined Contribution Plan: The funds are

- The employer has an obligation that is not paid until retirement - The obligation is increased each year for the interest which accrues on the existing obligation

Relation to PBO: Interest Cost

- This is the increase in the PBO due to the employees having worked one more year (more retirement benefits)

Relation to PBO: Service Cost

Increases the amounts owed in the future

Relation to PBO: Service Cost increases the PBO, as it

Service Period

Relation to PBO: Service Cost is an amount calculated for each separate year of the

Having worked during that one year

Relation to PBO: Service Cost is the present value (at year-end) of the retirement benefits earned by the employees for

This means we report all prior period financial statements (at least those which will be presented as comparative statements) as if the new method had been used in those prior periods

Retrospective Approach: What do we mean when we say that most voluntary changes in accounting principle are treated retrospectively?

It is treated as having been made as of the beginning of that year

Retrospective Approach: What happens when a change in principle is made any time during a fiscal year?

Appropriate balances, including retained earnings, will be adjusted as if the new method had been used in those prior years

Revise Comparative Financial Statements: What happens to the balance sheet when a new method has been implemented?

Appropriate amounts will be adjusted as if the new method had been used in those prior years

Revise Comparative Financial Statements: What happens to the income statement when a new method has been implemented?

The beginning retained earnings balance for the earliest period presented in the comparative statements must be adjusted for the cumulative effect of the change prior to that date

Revise Comparative Financial Statements: What happens to the statement of shareholder's equity when a new method has been implemented?

- Forms of payment whose value is dependent on the value of the company's stock

Share-Based Compensation

- BEPS: ((110,000 - 10,000) / 10,000) = $10.00 per share

Step 1: BEPS/DEPS Example: Calculate the DEPS (Assume Exercise/Conversion for Dilutive Items)

(Note: Options are dilutive compared to BEPS, so their exercise will be assumed) - DEPS1: ((100,000 + 0) / (10,000 + 500)) = $9.52 per share

Step 2: BEPS/DEPS Example: Calculate the DEPS (Assume Exercise/Conversion for Dilutive Items)

(Note: Bonds are dilutive compared to DEPS1, so their conversion will be assumed) - DEPS2: ((100,000 + 0 + 3,500) / 10,000 + 500 + 2,500) = $7.96 per share

Step 3: BEPS/DEPS Example: Calculate the DEPS (Assume Exercise/Conversion for Dilutive Items)

(Note: The preferred stock is still dilutive compared to DEPS2) - DEPS3: ((100,000 + 0 + 3,500 + 10,000) / (10,000 + 500 + 2,500 + 5,000)) = $6.31 (Note: $6.31 is the final DEPS because no other potential common shares exist)

Step 4: BEPS/DEPS Example: Calculate the DEPS (Assume Exercise/Conversion for Dilutive Items)

Divide the total value of the company into more pieces

Stock Dividends and Stock Splits

The value of the options also increases

Stock Option Plans: As the value of the stock increases

- A specified number of shares of the firm's stock - At a specified price - During a specified period of time

Stock Option Plans: Employees are given the option to buy

Since the exercise price is less than average market price, the options are not antidilutive and therefore assumed exercised when calculating diluted EPS

Stock options exercisable at $30 per share after January 1, 2023

Applies the new principle only to the adoption period (not to prior periods for comparative statements) and adjusts the beginning retained earnings for the current period

The Modified Retrospective Method

- Service Cost - Interest Cost - Prior Service Cost - Gain or Loss on PBO - Payment of Retirement Benefits

The PBO balance will change over time for five different reasons

- Any employer contributions/funding - The return on plan assets (Note) - We use the expected return rather than the actual return in this calculation

The Pension Plan Assets increase by what?

Funded Status

The balance in the Pension-Related Asset/Liability account will always equal the

The change in the funded status for the year

The debit or credit to the Pension-Related Asset/Liability account for the year will always equal

They will work hard to drive up the value of the shares, thus making their compensation worth more

The idea behind Share-Based Compensation is that if executives (and perhaps other employees) are compensated with share-based awards,

Beginning retained earnings for the year following the error, or for the earliest year being reported in the comparative financial statements if the error occurred before then

The prior period adjustment is applied to

A mandated change in accounting principle requires it

The prospective method is applied if

Government regulations and accounting standards make them costly and complicated to administer

Three reasons why almost all new pension plans are moving away from defined benefit plans to defined contribution plans (1)

Employer's increasing desire to avoid the risk of these plans (including increasing lifespan of retired employees)

Three reasons why almost all new pension plans are moving away from defined benefit plans to defined contribution plans (2)

A shift from employee/employer long-term loyalty

Three reasons why almost all new pension plans are moving away from defined benefit plans to defined contribution plans (3)

- The options, warrants, or rights were exercised and additional shares of the stock were issued

Treasury Stock Method assumes what? (1)

- The assumed money from the assumed exercise is used to buy back treasury shares at the average market price for the year

Treasury Stock Method assumes what? (2)

- The difference between the number of shares assumed issued minus the number of treasury shares assumed repurchased is added to the denominator in calculating diluted EPS (Note) - The assumed exercise happens at the beginning of the year or when the option, warrant, or right was issued, whichever comes later

Treasury Stock Method assumes what? (3)

Journal Entry: 1 - Debit Cash: 17,000 - Credit Office Supplies: 17,000 Journal Entry: 2 - Debit Tools: 17,000 - Credit Cash: 17,000

Two weeks prior to the audit, the company paid $17,000 for assembly tools and recorded the expenditure as office supplies. The error was discovered a week later

Journal Entry: 1 - Debit Retained Earnings: ((12 x 2,000) - 2,000) = 22,000 - Credit Paid-in Capital-Excess of Par: 22,000 Journal Entry: 2 - No Entry Required

Two years earlier, the company recorded a 4% stock dividend (2,000 common shares, $1 par) as follows: - Debit Retained Earnings: 2,000 - Credit Common Stock: 2,000 The shares had a market price at the time of $12 per share

Beginning of the year or when the convertible security was issued, whichever is later

Under the if-converted method, convertible securities are assumed converted at the

- Pension Related Asset/Liability Account for Year 4: (104 + 236 + 383 + 546) = $1,269 Funded Status Year 4 End: (546 + 723) = $1,269

Using the journal entries prepared in #7, calculate the balance in the Pension-Related Asset/Liability account at the end of year 4 and verify that it equals the funded status at the end of year 4 (calculated in #8above). [Note: Although this is true for this problem, it won't necessarily be true in general if the other potential components of pension expense, which we are not discussing, are included.]

- PBO at Year 4 End: (6,580 + (3,290 x 1.06) + (6,580 x 6%)) = $10,462 "Don't match" - PBO at age 38: $14,787 "Don't match" o N = 20 o I = 6% o PMT = (1.5% x (38 - 34) x 87,000) = -5,220 o PV = 59,873 § N = 24 § I = 6% § FV = -59,873 § PV = 14,787

Verify that the PBO at the end of year 4 (from #5 above) equals the PBO at the end of year 4 (from #3 in the in-class portion of this problem) within rounding error.

- Change in Funded Status from Year 3 End and Year 4 End: (1,269 - 723) = $546 - Net of Year 4 Pension Expense & Cash Contributions: (3,546 - 3,000) = $546

Verify that the change in the funded status from the end of year 3 to the end of year 4 equals the net of the year 4 pension expense and the year 4 cash contributions (from the year 4 journal entry in #7)

Since the exercise price is higher than the average market price, the warrants are antidilutive and therefore ignored when calculating diluted EPS

Warrants for 1,000 common shares with an exercise price of $35 per share

Treasury Stock Method (Note) - This will occur only when the average market price of the stock for the year exceeds the exercise price of the option, warrant, or right

What Method would you use if options, warrants or rights are dilutive in calculating diluted EPS?

Recording a balance sheet item in the wrong account (Note) Since this error does not affect income, no prior period adjustment would be needed

What are 3 examples of an error affecting previous financial statements, but not net income? (Example 1)

Recording an income statement item in the wrong account without affecting net income (Note) Since this error does not affect income, no prior period adjustment would be needed

What are 3 examples of an error affecting previous financial statements, but not net income? (Example 2)

Classifying a cash flow incorrectly in the statement of cash flows (Note) Since this error does not affect income, no prior period adjustment would be needed

What are 3 examples of an error affecting previous financial statements, but not net income? (Example 3)

- Accumulated Benefit Obligation (ABO) - Vested Benefit Obligation (VBO) - Projected Benefit Obligation (PBO)

What are 3 ways that The Pension Obligation can be measured?

- Service Cost - Interest Cost - Expected Return on the planned asset

What are the 3 out of 5 Pension Expense components that we need to know?

Simply reverse the incorrect entry and make the correct entry; or make a correcting entry to get to the correct account balances

What do you do when discovering an error in the same reporting period that it occurred?

- Overstated - Understated - No Effect

What does "O", "U", "NE" stand for in this class

- It is also affecting the balance sheet - May affect income statement - It is also affecting taxes

What does it mean when an error affects net income?

- The amount of the payments to be made to the employees during retirement is defined in the pension plan

What is a Defined Benefit Pension Plan?

The amount of the employer contribution is defined by the plan

What is a Defined Contribution Pension Plan?

Accumulated Benefit Obligation 2021: $56,148 o N = 18 o I = 7% o PMT = -21,600 o FV = 0 o PV = 217,276 § N = 20 § I = 7% § PMT = 0 § FV = -217,276 § PV = 56,148

What is the company's accumulated benefit obligation at the end of 2021 with respect to Davenport?

Interest Cost: (130,603 X 7%) = $9,142

What is the company's interest cost for 2021 with respect to Davenport?

Beginning PBO: $130,603 o Annual Retirement Payments: (1.6% x 14 years x $240,000) = 53,760 o N = 18 o I = 7% o PMT = -53,760 o FV = 0 o PV = 540,777 § N = 21 § I = 7% § PMT = 0 § FV = -540,777 § PV = 130,603

What is the company's projected benefit obligation at the beginning of 2021 (after 14 years' service) with respect to Davenport?

Projected Benefit Obligation 2021: $149,730 o N = 18 o I = 7% o PMT = -57,600 o FV = 0 o PV = 579,404 § N = 20 § I = 7% § PMT = 0 § FV = -579,404 § PV = 149,730

What is the company's projected benefit obligation at the end of 2021 with respect to Davenport?

Service Cost: $9,982 o N = 18 o I = 7% o PMT = -3,840 o FV = 0 o PV = 38,627 § N = 20 § I = 7% § PMT = 0 § FV = -38,627 PV = 9,982

What is the company's service cost for 2021 with respect to Davenport?

- Service Cost (Increases Pension Expense) - Interest Cost (Increases Pension Expense)

What will be included in Pension Expense from PBO?

- Expected Return on Plan Assets (Decreases Pension Expense)

What will be included in Pension Expense from Plan Assets?

FASB may specify the approach for handling the change or may give companies a choice of how to handle the change, using the: - Retrospective Method - Prospective Method - The Modified Retrospective Method

When a new accounting standard mandates a change in accounting principle

There wouldn't be any justification to do so

Why would we not expect companies to switch back and forth accounting changes?

It would reduce comparability

Why would we not expect to see a lot of accounting changes?