Intermediate Accounting

Required Steps for correcting an error

1. analyze original erroneous JE and determine all debits and credits recorded 2. determine correct JE and the appropriate debits and credits 3. evaluate whether the error has caused additional errors in other accounts 4. Prepare the correcting entry

Expected Losses on Long-Term Contracts

1. estimates of future costs indicate that there is a loss in the current period, but there will be a profit on the total contract. Recognize current period loss and treat as a charge in accounting estimate apply to both methods. (negative gross profit)

Methods of reporting accounting changes (1)

1. the retrospective application of new accounting principle restate its financial statements of prior periods, sometimes referred to as a retrospective adjustment or restatement

Error examples include:

1. use of not generally accepted principle 2. use of estimate not made in good faith 3. mathematical miscalculations 4. omission of deferral/accrual

Methods of reporting accounting changes (2)

2. Adjust for the change prospectively currently and going forward

Expected Losses on Long-Term Contracts

2. estimate of future costs indicate that there will be an overall loss on the entire contract. Recognize entire loss in current period apply to both methods

Installment Method Steps Cont.

4. Portion of deferred gross profit is recognized as gross profit for the year 5. In future years, remaining deferred gross profit is reduced and the gross profit is recognized based on the cash collected on the installment sales

Retrospective Adjustment (Step 3)

Adjust the financial statements of the current period and each prior period to reflect the specific effects of applying new principle. The comparative financial statements would appear as if the newly adopted principle was used in every period presented

Retrospective Adjustment (Step 4)

Disclose following: -nature/reason for change -description of prior-period information that has been retrospectively adjusted -effect of change on income, EPS, and any other FS line item for current period and to the prior period retrospectively adjusted -cumulative effect of the change of retained earnings at the beginning of the earliest period presented

Change in principle FASB

FASB provides transition rules that define the accounting method a company uses when it changes a principle to conform to a new principle required by the issuance of new GAAP

Cost Recovery Method

If there is high degree of uncertainty about the collectability of sales price, the recognition of profit maybe deferred until the cost of the entire sale has been recovered by the cash collections. This method is generally not acceptable GAAP doesn't distinguish between installment and cost recovery

After the period of sale

Installment method/Cost recovery method

How to achieve purpose?

This is achieved by a more relevant portrayal of the nature of its operations without a significant decrease in the reliability of the information

Change in accounting estimate

This type of change is required because an earlier estimate has proven to require modifying. As new events occur, more experience is acquired or additional information is obtained prospective

Change in accounting principle

accounted for by the retrospective application of the new principle to all prior periods presented SEC requires in annual reports (10-Ks),there must be comparative financial statements (IS-3 years, BS-2 years) summary financial/data previous 5 years

Change in a reporting entity

caused by a change in the entity being reported error corrections are accounted for similar to a change in accounting principle restrospective

Change in Reporting Entity

change in reporting entity is accounted for as a retrospective adjustment

Exception to principle change

change in the amortization or depreciation method is treated as a change in an estimate under GAAP

Correction of Errors

company accounts for the correction of a material error of a past period that it discovers in current period as a prior period adjustment. Similar to a change in principle.

Change in principle distinguished from change in estimate

company may adopt new method because of change in estimated benefits. Change in method inseparable from change in estimate Referred to as a change in accounting estimate affected by a change in accounting principle

At the completion of production

completed contract method accrual method - A/R deferral method - unearned revenue (most common)

Retrospective Adjustment (Step 1)

compute the cumulative effect of the change to a new principle as of the beginning of the first period presented

Delayed until a future event

deposit method

Change in principle

may not be feasible to determine the effect of applying a change in accounting principle to any prior period. GAAP requires company to apply new principles as if change was made prospectively as of earliest date practicable

Installment Method

method only acceptable under GAAP in exceptional cases where receivables are collected over an extended period and the probability of collection is not reasonably assured recognizes gross profit on installment method sales when cash is collected

Change in an accounting principle

occurs when a company adopts a GAAP different from the one used previously for reporting purposes retrospective

Prior to the period of sale

percentage completion method/proportional performance method

Purpose of Alternative Recognition Methods

purpose of advancing or deferring recognition is to increase the usefulness of a company's financial statements

Percentage of Completion Method

revenue and expense (profit) is recognized each period in proportion to the estimated percentage of the contract completed as profit is recognized, value of inventory is increased. inventory is valued at the cost incurred plus the cost-to-date minus any partial billings

Completed Contract Method

revenue and expense (profit) is recognized only upon completion of the contract thus, during the construction process inventory is valued at the costs incurred -- any partial billings no gross profit

Recognition of net assets

the period in which a company recognizes revenue and expenses is also the period in which it recognizes an increase in the value of its net assests net assets = assets - liabilities

Change in principle justification

when a company changes a principle management, must justify the change on ground that new principles are preferable to old. SEC requires auditor submit a letter indicating whether the change is preferable under the circumstances

Change in Reporting Entity occurs:

1. When company presents consolidated or combined statements in place of statements of individual companies 2. When change in specific subsidiaries for which company presents consolidate FS 3. When the companies included in combined financial statements change

How do we account for a change in principle?

-change from one GAAP to another -change in principle because an accounting standard update has been issued/former principle not accepted -change in method of applying an accounting principle

Rules for accounting changes

-change in accounting principle is accounted for by retrospective application -change in accounting estimate is accounted for prospectively -change in reporting entity is accounted for by retrospective adjustments, financial statements presented are for same entity -error is accounted for as a prior period adjustment

Change in Principle DOES NOT include

-initial adoption of a principle because of events or transaction occurring for the first time or were previously immaterial -adoption/modification of principle for transaction/events that are clearly different in substance from those previously immaterial -change to a GAAP from a non-GAAP principle -- would be treated as a correction of an error

Installment Method Steps

1. Total COGS, sales, collections recorded in a normal manner during the year 2. at the end of the year, installment sales are "reversed" and the deferred gross profit is recognized 3. At end of the year gross profit rate on installment sales is computed

Alternative Revenue Recognition Methods

Percentage of Completion Method -long term construction Proportional Performance Method -long term service Completed Contract Method -alternative to percentage of completion method

Retrospective Adjustment (Step 2)

Prepare a journal entry to adjust book value of assets/liabilities that are affected by change so their balances reflect the amounts that would have existed under newly adopted principle. Offsetting adjustment made to beginning balance of retained earnings for cumulative effect of the change (net of taxes)