Intermediate II - Chapter 20 - Accounting Changes and Errror Corrections

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

Changes in related economic conditions

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 income statement?

Overstated by $10,000

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.

In year 1, Clark Corp. failed to record an entry to record a sale on account. In year 2, Clark recorded the entry as a debit to accounts receivable and a credit to sales revenue. The entry in year 2 to correct this entry would be ________________.

debit sales revenue; credit retained earnings.

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

Which items are considered a correction of an error when the financial statements are adjusted?

1. failing to record an adjusting entry. 2. change from the cash basis of accounting to accrual basis 3. mathematical mistakes

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

1. inventory 2. cost of goods sold

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

1. net income 2. earnings per share 3. cost of goods sold

Which of the following is a change in accounting principle?

Change the method of inventory.

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. Reason: The prospective basis is used. The book value at the beginning of year 3 is $100,000 less $36,000 = $64,000. $64,000 divided by 8 remaining years is $8,000 depreciation expense for year 3.

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 Reason: $120,000/6 years = $20,000 per year x 2 years = $40,000 less tax savings of $12,000 = $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.

Which of the following errors will self-correct?

Miscounting ending inventory at the end of the 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 2 balance sheet?

Retained earnings is understated by $80,000 Reason: excess expense in year 1 of $100,000 less two years of omitted depreciation expense Assets are understated by $80,000 Reason: omitted equipment of $100,000 less accumulated depreciation

change in depreciation is >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

a change in estimate

Modified retrospective approach

accounting change is applied only to the adoption period with adjustment of the balance of retained earnings at the beginning of the adoption period to capture the cumulative effects of prior periods.

A change in ______ relates to a change in method of accounting for an item, whereas a change in ______ arises from a new calculation due to new information or new experience.

accounting principle; accounting estimate

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.

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. Reason: If beginning inventory is increased, ending inventory in the previous year is also increased. Cost of goods sold in previous years decreased, resulting in higher income. $10,000 x (1 - 30% tax rate) = $7,000 total increase to retained earnings, and a credit is made to retained earnings to adjust the beginning retained earnings.

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 _

debit to inventory for $20,000 credit to retained earnings for $12,000 Reason: Inventory is debited for $20,000 to increase inventory. Retained earnings is credited for $12,000 ($20,000 - 40% x $20,000 tax effect), and taxes payable is credited for $8,000

Prospective approach

effects of a change are reflected in the financial statements of only the year of the change and future years.

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.

When switching from FIFO to weighted average method >>>>>>>>>>>>>>>>>

record a deferred tax asset

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

retrospective

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.

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

the nature of the error

If inventory is overstated >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

then assets are overstated by the same amount and net income is also overstated by the same amount

If change of inventory occurs in year 2, then the increase will be

then the increase will be debited to inventory, the increase - ((tax rate X increase)) wil be creditied to retained earnings and the difference between the 2 will be creditied to taxes payable..

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

1. Adopt a new FASB standard. 2. Change from the cost to equity method.

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

1. Avoid irregular earnings patterns 2. Increase executive compensation 3. Report inflated earnings that are not associated with increased economic performance

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?

1. Credit income taxes payable $20,000. 2. Credit retained earnings $30,000.

In year 1, Fox Corp. failed to record an entry to record a sale on account. In year 2, Fox recorded the entry as a debit to accounts receivable and a credit to sales revenue. The entry in year 2 to correct this entry would include which of the following?

1. Credit retained earnings. 2. Debit sales revenue.

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?

1. Debit depreciation expense $16,000. 2. Credit accumulated depreciation $16,000.

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

1. Effect on executive compensation 2. Increases in earnings not based on changes in effectiveness or efficiency 3. A desire to hide potential debt covenant violations

If ending inventory is understated in this year, then cost of goods sold is overstated and retained earnings is understated >>>>>>>>>>>>>>>>>>>>>>>>

So, for this year, you would've paid NOT ENOUGH TAXES.

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

1. Experience relating to the estimates 2. New information becomes available

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

1. Failure to accrue salaries in the current year. 2. Miscounting ending inventory.

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

1. Inventory 2. Retained earnings 3. Cost of goods sold 4. Income tax payable

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?

1. Overstate net income $10,000. 2. Overstate assets $10,000.

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

1. Report inflated earnings that are not associated with increased economic performance 2. Avoid irregular earnings patterns 3. Increase executive compensation

A company's choice of accounting method is important because _________.

1. affects comparability with peer firms 2. it impacts reported net income

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

1. earnings per share 2. net income 3. cost of goods sold1

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?

1. Year 1 ending inventory will decrease. Reason: If year 2 beginning inventory is $5,000 lower, then ending inventory in year 1 is $5,000 lower. Year 1 cost of goods sold is higher, resulting in lower net income for year 1 and lower retained earnings for year 1. 2. Year 1 net income will decrease.

Change in inventory method is >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

a change in 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

debit to inventory for $20,000 credit to retained earnings for $12,000 Reason: Inventory is debited for $20,000 to increase inventory. Retained earnings is credited for $12,000 ($20,000 - 40% x $20,000 tax effect), and taxes payable is credited for $8,000.

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

estimate.

Which of the following are estimates used in asset depreciation?

1. pattern of receiving benefits 2. future benefits from the asset

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

1. total fixed assets 2. retained earnings 3. depreciation expense

If a company changes inventory methods and it results in an increase to beginning inventory >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

then you would credit retained earnings for amount of the increase X (1-tax rate)

If a company changes inventory methods and it results in a decrease to beginning inventory >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

then you would debit retained earnings for amount of decrease X (1+tax rate)

If equipment is put in an expense account >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

then, assets are understated by cost of equipment minus accumulated depreciation and retained earnings are understated by cost of equipment minus accumulated depreciation

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

1. To be consistent with others in the industry. 2. To apply a new method that is more appropriate

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

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

1. To be consistent with others in the industry. 2. To apply a new method that is more appropriate.