Chapter 20 - Accounting Changes and Error Corrections

In year 1, Claire miscounted ending inventory and understated ending inventory by $10,000. The error was discovered in year 2. Ignoring tax effects, the entry to record this error would include which of the following? (Select all that apply.)

- Credit retained earnings $10,000. - Debit inventory $10,000.

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? (Select all that apply.)

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

Which of the following are considered a change in reporting entity? (Select all that apply.)

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

Which of the following should be included in the disclosure for a change in reporting entity? (Select all that apply.)

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

Which of the following are acceptable reasons for an accounting change? (Select all that apply.)

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

For U.S. GAAP, which of the following are considered accounting changes? (Select all that apply.)

- change in accounting principle - change in accounting estimate - change in reporting entity

Haven Corp. purchases equipment and incorrectly debits maintenance expense. Which of the following amounts will be incorrect at year-end? (Select all that apply.)

- retained earnings - total fixed assets - depreciation expense

If a lack of information makes it impracticable to report a voluntary accounting change retrospectively, then (select all that apply)

- 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.

Which of the following is a change in accounting principle?

Change the method of inventory.

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.

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

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

Prospective approach

Accounting error

Restatement of financial statements

Change in accounting estimate

Revision of an amount due to new information or new experience

A prior period adjustment is

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

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.

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

change in accounting estimate.

A change in depreciation method is treated as a

change in estimate achieved by a change in accounting principle.

Failure to record an adjusting entry is a change that requires a:

correction of error

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.

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

error correction

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

estimate.

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

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.

Events that cause changes in retained earnings are reported in the

statement of retained earnings

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

The term "prior period adjustment" is used for

the correction of an error.

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

treated as an error correction

"Cookie jar" accounting involves

using unrealistic estimates to create reserves to smooth earnings.

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? (Select all that apply.)

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

Which of the following errors would self-correct in the following year? (Select all that apply.)

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

An accountant discovers an error in the current year accounting records. What are the appropriate actions the accountant should take? (Select all that apply.)

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

The selection of an accounting method is important because it can (Select all that apply.)

- complicate comparisons. - reduce comparability. - influence financial ratios.

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 _____.

Blank 1: estimate

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

Blank 1: preferable or preferred

Change in accounting principle

Change from one generally accepted method to another generally accepted method of accounting

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.

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.

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

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

Prospective

Change in accounting estimate

Prospective application

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

Prospective application

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

A change in reporting entity requires

financial statements of prior periods to be revised retrospectively.

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

the nature of the error

Which of the following are considered a change in accounting principle? (Select all that apply.)

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

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

Changes in related economic conditions

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

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

prospectively

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.

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

restate the financial statements.

An accounting change requires retrospective application of the new method to previous periods, whereas an accounting error requires

restatement of the financial statements of previous periods.

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

Which of the following are changes in accounting estimates? (Select all that apply.)

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

The retrospective approach to accounting changes supports which principles or concepts? (Select all that apply.)

- Comparability - Consistency

Gris Corp. purchases inventory on account and incorrectly records a debit to equipment and a credit to cash. Which entries would be used to reverse and correct this error? (Select all that apply.)

- Debit cash; credit equipment. - Debit inventory; credit accounts payable.

Lawry Corp. purchased equipment for $100,000 and incorrectly recorded the equipment as inventory. The equipment has a useful life of 10 years with no residual value. The entry to correct this error would include which of the following entries?

- Debit equipment $100,000. - Credit inventory $100,000.

What factors strongly contribute to the need for changes in estimates? (Select all that apply.)

- New information becomes available - Experience relating to the estimates

In year 1, Fris Corp. purchased equipment for $100,000. Fris incorrectly recorded the equipment purchase as repair expense in year 1. The equipment had a 5-year life with no residual value. In year 3, Fris discovered the error. Ignoring tax effects, what is the adjustment that should be made to retained earnings in year 3?

Credit retained earnings $60,000.

In year 1, Regal Corp. 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 in year 1 and year 2. Ignoring tax effects, what is the adjustment that should be made to retained earnings in year 3 assuming straight line depreciation?

Debit retained earnings $20,000.

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

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

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

Justification for the new method

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.

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

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

The rationale for retrospective application for accounting changes is that

accounting principles should be consistently applied from year to year.

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.

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.

Iris Company purchased equipment for cash and incorrectly recorded the entry as a debit to repair expense and a credit to cash. The entry required to correct the error is to

debit equipment; credit repair expense.

Jill accrues salaries and records the transaction by debiting salary expense and crediting notes payable. The entry to correct this error is

debit notes payable; credit salaries payable.

A reporting entity can be

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

A reporting entity can consist of

either a single or a group of companies

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

increasing; creates

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.

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

no change is made to previous years' financial statements.

Accounting changes include changes in

principles, estimates, or entities.

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

prospective

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

Which of the following are requirements for the correction of an accounting error? (Select all that apply.)

- Report a prior period adjustment to the beginning balance in retained earnings for the earliest year affected. - Prepare a journal entry to correct the error.

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? (Select all that apply.)

- Credit retained earnings. - Debit sales revenue.

When is the prospective approach used in accounting changes? (Select all that apply.)

- 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.

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

- Income tax payable - Inventory - Cost of goods sold - Retained earnings

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.

Which of the following occur with the prospective approach for reporting a change in accounting principle? (Select all that apply.)

- 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 should be made in the notes to the financial statements?

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

When a company changes accounting methods and the effects of the change can be calculated for each period, which of the following occurs? (Select all that apply.)

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

If a company changes its inventory method, what financial statement accounts are affected? (Select all that apply.)

- cost of goods sold - inventory

Which of the following are requirements for the correction of an accounting error? (Select all that apply.)

- Prepare a journal entry to correct the error. - Restate previous years' financial statements that are incorrect. - Disclose the nature of the error and the impact of the error on net income.

Which of the following is an exception to retrospective application of voluntary changes in accounting principle? (select all that apply)

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

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.

Blank 1: prospectively

Change in reporting entity

Consolidate a subsidiary not previously included in consolidated financial statements

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.

Which of the following may be objectives of companies that manage earnings? (Select all that apply.)

- Increasing income - Decreasing income - Smoothing income

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? (Select all that apply.)

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

Investors should be alert to accounting method changes that may be based on these hidden motivations: (Select all that apply.)

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

Which of the following are estimates used in asset depreciation? (Select all that apply.)

- future benefits from the asset - pattern of receiving benefits

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

retrospective

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

Blank 1: smoothing or smooth

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? (Select all that apply.)

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

If Allegan miscounts ending inventory in the current year, which of the following amounts will be incorrect on its financial statements? (Select all that apply.)

- cost of goods sold - inventory - net income

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 (Select all that apply.)

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

Crane Corp. changes its inventory method from FIFO to the weighted-average method. Which items will be affected on the income statement? (Select all that apply.)

- earnings per share - net income - cost of goods sold

Which items are considered a correction of an error when the financial statements are adjusted? (Select all that apply.)

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

A company's choice of accounting method is important because

- it impacts reported net income - affects comparability with peer firms

Error correction requires disclosure of the: (Select all that apply.)

- nature of the error - effect of its correction on operations

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.

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

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.

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

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

Rex Corp. purchased supplies on account and recorded it in the inventory account. What is the journal entry to correct this error?

Debit supplies; credit inventory.

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? (Select all that apply.)

- Understate retained earnings. - Understate assets. - Understate net income.

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.

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? (Select all that apply.)

- Overstate net income $10,000. - Overstate assets $10,000.

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.

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

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

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

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.

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 Reason: $120,000 / 6 yrs = $20,000 year x 2 years = $40,000 depreciation expense was not deducted x .30 = $12,000 receivable because reported tax income was higher than it would have been had depreciation been deducted.

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