Ch. 20 Accounting Changes and Error Corrections

Correction of Errors -- error affecting previous financial statements but NOT net income

(1) correct those incorrect account balances (2) last years balance sheet should be RESTATED to report the correct amount (3) no prior period adjustment (since last years net income was left unaffected, the RE balance was incorrect as well) (4) disclosure note only describing the nature of the error

The situations deemed to constitute a change in reporting entity

(1) presenting consolidated financial statements in place of statements of individual companies (2) changing the specific companies that comprise the group for which consolidated or combined statements are prepared.

Steps to correct an error

(1) record a journal entry to correct account balances that are incorrect because of the error (2) previous years' financial statements that are incorrect are RETROSPECTIVELY RESTATED to reflect the correction (3) if retained earnings balance is affected, a prior period adjustment is made to the RE beginning balance in a statement of SHE (or RE) (4) disclosure note should describe the nature of the error and the impact of its correction on EACH YEARS net income, EPS, and income from continuing operations

Correction of Errors -- error discovered in same period error was made

(1) reverse erroneous entry (2) record appropriate entry

What are the four steps of Error Correction?

1. Post a journal entry to correct the error. 2. Restate Prior Year Financials. (retrospective) 3. If retained earnings are affected, show a prior period adjustment. 4. Disclosure Notes.

Formula to calculate the new depreciation after a change is made to the estimated useful life or salvage value of a plant asset

= (book value - residual value)/remaining years

A change in depreciation is considered a change in ______________

A change in accounting estimate reflected by a change in accounting principle. Change is adopted to reflect a change in: (a) estimated future benefits from asset (b) pattern of receiving those future benefits (c) the company's knowledge about the future benefits PROSPECTIVE approach

Changes in reporting entity

Change from reporting as one type of entity to another entity. Retrospective approach

Change actuarial (risk & uncertainty) estimates pertaining to a pension plan

Changes in accounting estimate

Change in depreciation method

Changes in accounting estimate

Change in estimate of a plant asset's salvage value

Changes in accounting estimate

Change in estimate of a plant asset's useful life

Changes in accounting estimate

Change in estimate of periods benefitted by an intangible asset

Changes in accounting estimate

Change from cost method to equity method and vice versa

Changes in accounting principle

Change inventory costing methods

Changes in accounting principle

Changes in accounting principle

Companies switch from one acceptable accounting method to another Retrospective approach

Prospective approach

Effects of a change are reflected only in the current and future years No journal entries No revision of previous financial statements USE for: changes in estimate (including change in depreciation method) change in accounting principle when retrospective application is impractical and change in accounting principle when prospective application is mandated)

When it is not possible to distinguish between a change in principle and a change in estimate, treat the change as a change in ______________.

Estimate.

How is an error corrected if it is found in a different reporting period, but doesn't affect net income?

Fix the accounts incorrectly recorded. Since net income is not affected, no prior period adjustments to the accounts are necessary.

LIFO produces a ______________ COGS than does FIFO

HIGHER cogs

Prior Period Adjustment

If retained earnings is one of the accounts whose balance is incorrect, the correction of the error is reported NET OF TAX as a prior period adjustment to the Retained Earnings BEG BAL in a Statement of Shareholders Equity

In times of RISING PRICES, which inventory costing method produces the LOWEST amounts of income and assets?

LIFO Rising prices: LIFO produces lowest amounts of income & assets

FIFO usually produces ______________ COGS and ______________ inventory than does LIFO

LOWER cogs HIGHER inventory

Effects of a switch to FIFO

Lower cogs, Higher inventory Higher pretax income Higher income taxes Higher net income Higher retained earnings

What are some examples of error changes?

Mathematical corrections, wrong inventory count., change from cash to accrual basis, missed adjusting entries, asset/expense recorded as the other, fraud/negligence.

Which errors will self-correct in the following year?

Miscounting ending inventory at the end of the year. Failure to accrue salaries in the current year.

Which items on the income statement would be affected if a company changed its inventory costing method from FIFO to the weighted average method?

Net income EPS Cogs

Glimmer Corp miscounts & overstates its ending inventory in year 1 by $10,000. Ignoring tax effects, what are the financial statement effects of this error in year 1?

Overstate assets by 10,000 Overstate net income by 10,000

Correction of Errors

RETROSPECTIVE approach -- retrospectively restate. -mathematical errors -inaccurate physical count of inventory -change in cash basis of accounting to accrual basis of accounting -failure to record an adjusting entry -recording an asset as an expense (or vise versa) -fraud or gross negligence

Haven Corp. purchases equipment & incorrectly debits maintenance expense. Which account balances will be incorrect at year-end?

Retained Earnings Total fixed assets Depreciation expense

Retrospective approach

Revise financial statements issued in previous years Revise the account balance of each account affected Financial statements are made to appear as if the newly adopted accounting method had been applied all along and an error never occurred Record a journal entry to adjust all affected balance Disclosure note: describing the change, justifying the new method, describe effects of the change on all affected items (including RE bal revised in the Stmt SHE)

Changes in accounting estimate

Revision of previous estimates when new information or knowledge becomes available Prospective approach

In times of RISING COSTS, FIFO produces ______________ COGS, ______________ net income and ______________ retained earnings than does LIFO.

Rising costs: FIFO produces LOWER cogs, HIGHER net income, and HIGHER retained earnings than does LIFO.

How is an error corrected if it is found in the same reporting period?

The incorrect entry is reversed and the appropriate entry is recorded.

Which approach is used to account for changes in accounting estimates?

The prospective approach.

Which approach is used to account for error correction?

The retrospective approach.

How is an error corrected if it is found in a different reporting period and net income is affected?

Usually, both the balance sheet and income statements need to be restated. Retained Earnings must be adjusted to make up for the affect to net income as well as the income tax expense based on that amount of income.

A change in depreciation method is considered a change in ______________ if we are simply changing assumptions about life and / or salvage value...

change in accounting estimate no need to be restated.

A change in depreciation method is considered a change in ______________ if we are changing from SL method to DDB method (or to SYD method)...

change in accounting principle retrospectively restate past statements to reflect a change in accounting principle.

Most voluntary changes in accounting principles are reported...

retrospectively