D105 - Unit 6

What is accounted for as a change in accounting principle?

A change from double-declining balance method to the straight-line method of calculating depreciation

Recording interest revenue as part of sales is which type of error?

Income Statement

Which item is considered an accounting error in accrual accounting?

Recoding the incorrect inventory value due to a mathematical mistake This is an accounting error.

What describes a change in reporting entity?

A company changes the companies included in combined financial statements A change in reporting entity is a change from reporting as one type of entity to another type of entity. As an example, a company might change the subsidiaries for which it prepares consolidated financial statements.

On July 1, 2020, Elberta Corp. acquired equipment at a cost of $1,020,000. It is to be depreciated on the straight-line method over a four-year period with no residual value. Because of a bookkeeping error, no depreciation was recognized in Elberta's 2020 financial statements. The oversight was discovered during the preparation of Elberta's 2021 financial statements. Which account will be affected by correcting the error that occurred in 2020, assuming comparative financial statements are not prepared?

Accumulated Depreciation Accumulated Depreciation is affected when fixing a bookkeeping error where no depreciation was recognized in Elberta's 2020 financial statements.

Which type of change occurs when presenting consolidated financial statements this year when statements of individual companies were presented last year?

An accounting change that should be reported by restating the financial statements of all prior periods presented An accounting change that should be reported by restating the financial statements of all prior periods presented occurs when presenting consolidated financial statements this year when statements of individual companies were presented last year.

In 2021, Stone Company changed its method of pricing inventories from FIFO to LIFO. Stone prepares comparative financial statements, comparing both years, 2020 and 2021. According to FASB, how should this type of accounting change be presented in Stone's financial statements?

As a change in accounting principle; 2020 financial statements should be restated. A change in inventory valuation is defined as a change in accounting principle. FASB requires that changes in accounting principles use the retrospective approach when presenting financial statements. The retrospective approach requires the company to "go back" and adjust (restate) prior year financial statements.

The classification of a note payable as an account payable is which type of error?

Balance Sheet Examples of balance sheet errors are the classification of a short-term receivable as part of the investment section, the classification of a note payable as an account payable, and the classification of plant assets as inventory.

A company needs to update one of its accounting estimates and report this update in the financial statements. How should this change be reported?

By prospectively applying the change to current and future periods A change in accounting estimate is handled prospectively for current and future periods.

A manufacturing company measured its raw materials inventory using the LIFO method for all years prior to Year 2. Beginning with January 1, Year 2, the company elects to use the FIFO method and will present two years in the financial statements. How should the company account for any additional changes?

By reporting inventory using FIFO on the December 31, Year 1 balance sheet and recording a one-time adjustment to retained earnings on January 1, Year 1 A change in accounting principle requires a company to restate prior-year financial statements that are included in the current presentation.

An accounting company identifies a material understatement of prior-year amortization expenses on a client's financial statement. What is part of the current year's entry for the correction of the error?

Debit Retained Earnings A debit to Retained Earnings will be required to address the overstatement in Net Income.

Changes in Accounting Estimate

Employ the current and prospective approach by: Reporting current and future financial statements on the new basis. Presenting prior period financial statements as previously reported. Making no adjustments to current-period opening balances for the effects in prior periods.

Changes Due to Error

Employ the restatement approach by: Correcting all prior period statements presented. Restating the beginning balance of retained earnings for the first period presented when the error effects occur in a period prior to the first period presented.

In 2019, PWT Company failed to record depreciation expense on some of its assets. When the error is discovered in 2020, how will the error be accounted for?

As a prior period adjustment As soon as a company discovers an error, it must correct the error. Companies record corrections of errors from prior periods as an adjustment to the beginning balance of retained earnings in the current period. Such corrections are called prior period adjustments. Failure to record depreciation is accounted for as a prior period adjustment.

What is the reason why companies prefer certain accounting methods?

Bonus payments Studies have found that if compensation plans tie mangers' bonus payments to income, management will select accounting methods that maximize their bonus payments.

Where is the cumulative effect of a change in accounting principle reported?

On the retained earnings statement as an adjustment to the beginning balance of the earliest year presented The cumulative effect of a change in accounting principle is reported on the retained earnings statement as an adjustment to the beginning balance of the earliest year presented.

What is an example of an balance sheet statement error?

Classifying a note payable as an account payable Examples of balance sheet errors are the classification of a short-term receivable as part of the investment section, the classification of a note payable as an account payable, and the classification of plant assets as inventory.

A company discovers an accounting error related to a prior period. How should the correction of this material error be reported?

On the retained earnings statement as an adjustment to the opening balance A prior period adjustment is made to the opening Retained Earnings balance.

A company has elected to change from using the LIFO method for valuing its inventory from the previously reported FIFO method. As a result of the change, the prior year's net income increases, requiring the company to pay an additional profit-sharing bonus to its employees. Which statement accurately depicts how this change should be accounted for as it relates to profit-sharing?

Recognize an indirect effect and record the change in expense in the current period Because the scenario is an indirect impact of a change in accounting principle, the expense is recorded in the current period and is not required to be retrospectively adjusted.

A company purchases a machine on January 1 of Year 1 for $10,000 that was estimated to have a five-year life and $0 salvage value. Straight-line depreciation is used. On January 1 of Year 3, the company estimates that the machine will last until the end of Year 7, with a salvage value of $500. How much depreciation expense is recorded in Year 4?

$1,100 $1,100 = ( ($10,000 - ( ($10,000 / 5) x 2) ) - 500) / (7 - 2) ). The book value at the time of the estimated life changed should be divided by the remaining life.

A charter airplane company purchases a jet for $5,000,000 on January 1, Year 1. On the date of purchase, the company estimates the jet to have a useful life of 5 years and no salvage value. The company records depreciation using the straight-line method for each of the Year 1, Year 2, and Year 3 calendar years. On January 1, Year 4, the company revises its estimate of the jet's useful life, and it now believes the jet will have a total life of 10 years. Which amount of depreciation expense will the company record for this asset for the calendar year that ended December 31, Year 4?

$285,714 $285,714 = ($5,000,000 - (1,000,000 x 3) ) / 7. The original depreciation would have been $1,000,000 per year (calculated as $5,000,000 / 5 years). Thus, the book value at January 1, Year 4, would have been $2,000,000 (calculated as $5,000,000 - ( 3 x $1,000,000) ). This correctly calculates prospective depreciation expense over the seven years that remain in the new useful life of the asset.

How is the failure to record depreciation expense in a given year accounted for?

As a prior period adjustment The failure to record depreciation expense in a given year accounted for as a prior period adjustment.

Which type of accounting change should always be accounted for in current and future periods?

Change in accounting estimate The type of accounting change is accounted for in current and future periods is the change in accounting estimate.

When a company changes from an accelerated method to the straight-line method of depreciation, which type of change does this represent?

Change in accounting estimate When a company changes from an accelerated method to the straight-line method of depreciation, this change should be handled as a change in accounting estimate.

What is an example of a correction of an error in previously issued financial statements?

Change to compensation expense for bonuses earned in the prior period that are paid in the subsequent period Bonuses are to be accrued in the period earned and not in the period paid.

A company experiences a change in reporting entity. Which event triggered this change?

Changing the companies included in the combined financial statements This is a change in reporting entity.

A company president is comparing the company's circumstances in the current period to that of the prior period and noticed several changes. The president has determined that the circumstances qualify as a change in the reporting entity. Which change will require this treatment?

Changing the included companies in consolidated financial statements Altering the companies included within combined financial statements represents a change in the reporting entity.

A company purchases equipment costing $50,000 that is expected to have a useful life of five years with no salvage value. In Year 3, after two years of depreciation have been recorded, the company changes methods and decides the asset should be depreciated using a declining balance method. Which disclosure completely illustrates the treatment required for this change?

Companies need to disclose the effect on income from operations, the related per share amounts for the current period, and why the new method is preferred. All of these are required disclosures for a change in estimate caused by a change in accounting principle.

Company A acquires all shares of Company B on January 1 of Year 2. Both companies have conducted operations for the past 10 years. Company A presents two years of its financial position and results of operations when preparing financial statements. What is the appropriate financial statement treatment for this situation?

Company A should report consolidated information for both Year 1 and Year 2 financial statements. This situation is a change in reporting entity. When changing a reporting entity, U.S. GAAP requires companies to restate all prior periods presented. Because Company A presents two years of financial results, both Years 1 and 2 should be presented on a consolidated basis.

Which type of error(s) affects both the income statement and balance sheet?

Counterbalancing and Noncounterbalancing A counterbalancing or noncounterbalancing error affects both the income statement and balance sheet.

A company using periodic inventory methods discovered it had understated inventory by $8,000,000 after the books had been closed for Year 1. The company's tax rate is 18%. Which partial entry should be included to correct this error in the financial statements for Year 2?

Credit Retained Earnings for $6,560,000 $6,560,000 = $8,000,000 - ($8,000,000 x 0.18). The understated inventory would result in an overstated cost of goods sold and thus an understated income tax expense. This means net income is understated and would be corrected by a credit to Retained Earnings.

A company purchases $1,000 of inventory that is subsequently sold. The company incorrectly records the purchase for $10,000. Which entry should be used to correct this material error on the balance sheet?

Debit Retained Earnings for $9,000; Credit Inventory for $9,000 The entry decreases Retained Earnings and Inventory.

The estimated life of a building that has been depreciated for 30 years of an originally estimated life of 50 years has been revised to a remaining life of 10 years. There is no salvage value. Based on this information, how should the accountant record depreciation and adjustments, if any?

Depreciate the remaining book value over the remaining life of the asset Changes in useful lives of assets are classified as a change in accounting estimate. Changes in accounting estimates are reported prospectively. Therefore, no adjustments are necessary. The company will depreciate the remaining book value over the remaining 10 years (the remaining life of the asset).

Changes in Accounting Principle

Employ the retrospective approach by: Changing the financial statements of all prior periods presented. Disclosing in the year of the change the effect on net income and earnings per share for all prior periods presented. Reporting an adjustment to the beginning retained earnings balance in the retained earnings statement in the earliest year presented. If impracticable to determine the prior period effect (e.g., change to LIFO): Do not change prior years' income. Use opening inventory in the year the method is adopted as the base-year inventory for all subsequent LIFO computations. Disclose the effect of the change on the current year, and the reasons for omitting the computation of the cumulative effect and pro forma amounts for prior years.

Changes in Reporting Entity

Employ the retrospective approach by: Restating the financial statements of all prior periods presented. Disclosing in the year of change the effect on net income and earnings per share data for all prior periods presented.

What is an example of a counterbalancing error?

Failure to record prepaid expenses Failure to record prepaid expenses, overstatement of ending inventory, and understatement of purchases are all example of counterbalancing errors

What happens when there is a failure to record accrued wages in the previous period?

Net Income for the first period is overstated The failure to record accrued wages in the previous period means (1) net income for the first period is overstated, (2) accrued wages payable is understated, and (3) wages expense is understated.

If retrospective application of a change in accounting principle requires assumptions about management's intent in a prior period, then which approach should be used to account for the change?

Prospective Companies should use the prospective approach if the folowing conditions exist: (1) The company cannot determine the effects of the retrospective application, (2) Retrospective application requires assumptions about management's intent in a prior period, and (3) Retrospective application requires significant estimates for a prior period, and the company cannot objectively verify the necessary information to develop these estimates.

At December 31, 2020, Sorrento Inc. estimated bad debts as 3% of the outstanding balance of Accounts Receivable. At December 31, 2020, Sorrento determined that it should increase its estimate to 6.5%. On which basis is this change handled?

Prospective basis This change of estimated bad debt estimate increase is handled on a prospective basis.

Which disclosure is required for a change from sum-of-the-years-digits to straight-line depreciation method?

Recomputation of current and future years' depreciation. The disclosure of recomputation of current and future years' depreciation is required for a change from sum-of-the-years-digits to straight-line depreciation method.

Company A acquires all shares of Company B on January 1 of Year 2. Both companies have conducted operations for the last 10 years. Company A presents two years of its financial position and results of operations when preparing financial statements. What is the appropriate financial statement disclosure for Company A in this situation?

Report the nature of and reason for the change in the disclosure notes for Year 2, with no requirement to repeat the disclosure for subsequent periods This situation is a change in the reporting entity. U.S. GAAP requires both disclosures in the year of the change but does not require repeated disclosure in subsequent periods.

A company that previously issued separate financial statements for several subsidiaries is now choosing to issue consolidated financial statements. Which accounting change was made by this company?

Reporting entity This scenario describes a change in reporting entity where previously each entity was reporting separate financial statements, changing to consolidated statements.

A company did not accrue annual insurance expense in the prior year's financial statements. The error resulted in a material overstatement of last year's net income, and the books are closed for last year. Which account should the company adjust in the books for the current year to correct this error?

Retained Earnings The books are closed for last year; therefore, the company should adjust for the error through retained earnings.

On December 31, 2020, Paiva Inc. appropriately changed its inventory valuation method to weighted-average cost from FIFO cost for financial statement purposes. The change will result in a decrease in the inventory account at January 1, 2020. The amount of the change, net of tax is, $1,480,000 (all tax effects should be ignored). Where should the cumulative effect of this accounting change should be reported by Paiva Inc. in 2020?

Retained earnings statement as a $1,480,000 deduction from the beginning balance The cumulative effect of this accounting change should be reported by Paiva Inc. in 2020 in the retained earnings statement as a $1,480,000 deduction from the beginning balance.

On December 31, 2020, Dodd Inc. appropriately changed its inventory valuation method to FIFO cost from weighted-average cost for financial statement purposes. The change will result in an increase in the Inventory account at January 1, 2020. The amount of the change, net of tax is, $2,300,000 (all tax effects should be ignored). What is the cumulative effect of this accounting change that should be reported by Dodd Inc, in 2020?

Retained earnings statement as a $2,300,000 addition to the beginning balance The cumulative effect of this accounting change should be reported by Dodd Inc, in 2020 in the retained earnings statement as a $2,300,000 addition to the beginning balance.

Which approach does the FASB require when accounting for changes in accounting principle?

Retrospective The FASB requires that companies use the retrospective approach. Because it provides financial statement users with more useful information than the cumulative-effect or prospective approaches.

On December 31, Year 1, a company records revenue for $150,000 that applied to Year 2. The books have already been closed in Year 2. Which action, if any, should the company take to address the error?

The company should take no action as the error is counterbalanced. The books are closed, therefore, no entry is required as the errors have counter balanced. Revenue is understated in Year 1 by $150,000 and overstated in Year 2 by $150,000 with a net effect of $0.

Which disclosure is required for a change from LIFO to FIFO?

The cumulative effect on prior years (net of tax) in the current retained earnings statement; the justification for the change; and restated prior year income The following disclosures is required for a change from LIFO to FIFO: The cumulative effect on prior years, net of tax, in the current retained earnings statement; the justification for the change; and restated prior year income.