CH 20

Which of the following are considered a change in accounting principle?

Change from the cost to equity method. Adopt a new FASB standard.

A change in depreciation method is treated as a(n)

Change in accounting estimate

Which of the following is a change in accounting estimate?

Change in actuarial calculations pertaining to pension plan.

Which of the following is a change in accounting estimate achieved by a change in accounting principle?

Change in depreciation methods.

Which of the following are changes in accounting estimates?

Change in useful life of a depreciable asset. Change in estimate of periods benefited by intangible asset.

Which of the following is a change in accounting principle?

Change the method of inventory.

Which of the following situations would be an appropriate reason for an accounting principle change?

Changes in related economic conditions

Which of the following are considered a change in reporting entity?

Changing specific companies that are included in the consolidated statements. Presenting consolidated financial statements in place of individual statements.

The retrospective approach to accounting changes supports which principles or concepts?

Consistency Comparability

In year 1, Durham Corp. failed to record a sale for $50,000. Durham also failed to record this revenue on the tax return. In year 2, the error was discovered. Durham's tax rate is 40%. Which of the following entries would be required to record the correction of the error including tax effects?

Credit income taxes payable $20,000. Credit retained earnings $30,000.

In year 1, Orrin Company purchased equipment for $120,000. Orrin appropriately debited the equipment account in year 1. The equipment had a 6-year life with no residual value. In year 3, Orrin discovered that it failed to record depreciation expense or tax depreciation in year 1 and year 2. Straight-line depreciation was used for both book and tax purposes. Orrin's tax rate is 30%. Which of the following entries would be required to record the correction of the error including tax effects?

Debit retained earnings $28,000

If a change in accounting principle does not require additional taxes to be paid or taxes to be refunded, which account is used to record the tax effects of a change in accounting principle?

Deferred tax asset or liability accounts

In year 2, Rossman Corp. changed its inventory method from FIFO to the weighted-average method. The change resulted in a decrease in beginning inventory for year 2 of $10,000. What were the income statement effects of this change?

Earnings per share for year 1 decreased.

Investors should be alert to accounting method changes that may be based on these hidden motivations:

Effect on executive compensation Increases in earnings not based on changes in effectiveness or efficiency A desire to hide potential debt covenant violations

Adam needs to correct an error that affected prior year income. Adam correctly judges that retrospective reporting is impracticable for this error. Under which accounting standards may Adam report the effect of the error in the current period?

IFRS only

A difference in accounting rules for accounting changes for U.S. GAAP and IFRS is

IFRS permits the effect of an error to be reported in the current period if it is not considered practicable to report it retrospectively.

In year 1, Orrin Company purchased equipment for $120,000. Orrin appropriately debited the equipment account in year 1. The equipment had a 6-year life with no residual value. In year 3, Orrin discovered that it failed to record depreciation expense or tax depreciation in year 1 and year 2. Straight-line depreciation was used for both book and tax purposes. Orrin's tax rate is 30%. What is the tax effect of the prior period adjustment in year 3?

Increase income tax receivable $12,000

An error in which of the following accounts typically does not self-correct?

Land

Which of the following errors will self-correct?

Miscounting ending inventory at the end of the year.

Which of the following errors would self-correct in the following year?

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

At the beginning of year 1, Rudolf Corp. purchased equipment for $100,000. Rudolph debited the cost to an expense account. The equipment had a 10-year life with no residual value. The company usually depreciates such assets straight-line. Ignoring tax effects, what is the effect on the year 1 income statement?

Net income understated by $90,000

If it is impracticable to measure the period-specific effects of a change in accounting principle, what approach is used?

Prospective

What method is used to account for a change in accounting estimate?

Prospective application

When a company changes its inventory method from LIFO to FIFO, what accounts are affected in the comparative financial statements?

Retained earnings Inventory Income tax payable Cost of goods sold

Which of the following may be objectives of companies that manage earnings?

Smoothing income Increasing income Decreasing income

When a company changes accounting methods and the effects of the change can be calculated for each period, which of the following occurs?

The adjusted net income for each year is shown on the retained earnings statement for that year. Retained earnings is adjusted for the earliest period presented.

Mirage Corp. miscounts and understates its ending inventory in year 1 by $5,000. Ignoring tax effects, what are the financial statement effects of this error in year 1?

Understate assets. Understate net income. Understate retained earnings.

"Cookie jar" accounting involves

Using unrealistic estimates to create reserves to smooth earnings

In year 2, Rogers Corp. changes its inventory method from FIFO to the weighted-average method. Under the weighted-average method, the year 2 beginning inventory is $5,000 lower than under the FIFO method. The financial statements are revised using the retrospective approach. What are the financial statement effects of the change in accounting principle?

Year 1 ending inventory will decrease. Year 1 net income will decrease.

Modified retrospective application for a change in accounting principle requires that

an adjustment is made to retained earnings at the beginning of the adoption period.

Modified retrospective application for a change in accounting principle requires that the new standard is applied to the adoption period and

an adjustment is made to retained earnings at the beginning of the adoption period.

Retrospective application for a change in accounting principle requires that

an adjustment is made to retained earnings for the earliest period presented.

A change in depreciation method is treated as a

change in estimate achieved by a change in accounting principle.

Candy changes inventory methods in year 2, resulting in a $20,000 increase to beginning inventory in year 2. The tax rate is 40%. The journal entry required to record the change in accounting principles will require

credit to retained earnings for $12,000 debit to inventory for $20,000

Kroft changes inventory methods in year 2, resulting in a $10,000 increase to beginning inventory in year 2. The tax rate is 30%. The journal entry required to record the change in accounting principles will require a

credit to retained earnings for $7,000.

When it is impossible to distinguish between a change in principle and a change in estimate, the change should be treated as a change in _____.

estimate

New information that becomes available about an event or transaction frequently results in a change in

estimate.

Error correction requires disclosure of the:

nature of the error effect of its correction on operations

Crane Corp. changes its inventory method from FIFO to the weighted-average method. Which items will be affected on the income statement?

net income earnings per share cost of goods sold

The prospective approach for reporting a change in accounting principle requires that

no change is made to previous years' financial statements.

Which of the following are estimates used in asset depreciation?

pattern of receiving benefits future benefits from the asset

A voluntary accounting change can be made only if it is justified as being _____ to the previous method.

preferable

Accounting changes include changes in

principles, estimates, or entities.

GAAP requires that a change from the equity method to another method of accounting for long-term investments is accounted for:

prospectively

When it is impracticable to determine the cumulative effect of prior years of a voluntary change in accounting principle, then the new method is applied _____ beginning in the earliest year practicable.

prospectively

Schumacher Company used the LIFO inventory costing method for its first 5 years of operations, generating tax savings of $75,000. In year 6, Schumacher switches from LIFO to FIFO. The company

records a current and noncurrent liability to show that it must repay the $75,000 over time.

If it is impracticable to adjust each year reported for the effect of a voluntary accounting principle change, the change is applied

retrospectively to the earliest year practicable.

If an accountant discovers an error in the current year accounting records before the financial statements are prepared, the accountant should

reverse the incorrect entry and prepare a correct entry.

When a company makes accounting choices that cause earnings to follow a steady trend from year to year, this manipulation is called income .

smoothing

When an error causes the ending balance of retained earnings to be incorrect, a prior period adjustment is reported in the

statement of retained earnings

If a change in accounting principle requires prior tax savings to be repaid, the tax effects are recorded in a ________ account; however, if the tax law does not require a recapture of prior tax savings, then the tax effects are recorded in a _________ account.

taxes payable; deferred tax liability

If a lack of information makes it impracticable to report a voluntary accounting change retrospectively, then

the company should disclose the reason why retrospective application was impracticable. the new method is applied prospectively as of the beginning of the year of change.

If a company records an error correction, it must disclose _____________ in its notes to the financial statements.

the nature of the error

In year 1, Regal Corporation purchased equipment for $100,000. Regal appropriately debited the equipment account in year 1. The equipment had a 10-year life with no residual value. In year 3, Regal discovered that it did not record depreciation expense or tax depreciation in year 1 and year 2. Straight-line depreciation is used. Regal's tax rate is 40%. What is the tax effect of the prior period adjustment in year 3?

Increase income tax receivable $8,000

Which of the following occur with the prospective approach for reporting a change in accounting principle?

It does not restate financial statements. It reflects the changes in the current and future years only.

When an accounting change is made, what disclosures are necessary in the notes to the financial statements?

Justification for the new method

Which of the following represents a situation when it may be difficult to distinguish between a change in estimate and a change in principle?

The cost of tools are capitalized instead of expensed

Which of the following represents a situation for which it may be difficult to distinguish between an estimate and a principle change?

The costs of tools are capitalized instead of expensed

True or false: A prior period adjustment requires an adjustment to the beginning balance of retained earnings for the year following the error or for the earliest year being reported in the comparative financial statements if the error occurred prior to the earliest year presented.

True

True or false: Because of the convergence efforts by FASB and IASB, few differences remain between U.S. GAAP and IFRS with respect to accounting changes and error correction.

True

An exception to the retrospective application of voluntary changes in accounting principles is when

authoritative literature requires prospective application for a change in accounting methods.

Relay Corp. estimates bad debt expense as 3% of credit sales. During year 1 Relay sold $100,000 of goods on account. During year 2, Relay determines that a more accurate estimate of bad debts is 4% of credit sales. Year 2 sales on account was $300,000. The entry in year 2 to record the change in accounting estimate would include a debit to

bad debt expense for $12,000.

The rationale for a change of depreciation method to be treated as a change in accounting estimate is that

changing depreciation method is done to reflect changes in estimated future benefits.

The selection of an accounting method is important because it can

complicate comparisons. influence financial ratios. reduce comparability.

A reporting entity can be

either a single company or group of companies that reports a single set of financial statements

The revision of an erroneous accounting estimate is accounted for as a(n):

error correction

When it is not possible to distinguish between a change in principle and a change in estimate, the change should be treated as a change in

estimate.

When a company changes accounting methods, if the effects of the change can be calculated, the cumulative effect of the change is reflected

in the beginning balance of retained earnings for the earliest year presented for the years prior to that date.

Companies can create smooth earnings patterns by ___________ estimated expenses in a year with higher than expected earnings, which ___________ income in later years.

increasing; creates

If a company changes its inventory method, what financial statement accounts are affected?

inventory cost of goods sold

If Allegan miscounts ending inventory in the current year, which of the following amounts will be incorrect on its financial statements?

inventory cost of goods sold net income

A company's choice of accounting method is important because

it impacts reported net income affects comparability with peer firms

When a new accounting standard is applied to the adoption period and an adjustment is made to the balance of retained earnings at the beginning of the adoption period, the ______ approach is used.

modified retrospective

When an adjustment is made to the balance of retained earnings at the beginning of the adoption period to reflect the impact of a change in accounting principle, the ______ approach is used.

modified retrospective

A voluntary accounting principle change:

must be justified as being preferable

Emile Company utilized the LIFO inventory costing method for the past ten years and saved $350,500 in taxes. If Emile switches away from LIFO, the company

must repay the prior years' tax savings to the IRS.

An accountant discovers an error in the current year accounting records. What are the appropriate actions the accountant should take?

Prepare the correct journal entry for the transaction. Reverse the incorrect entry.

Which of the following is an exception to retrospective application of voluntary changes in accounting principle?

When there is insufficient information to determine the cumulative effect of prior years When authoritative literature requires prospective application

The rationale for retrospective application for accounting changes is that

accounting principles should be consistently applied from year to year.

A prior period adjustment is

an addition or reduction in the beginning balance of retained earnings due to an error correction.

At the beginning of year 1, Rudolf Corp. purchased equipment for $100,000. Rudolph debited the cost to an expense account. The equipment had a 10-year life with no residual value. The company usually depreciates such assets straight-line. Ignoring tax effects, what is the effect on the year 2 balance sheet?

Assets are understated by $80,000 Retained earnings is understated by $80,000

On January 1, year 1, Yuri Corp. purchases equipment for $120,000. The equipment has a 6-year useful life with no residual value. Yuri uses the double-declining-balance method of depreciation, and depreciates the equipment $40,000 in year 1. In year 2, Yuri changes its depreciation method to straight-line depreciation. The journal entry in year 2 to record the depreciation expense will include which of the following journal entries?

Credit accumulated depreciation $16,000. Debit depreciation expense $16,000.

In year 2, Rocco changes its inventory method from the weighted-average to the FIFO method. If FIFO would have been used in year 1, cost of goods sold would be $20,000 lower. Rocco has an effective tax rate of 21%. What is the after-tax effect on retained earnings for year 1 for the change in accounting method?

Increase retained earnings $15,800

In year 2, Reynolds changes its inventory method from FIFO to the weighted-average method. If the weighted-average method would have been used in year 1, cost of goods sold would be $10,000 higher. Reynolds has an effective tax rate of 40%. What is the after-tax effect on retained earnings for year 1 for the change in accounting method?

Decrease retained earnings $6,000.

An example of a change in accounting estimate that is effected by a change in accounting principle is a change in

depreciation methods.

When an accounting change is made, what disclosures should be made in the notes to the financial statements?

Per share amounts in the current or prior period affected by the change Justification for the new method

What factors strongly contribute to the need for changes in estimates?

Experience relating to the estimates New information becomes available

Glimmer Corp. miscounts and 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 net income $10,000. Overstate assets $10,000.

In year 2, Sammi Corp. changes its inventory method from FIFO to the weighted-average method. Under the weighted-average method, the year 2 beginning inventory is $3,000 higher than the FIFO method. The financial statements are revised using the retrospective approach. What are the financial statement effects of the change in accounting principle?

Year 1 retained earnings will increase. Year 1 net income will increase.

When correcting errors in previously issued financial statements, IFRS ______ the effect of the error to be reported in the current period if it is not considered practicable to report it retrospectively; U.S. GAAP ____ such treatment.

permits; prohibits

On January 1, year 1, Weston Corp. purchases equipment for $100,000. The equipment has a 10-year useful life with no residual value. Weston uses the double-declining-balance method of depreciation, and depreciates the equipment $20,000 in year 1 and $16,000 in year 2. In year 3, Weston changes its depreciation method to straight-line depreciation. The journal entry in year 3 to record the depreciation expense will include which of the following journal entries?

Debit depreciation expense $8,000.

In the past, Marty Corporation held 30% of the outstanding common shares of Trace Company. During the current year, Marty sold 18% of its investment. This change should be accounted for

prospectively.

Haven Corp. purchases equipment and incorrectly debits maintenance expense. Which of the following amounts will be incorrect at year-end?

total fixed assets retained earnings depreciation expense

If an estimate must be revised because it was based on erroneous information, the revision is

treated as an error correction

During 2017, Trey Corporation accrued warranty expense based on 3.5% of net sales revenue. During 2018, Trey Corporation revised its estimate to 4%. Sales revenue was $2 million for each year. For the year ended December 31, 2018, the warranty-related entry would include a debit to:

warranty expense for $80,000

What hidden motivations should investors and creditors be wary of when a company makes an accounting method change?

Avoid irregular earnings patterns Increase executive compensation Report inflated earnings that are not associated with increased economic performance

Which of the following errors typically do not self-correct?

Recording equipment purchased in the land account

What is the approach used for an error correction?

Restatement of previous years' financial statements

What approach is used to account for a change in depreciation method?

Prospective approach

A reporting entity can consist of

either a single or a group of companies

Accounting changes include changes in accounting _____, in accounting _____, and in reporting entity.

principle, estimate

When is the prospective approach used in accounting changes?

For a change in accounting estimate. For a change in accounting principle if it is impracticable to determine the effect of the change on previous years.

Which of the following should be included in the disclosure for a change in reporting entity?

The reason for the change. The nature of the change. The effect of the change on net income.

Which of the following are acceptable reasons for an accounting change?

To apply a new method that is more appropriate. To be consistent with others in the industry.

An addition to or reduction of the beginning balance of retained earnings is referred to as a(n) _____ _____ adjustment.

prior period

A change in accounting estimate is accounted for using the _____ approach.

prospective

When it is impracticable to measure the period-specific effects of a change in accounting principle, the _____ approach should be used.

prospective

After a recent acquisition, Joann Inc. issues consolidated financial statements for the first time. Joann should report the acquisition as a change in _____.

reporting entity

If a company discovers an error in previously issued financial statements, it must

restate the financial statements.

The prior period adjustment is applied to ______ for the year following the error or for the earliest period being reported in the comparative financial statements.

retained earnings

When financial statements are revised to reflect the impact of a change in accounting principle, the ______ approach is used.

retrospective