Acc 3020 - Exam 3
- Basic EPS: ((150,000 - 77,000) / 40,000) = $1.83 per share - Diluted EPS with Conversion of Preferred Stock: (150,000 / (40,000 + 20,000)) = $2.50 per share - Answer: Antidilutive, because the conversion cause Basic EPS to increase
10,000 shares of 7.7% of $100 par convertible, cumulative preferred stock. Each share may be converted into two common shares
A journal entry is made to correct any incorrect amounts
4 Steps for the Correction of Accounting Errors: (Step 1)
Previous year's financial statements presented for comparison are changed to reflect the correct amounts
4 Steps for the Correction of Accounting Errors: (Step 2)
If retained earnings is one of the incorrect accounts, the correction is reported as a prior period adjustment to beginning retained earnings
4 Steps for the Correction of Accounting Errors: (Step 3)
A disclosure note should describe the error and the impact of its correction
4 Steps for the Correction of Accounting Errors: (Step 4)
- Basic EPS: (150,000 / 40,000) = $3.75 - Diluted EPS with Conversion of Preferred Stock: ((150,000 + (32,000 - (32,000 x 25%))) / (40,000 + 5,000)) = $3.87 per share (Note: 32,000 = (500,000 x 6.4%)) - Answer: Antidilutive, because the conversion cause Basic EPS to increase
6.4% convertible 10-year, $500,000 of bonds, issued at face value. The bonds are convertible to 5,000 shares of common stock
Change in estimate achieved by a change in accounting principle using the Prospective Method
A change in the method of depreciation, amortization, or depletion is considered to be a
Adjust accounts to the correct balances reflecting the new principle as of the beginning of the year of the change
A journal entry needs to be made to
Journal Entry: 1 - Debit Prepaid Insurance: ((72,000 / 3) x 2) = 48,000 - Credit Retained Earnings: (72,000 - (72,000 / 3)) = 48,000 Journal Entry: 2 - Debit Insurance Expense: (72,000 / 3) = 24,000 - Credit Prepaid Insurance: 24,000
A three-year liability insurance policy was purchased at the beginning of 2020 for $72,000. The full premium was debited to insurance expense at the time
A revision in estimate because of new information
Accounting Changes: Changes in Accounting Estimate
A change from one generally accepted accounting principle to another
Accounting Changes: Changes in Accounting Principle
Represents the present value of future expected retirement benefits to be paid based on salaries already earned (accumulated))
Accumulated Benefit Obligation (ABO)
Journal Entry: 1 - Debit Equipment: 45,000 - Credit Accumulated Depreciation: ((45,000 / 5) x 2) = 18,000 - Credit Retained Earnings: (45,000 - (9,000 x 2) = 27,000 Journal Entry: 2 - Debit Depreciation Expense: (45,000 / 5) = 9,000 - Credit Accumulated Depreciation: 9,000
Additional computers were acquired at the beginning of 2019 and added to the company's office network. The $45,000 cost of the computers was inadvertently recorded as maintenance expense. Computers have five-year useful lives and no material salvage value. This class of equipment is depreciated by the straight-line method
1.5% x Number of years x Highest Salary
Annual Retirement Benefit Formula
That item is antidilutive and is not considered for diluted EPS
Antidilutive Convertible Securities: If the incremental effect is higher than basic EPS
Dividing the assumed change to the numerator by the assumed changed to the denominator
Antidilutive Convertible Securities: The earnings per incremental share of any assumed conversion can be calculated by
It would be irrational to think that exercise would have taken place (Note) - Using the treasury stock method would decrease the number of shares assumed outstanding which would be anti-dilutive
Antidilutive Securities Options, Warrants, Rights: If the exercise price > the average market price
No assumed exercise or conversion of potential common shares could reduce EPS (Note) - All options, warrants, rights, convertible bonds, and shares of convertible preferred stock are anti-dilutive, and they are not considered for diluted EPS
Antidilutive Securities: If a company has a basic loss per share
These items are anti-dilutive and are not considered for diluted EPS, but they would be included in the disclosure notes (Note) - All options, warrants, rights, convertible bonds, and shares of convertible preferred stock are anti-dilutive, and they are not considered for diluted EPS
Antidilutive Securities: If the assumed exercise or conversion of potential common shares outstanding would increase the EPS
Beginning Inventory: NE, 0 Plus: Net Purchases: NE, 0 Less: Ending Inventory: U, 6,000 COGS: O, 6,000 Revenues: Less: COGS: O, 6,000 Less: Other Expenses: NE, 0 Net Income: U, 6,000 Retained Earnings: U, 6,000
Assuming that the errors were discovered after the 2020 financial statements were issued, analyze the effect of the errors on 2020 and 2019 cost of goods sold, net income, and retained earnings (Ignore income taxes) "2019"
Beginning Inventory: U, 6,000 Plus: Net Purchases: U, 3,000 Less: Ending Inventory: O, 9,000 COGS: U, 18,000 Revenues: Less: COGS: U, 18,000 Less: Other Expenses: NE, 0 Net Income: O, 18,000 Retained Earnings: O, 12,000
Assuming that the errors were discovered after the 2020 financial statements were issued, analyze the effect of the errors on 2020 and 2019 cost of goods sold, net income, and retained earnings (Ignore income taxes) "2020"
Journal Entry: 1 - Debit Retained Earnings: 104,000 - Credit Interest Expense: 104,000 Journal Entry: 2 - Debit Interest Expense: 104,000 - Credit Interest Payable: 104,000
At the end of 2020, the company failed to accrue $104,000 of interest expense that accrued during the last four months of 2020 on bonds payable. The bonds, which were issued at face value, mature in 2025. The following entry was recorded on March 1, 2021, when the semiannual interest was paid, as well as on September 1 of each year: - Debit Interest Expense: 156,000 - Credit Cash: 156,000
($110,000 - $10,000)/10,000 shares = $10/share
BEPS/DEPS Example: Calculate the BEPS
Earnings Per Incremental Share: - Step 1: (((50,000 x 10%) x 70%) / 2,500) = $1.40 per share
BEPS/DEPS Example: Calculate the DEPS (Convertible Bonds)
Earnings Per Incremental Share: - Step 1: (Assumed New Shares "2,000" - Assumed Treasury Shares Repurchased "1,500") = 500 Step 2: ($0 / 500) = $0 per share (1) (Note: 1,500 = ((2,000 x 15) / 20))
BEPS/DEPS Example: Calculate the DEPS (Options)
Earnings Per Incremental Share: - Step 1: (10,000 / 5,000) = $2.00
BEPS/DEPS Example: Calculate the DEPS (Preferred Stock)
(1) Options (2) Bonds (3) Preferred Stock
BEPS/DEPS Example: Options, Bonds, Preferred Stock Rank
- Is based on what actually happened during the year and is calculated as income available to common shareholders divided by the weighted average number of common shares outstanding during the period (Note) - All companies need to report basic EPS on the face of the income statement
Basic Earnings Per Share (EPS)
The "earnings per incremental share" of dilutive options, warrants, or rights are always $0 (Note) - ($0/assumed change to the denominator)
Because there is an assumed change to the denominator but no assumed change to the numerator
Net Pension Asset: (160,000 - 150,000) = $10,000 Net Pension Liability: (346,000 - 359,000) = $13,000
Calculate each of the following amounts as of both December 31, 2021, and December 31, 2022. (Net Pension Asset or Net Pension Liability)
Pension Expense: $150,000 - Service Cost: 150,000 - Interest Cost: (6% x 0) = 0 - Expected Return on the Plan Assets: (10% x 0) = 0 Balance 12/31/21: (150,000 + 0 - 0) = 150,000 Pension Expense: $193,000 - Service Cost: 200,000 - Interest Cost: (6% x 150,000) = 9,000 - Expected Return on the Plan Assets: (10% x 160,000) = 16,000 - Total: (200,000 + 9,000 - 16,000) = 193,000
Calculate each of the following amounts as of both December 31, 2021, and December 31, 2022. (Pension Expense)
Plan Assets: $160,000 - Balance 1/1/21: 0 - Actual Return on Plan Assets: (10% x 0) = 0 - Contributions in year 2021: 160,000 - Benefits Paid: 0 - Balance 12/31/21: (0 + 0 + 160,000 - 0) = 160,000 Plan Assets: $346,000 - Balance 1/1/21: 160,000 - Actual Return on Plan Assets: (10% x 160,000) = 16,000 - Contributions in year 2022: 170,000 - Benefits Paid: 0 - Total: (160,000 + 16,000 + 170,000 - 0) = 346,000
Calculate each of the following amounts as of both December 31, 2021, and December 31, 2022. (Plan Assets)
PBO: $150,000 - Balance 1/1/21: 0 - Service Cost: 150,000 - Interest Cost: (6% x 0) = 0 - Benefits Paid: 0 - Balance 12/31/22: (0 + 150,000 + 0 - 0) = 150,000 PBO: $359,000 - Balance 1/1/22: 150,000 - Service Cost: 200,000 - Interest Cost: (6% x 150,000) = 9,000 - Balance 12/31/23: (150,000 + 200,000 + 9,000 - 0) = 359,000
Calculate each of the following amounts as of both December 31, 2021, and December 31, 2022. (Projected Benefit Obligation)
- Pension Expense Year 3: (3,487 + 395 - 499) = $3,383 - Pension Expense Year 4: (3,696 + 628 - 779) = $3,545
Calculate pension expense for years 3 and 4, assuming $3,000 contributions to the pension fund at the end of each year and an 8% actual and expected rate of return on the plan assets
- ABO at age 39: $9,793 o Annual Retirement Payments: (1.5% x 5 years x $43,500) = 3,263 o N = 20 o I = 6% o PMT = -3,263 o FV = 0 o PV = 37,421 § N = 23 § I = 6% § PMT = 0 § FV = -37,421 § PV = 9,793
Calculate the ABO at age 39, five years after the employee began working
End Mode: Calculate PV N = 20 I = 6% PMT = (1.5% x (38 - 34) x 87,000) = 5,220 PV = 59,873 CLR TUM: Calculate PV N = 24 I = 6% FV = 59,873 PV = 14,787
Calculate the PBO at age 38, four years after the employee began working
- PBO at age 39: $19,593 o Annual Retirement Payments: (1.5% x 5 years x $87,000) = 6,525 o N = 20 o I = 6% o PMT = -6,525 o FV = 0 o PV = 74,841 § N = 23 § I = 6% § PMT = 0 § FV = -74,841 § PV = 19,593
Calculate the PBO at age 39, five years after the employee began working
- Ending PBO Year 3: (3,104 + (3,104 x 1.06) + (3,104 x 6%)) = $6,580 - Ending PBO Year 4: (6,580 + (3,290 x 1.06) + (6,580 x 6%)) = $10,462
Calculate the PBO balance at the end of years 3 and 4 by accumulating service cost and interest cost over the appropriate years, starting from year 1
End Mode: Calculate PV N = 20 I = 6% PMT = (1.5% x (38 - 34) x 42,000) = 2,520 PV = 28,904 CLR TUM: Calculate PV N = 24 I = 6% FV = 28,904 PV = 7,139
Calculate the accumulated benefit obligation (ABO) at age 38, four years after the employee began working
- Funded Status Year 3: (6,580 - 6,240) = $340 - Funded Status Year 4: (10,462 - 9,739) = $723
Calculate the difference between the plan asset balance and the PBO at the end of year 3 and the end of year4 (this difference is called "funded status").
1.5% x (62 - 34) x 87,000 = 36,540
Calculate the estimated annual retirement benefit at the time of retirement
Year 1 Pension Expense: (3,104 + 0 - 0) = 3,104 Service Cost: 3,104 End Mode: Calculate PV N = 20 I = 6% PMT = (1.5% x 1 x 87,000) = 1,305 PV = 14,968 CLR TUM: Calculate PV N = (62 - 35) = 27 I = 6% FV = 14,968 PV = 3,104 Interest Cost: (0 x 6%) = 0 Expected Return: (0 x 8%) = 0 Year 2 Pension Expense: (3,290 + 186 - 240) = 3,236 Service Cost: (3,104 x 1.06) = 3,290 Interest Cost: (3,104 x 6%) = 186 Expected Return: (3,000 x 8%) = 240
Calculate the pension expense for years 1 and 2, assuming $3,000 contributions to the pension fund at the end of each year. The expected and actual rate of return on the pension fund was 8%
- Planned Asset Year 1: ((0 x 8%) + 3,000) = $3,000 - Planned Asset Year 2: ((3,000 x 8%) + 3,000 + 3,000) = $6,240 - Planned Asset Year 3: ((6,240 x 8%) + 6240 + 3,000) = $9,739 - Planned Asset Year 4: ((9,739 x 8%) + 9,739 + 3,000) = $13,518
Calculate the plan asset balance at the end of years 3 and 4 by accumulating contributions and return on the pension fund over the appropriate years, starting from year 1
End Mode: Calculate PV N = 20 I = 6% PMT = 36,540 PV = 419,111
Calculate the projected benefit obligation (PBO) at the time of retirement
- Year 3 o Service Cost: (3,290 x 1.06) = $3,487 o Interest Cost: ((3,104 +3,290 +186) x 6%) = $395 - Year 4 o Service Cost: (3,487 x 1.06) = $3,696 Interest Cost: ((6,580 + 3,487 + 395) x 6%) = $628
Calculate the service cost and interest cost components of pension expense for years 3 and 4
Prospective Method
Changes in estimate are treated using what method?
Projected Benefit Obligation: (130,603 + 9,982 + 9,142) = $149,727
Combine your answers to requirements 1, 3, and 4 to determine the company's projected benefit obligation at the end of 2021 (after 15 years' service) with respect to Davenport
- Numerator: 520,000,000 - 120,000,000) = 400,000,000 (Note: 120,000,000 = 60,000,000 x 2) - Denominator: 100,000,000 - EPS: (400,000,000 / 100,000,000) = $4.00 per share
Compute Basic EPS for the year end 12/31/21
NOT EPS: - Conversion of Preferred Stock: (120,000,000 / 32,000,000) = $3.75 - Conversion of Bonds: ((72,000,000 - (72,000,000 x 25%)) / 32,000,000) = $4.00 per sahre EPS: - Numerator with Conversion of Preferred Stock: (400,000,000 + 120,000,000) = 520,000,000 - Denominator with Conversion of Preferred Stock: (100,000,000 + 32,000,000) = 132,000,000 - EPS with Conversion of Preferred Stock: (520,000,000 / 132,000,000) = $3.94 (Note) Since $4.00 > $3.94 means that the Conversion of bonds is anti-dilutive, so we won't include them. This also means that are Dilutive EPS is $3.94 as there are no other earnings per share to be exercised or converted
Compute Diluted EPS for the year end 12/31/21
Additional shares of common stock that would have been outstanding if the bonds had been converted
Convertible Bonds: Add back to the denominator the number of
After-tax bond interest that wouldn't have been subtracted in calculating net income if the bonds had instead been converted to stock
Convertible Bonds: Add back to the numerator the
Additional shares of common stock that would have been outstanding if the preferred stocks had been converted
Convertible Preferred Stock: Add back to the denominator the number of
Preferred dividends that wouldn't have been subtracted if the preferred stock had instead been converted to common stock
Convertible Preferred Stock: Add back to the numerator the
Actually dilutive
Convertible securities are only included in diluted EPS if they are
Accounting for similarly using the retrospective approach
Corrections of errors are not accounting changes but are
- Obligation - The plan assets set aside to pay the obligation - The periodic expense of having a pension plan (Note) While the first two of these are not separately reported in the balance sheet, it is important to understand the composition of both, and they are reported in the disclosure notes
Defined Benefit Pension Plan Key Elements
- Total Compensation Cost: (3 x 12,000,000) = $36,000,000
Determine the total compensation cost pertaining to the incentive stock option plan
Is a hypothetical number showing the dilutive effective of all potential common shares
Diluted Earnings Per Share
It has a simple capital structure and only needs to report basic EPS
Diluted Earnings Per Share: If a company has no potential common shares outstanding
It has a complex capital structure and needs to report both basic EPS and diluted EPS
Diluted Earnings Per Share: If it has potential common shares outstanding
Any claim by senior securities such as preferred shareholders
Earnings Available to Common Shareholders: Net income minus
- The preferred stock is cumulative or - The preferred dividends were declared
Earnings Available to Common Shareholders: Preferred dividends were declared if
A single number reported frequently to summarize a company's performance
Earnings Per Share
Annual Retirement Payments: (1.6% x 15 years x $90,000) = $21,600
Estimate by the accumulated benefits approach the amount of Davenport's annual retirement payments earned as of the end of 2021
Annual Retirement Payments: (1.6% x 15 years x $240,000) = $57,600
Estimate by the projected benefits approach the amount of Davenport's annual retirement payments earned as of the end of 2021
Annual Retirement Payments: (1.6% x $240,000) = $3,840
Estimate by the projected benefits approach the portion of Davenport's annual retirement payments attributable to 2021 service
A correcting journal entries and/or restatement of prior years' numbers in comparative statements)
Even if errors affecting a prior year's net income self correct, some errors may need
- Stock Option Plans (We will only cover this on) - Stock Plans - Stock Appreciation Rights Plans
Examples of Share-Based Compensation
Fair Value accounting for employee stock options
Expense - The Great Debate: Led to current GAAP requirement of
Retroactively
How are Stock Dividends and Stock Splits treated at the beginning of the year
Debit: Pension Expense Debit/Credit: Pension-Related Asset/Liability Credit: Cash
How do you account for a Defined Benefit Pension Plan?
Debit: Pension Expense Credit: Cash
How do you account for a Defined Contribution Pension Plan?
- The funded status of the pension plan is the difference between the PBO and the plan asset balance - If PBO < plan asset balance = overfunded amount If PBO > plan asset balance = underfunded amount
How do you report the Funded Status of the Pension Plan?
Accumulated Benefit Obligation 2024: $91,711 o Annual Retirement Payments: (1.6% x 18 years x $100,000) = $28,800 o N = 18 o I = 7% o PMT = -28,800 o FV = 0 o PV = 289,702 § N = 17 § I = 7% § PMT = 0 § FV = -289,702 § PV = 91,711
If no estimates are changed in the meantime, what will be the accumulated benefit obligation at the end of 2024 (three years later), when Davenport's salary is $100,000?
Projected Benefit Obligation 2024: $220,106 o Annual Retirement Payments: (1.6% x 18 years x $240,000) = 69,120 o N = 18 o I = 7% o PMT = -69,120 o FV = 0 o PV = 695,284 § N = 17 § I = 7% § PMT = 0 § FV = -695,284 § PV = 220,106
If no estimates are changed in the meantime, what will be the company's projected benefit obligation at the end of 2024 (three years later) with respect to Davenport?
If-Converted Method
In considering convertible securities for diluted EPS, we use what method?
If additional shares are issued during the year, these shares are included in the denominator, weighted for the fraction of the year they were outstanding
Issuance of New Shares
Debit Cash: (for the amount of the option price received) Debit Paid-in Capital-Stock Options: (for the amount related to the options) Credit Common Stock: (record stock issued) (often) Credit Paid-in Capital-Excess of par: (record stock issued)
Journal Entry for when Options are Exercised
- Options - Warrants - Rights - Convertible bonds - Shares of convertible preferred stock which could be exercised or converted to become more shares of common stock
List of Potential Common Shares
- Journal Entries Year 1: o Debit Pension Expense: (3,104 + 0 - 0) = 3,104 o Credit Cash: 3,000 o Credit Pension Related Asset/Liability: (3,104 - 3,000) = 104 - Journal Entries Year 2: o Debit Pension Expense: (3,290 + 186 - 240) = 3,236 o Credit Cash: 3,000 o Credit Pension Related Asset/Liability: (3,236 - 3,000) = 236 - Journal Entries Year 3: o Debit Pension Expense: (3,487 + 395 - 499) = 3,383 o Credit Cash: 3,000 o Credit Pension Related Asset/Liability: (3,383 - 3,000) = 383 - Journal Entries Year 4: o Debit Pension Expense: (3,696 + 628 - 779) = 3,546 o Credit Cash: 3,000 o Credit Pension Related Asset/Liability: (3,546 - 3,000) = 546
Make the journal entries for years 1-4 to record pension expense and contributions to the pension fund
- When the employees retire - How long they live during retirement - Inflation - Future compensation levels - Interest rates - Employee turnover
Many factors affect the amount of the pension payments
Are not adjusted
Modified Retrospective Method: Numbers reported in comparative statements
Journal Entry: 1 - Debit Inventory: 78,000 - Credit Retained Earnings: 78,000 Journal Entry: 2 - No Entry Required
On December 31, 2020, merchandise inventory was understated by $78,000 due to a mistake in the physical inventory count. The company uses the periodic inventory system
Calculate the earnings per incremental share for each of the potential common shares
Order of Entry for Multiple Convertible Securities: (Step 1)
Assume their exercise or conversion one at a time, starting with the item with the smallest earnings per incremental share (if dilutive), and continue to assume the exercise or conversion of other items with increasing earnings per incremental share, as long as they are still dilutive compared to the prior calculation
Order of Entry for Multiple Convertible Securities: (Step 2)
When we have included all potential common shares or the next item becomes antidilutive, the last calculation becomes the diluted EPS
Order of Entry for Multiple Convertible Securities: (Step 3)
Hypothetical worst case scenario or lowest possible EPS
Order of Entry for Multiple Convertible Securities: For diluted EPS, we want the
Are designed to provide income to individuals during their retirement years
Pension Plan
The employer needs to invest money such that enough will be available to pay the promised benefits
Pension Plan Assets
- Income from Continuing Operations: - Net Income: - Earnings Per Common Share
Prepare the 2021-2020 comparative income statements beginning with income from continuing operations (adjusted for any revisions). Include per share amounts: Income From Continuing Operations (2020)
- Income from Continuing Operations: - Net Income: - Earnings Per Common Share:
Prepare the 2021-2020 comparative income statements beginning with income from continuing operations (adjusted for any revisions). Include per share amounts: Income From Continuing Operations (2021)
12/31/21: - Debit Compensation Expense: (36,000,000 / 3 years) = 12,000,000 - Credit Paid in Capital Stock Options: 12,000,000
Prepare the appropriate journal entries to record compensation expense on December 31, 2021, 2022, and 2023. Record the exercise of the options if all of the options are exercised on May 11, 2025, when the market price is $14 per share. (Entry 1)
12/31/22: - Debit Compensation Expense: (36,000,000 / 3 years) = 12,000,000 - Credit Paid in Capital Stock Options: 12,000,000
Prepare the appropriate journal entries to record compensation expense on December 31, 2021, 2022, and 2023. Record the exercise of the options if all of the options are exercised on May 11, 2025, when the market price is $14 per share. (Entry 2)
12/31/23: - Debit Compensation Expense: (36,000,000 / 3 years) = 12,000,000 - Credit Paid in Capital Stock Options: 12,000,000
Prepare the appropriate journal entries to record compensation expense on December 31, 2021, 2022, and 2023. Record the exercise of the options if all of the options are exercised on May 11, 2025, when the market price is $14 per share. (Entry 3)
05/11/25: - Debit Cash: (11 x 12,000,000) = 132,000,000 - Debit Paid in Capital Stock Options: (12,000000 x 3 years) = 36,000,000 - Credit Common Stock: (12,000,000 x 1) = 12,000,000 - Credit Paid in Capital Excess of Par: (132,000,000 + 36,000,000 - 12,000,000) = 156,000,000
Prepare the appropriate journal entries to record compensation expense on December 31, 2021, 2022, and 2023. Record the exercise of the options if all of the options are exercised on May 11, 2025, when the market price is $14 per share. (Entry 4)
01/01/2021: Debit Inventory: (155,000 - 120,000) = 35,000 Credit: Retained Earnings: 35,000
Prepare the journal entry at January 1, 2021, to record the change in accounting principle (Ignore all taxes)
- Asset's Cost: 21,000 - Accumulated Depreciation (SYD): (6,909) - Undepreciated Cost, 01/01/2021: (21,000 - 6,909) = 14,091 - Estimated Residual Value to be depreciated over remaining 8 years: (1,000) - Annual straight-line depreciation 2021-2028: ((14,091 - 1,000) / 8) = $1,636 (Note) A disclosure note should justify that the change is preferable and describe the effect of a change on any financial statement line items and per share amounts affected for all periods reported ANSWER: Debit Depreciation Expense: 1,636 Credit Accumulated Depreciation: 1,636
Prepare the journal entry that Faulkner will record in 2021 related to the change
- Event: An Error - Type of Change: Not Applicable (NA) Journal Entry: 1 - Debit Prepaid Insurance: ((35,000 / 5) x 3) = 21,000 - Credit Retained Earnings: (35,000 - ((35,000 / 5) x 2)) = 21,000 Journal Entry: 2 - Debit Insurance Expense: (35,000 / 5) = 7,000 - Credit Prepaid Insurance: 7,000
Problem A: A five-year casualty insurance policy was purchased at the beginning of 2019 for $35,000. The full amount was debited to insurance expense at the time - State whether it represents and accounting change or an error - If an accounting change, what type of change - Journal Entry if needed
- Event: An Accounting Change - Type of Change: Change in Estimate Journal Entry: 1 - No Entry Required Journal Entry: 2 - Debit Depreciation Expense: ((600,000 - (12,500 x 10) - 25,000)) / 30) = 15,000 - Credit Accumulated Depreciation: 15,000
Problem B: Effective January 1, 2021, the company changed the salvage value used in calculating depreciation for its office building. The building cost $600,000 on December 29, 2010, and has been depreciated on a straight-line basis assuming a useful life of 40 years and a salvage value of $100,000. Declining real estate values in the area indicate that the salvage value will be no more than $25,000 - State whether it represents and accounting change or an error - If an accounting change, what type of change - Journal Entry if needed
- Event: An Error - Type of Change: NA Journal Entry: 1 - Debit Retained Earnings: 25,000 - Credit Inventory: 25,000 Journal Entry: 2 - No Entry Required
Problem C: On December 31, 2020, merchandise inventory was overstated by $25,000 due to a mistake in the physical inventory count using the periodic inventory system - State whether it represents and accounting change or an error - If an accounting change, what type of change - Journal Entry if needed
- Event: An Accounting Change - Type of Change: Change in Accounting Principle Journal Entry: 1 - Debit Inventory: 960,000 - Credit Retained Earnings: 960,000 Journal Entry: 2 - No Entry Required
Problem D: The company changed inventory cost methods to FIFO from LIFO at the end of 2021 for both financial statement and income tax purposes. The change will cause a $960,000 increase in the beginning inventory at January 1, 2022 - State whether it represents and accounting change or an error - If an accounting change, what type of change - Journal Entry if needed
- Event: An Error - Type of Change: NA Journal Entry: 1 - Debit Retained Earnings: 15,500 - Credit Compensations Expense: 15,500 Journal Entry: 2 - No Entry Required
Problem E: At the end of 2020, the company failed to accrue $15,500 of sales commissions earned by employees during 2020. The expense was recorded when the commissions were paid in early 2021 - State whether it represents and accounting change or an error - If an accounting change, what type of change - Journal Entry if needed
- Event: An Accounting Change - Type of Change: Change in estimate resulting from a change in accounting principle Journal Entry: 1 - No Entry Required Journal Entry: 2 - Debit Depreciation Expense: ((460,800 - 0) / 8) = 57,600 - Credit Accumulated Depreciation: 57,600
Problem F: At the beginning of 2019, the company purchased a machine at a cost of $720,000. Its useful life was estimated to be 10 years with no salvage value. The machine has been depreciated by the double-declining balance method. Its book value on December 31, 2020, was $460,800. On January 1, 2021, the company changed to the straight-line method - State whether it represents and accounting change or an error - If an accounting change, what type of change - Journal Entry if needed
- Event: An Accounting Change - Type of Change: Change in Estimate Journal Entry: 1 - No Entry Required Journal Entry: 2 - Debit Warranty Expense: (4,000,000 x 0.75%) = 30,000 - Credit Warranty Liability: 30,000
Problem G: Warranty expense is determined each year as 1% of sales. Actual payment experience of recent years indicates that 0.75% is a better indication of the actual cost. Management effects the change in 2021. Credit sales for 2021 are $4,000,000; in 2020 they were $3,700,000 - State whether it represents and accounting change or an error - If an accounting change, what type of change - Journal Entry if needed
The present value of the expected future retirement benefits to be paid based on future (projected) salary levels prior to retirement
Projected Benefit Obligation (PBO)
Is simply applied to the current and future periods, and prior-period comparative statements are not restated
Prospective Approach
The prospective method may be used
Prospective Approach: If it is impracticable to use the retrospective method
Reduced by the number of shares repurchased, weighted for the fraction of the year these shares were not outstanding
Reacquired Shares: If shares are reacquired during the year, the weighted average number of shares outstanding is
Used to determine the fair value of the options
Recognizing the Fair Value Options: Option Pricing Model
Over the service/vesting period - Usually the vesting period is several years - The employees must stay with the company for that period to keep their options - As the amount is expensed over the vesting period (Note) - The amount is added to Paid-in Capital-Stock Options
Recognizing the Fair Value Options: The total value of the options is expensed
Grant Date
Recognizing the Fair Value Options: We measure fair value of the options at the
Compensation expense over the service period for which the options are granted
Recognizing the Fair Value Options: We record the fair value of the options as
How well the fund has grown over time
Relating to Defined Contribution Plan: Employee will get retirement income based on
The employer bears no risk once the contributions are made
Relating to Defined Contribution Plan: The employee bears the risk of the investment returns, meaning
Invested (usually with input from the employee choosing among designated funds based on their risk preferences)
Relating to Defined Contribution Plan: The funds are
- The employer has an obligation that is not paid until retirement - The obligation is increased each year for the interest which accrues on the existing obligation
Relation to PBO: Interest Cost
- This is the increase in the PBO due to the employees having worked one more year (more retirement benefits)
Relation to PBO: Service Cost
Increases the amounts owed in the future
Relation to PBO: Service Cost increases the PBO, as it
Service Period
Relation to PBO: Service Cost is an amount calculated for each separate year of the
Having worked during that one year
Relation to PBO: Service Cost is the present value (at year-end) of the retirement benefits earned by the employees for
This means we report all prior period financial statements (at least those which will be presented as comparative statements) as if the new method had been used in those prior periods
Retrospective Approach: What do we mean when we say that most voluntary changes in accounting principle are treated retrospectively?
It is treated as having been made as of the beginning of that year
Retrospective Approach: What happens when a change in principle is made any time during a fiscal year?
Appropriate balances, including retained earnings, will be adjusted as if the new method had been used in those prior years
Revise Comparative Financial Statements: What happens to the balance sheet when a new method has been implemented?
Appropriate amounts will be adjusted as if the new method had been used in those prior years
Revise Comparative Financial Statements: What happens to the income statement when a new method has been implemented?
The beginning retained earnings balance for the earliest period presented in the comparative statements must be adjusted for the cumulative effect of the change prior to that date
Revise Comparative Financial Statements: What happens to the statement of shareholder's equity when a new method has been implemented?
- Forms of payment whose value is dependent on the value of the company's stock
Share-Based Compensation
- BEPS: ((110,000 - 10,000) / 10,000) = $10.00 per share
Step 1: BEPS/DEPS Example: Calculate the DEPS (Assume Exercise/Conversion for Dilutive Items)
(Note: Options are dilutive compared to BEPS, so their exercise will be assumed) - DEPS1: ((100,000 + 0) / (10,000 + 500)) = $9.52 per share
Step 2: BEPS/DEPS Example: Calculate the DEPS (Assume Exercise/Conversion for Dilutive Items)
(Note: Bonds are dilutive compared to DEPS1, so their conversion will be assumed) - DEPS2: ((100,000 + 0 + 3,500) / 10,000 + 500 + 2,500) = $7.96 per share
Step 3: BEPS/DEPS Example: Calculate the DEPS (Assume Exercise/Conversion for Dilutive Items)
(Note: The preferred stock is still dilutive compared to DEPS2) - DEPS3: ((100,000 + 0 + 3,500 + 10,000) / (10,000 + 500 + 2,500 + 5,000)) = $6.31 (Note: $6.31 is the final DEPS because no other potential common shares exist)
Step 4: BEPS/DEPS Example: Calculate the DEPS (Assume Exercise/Conversion for Dilutive Items)
Divide the total value of the company into more pieces
Stock Dividends and Stock Splits
The value of the options also increases
Stock Option Plans: As the value of the stock increases
- A specified number of shares of the firm's stock - At a specified price - During a specified period of time
Stock Option Plans: Employees are given the option to buy
Since the exercise price is less than average market price, the options are not antidilutive and therefore assumed exercised when calculating diluted EPS
Stock options exercisable at $30 per share after January 1, 2023
Applies the new principle only to the adoption period (not to prior periods for comparative statements) and adjusts the beginning retained earnings for the current period
The Modified Retrospective Method
- Service Cost - Interest Cost - Prior Service Cost - Gain or Loss on PBO - Payment of Retirement Benefits
The PBO balance will change over time for five different reasons
- Any employer contributions/funding - The return on plan assets (Note) - We use the expected return rather than the actual return in this calculation
The Pension Plan Assets increase by what?
Funded Status
The balance in the Pension-Related Asset/Liability account will always equal the
The change in the funded status for the year
The debit or credit to the Pension-Related Asset/Liability account for the year will always equal
They will work hard to drive up the value of the shares, thus making their compensation worth more
The idea behind Share-Based Compensation is that if executives (and perhaps other employees) are compensated with share-based awards,
Beginning retained earnings for the year following the error, or for the earliest year being reported in the comparative financial statements if the error occurred before then
The prior period adjustment is applied to
A mandated change in accounting principle requires it
The prospective method is applied if
Government regulations and accounting standards make them costly and complicated to administer
Three reasons why almost all new pension plans are moving away from defined benefit plans to defined contribution plans (1)
Employer's increasing desire to avoid the risk of these plans (including increasing lifespan of retired employees)
Three reasons why almost all new pension plans are moving away from defined benefit plans to defined contribution plans (2)
A shift from employee/employer long-term loyalty
Three reasons why almost all new pension plans are moving away from defined benefit plans to defined contribution plans (3)
- The options, warrants, or rights were exercised and additional shares of the stock were issued
Treasury Stock Method assumes what? (1)
- The assumed money from the assumed exercise is used to buy back treasury shares at the average market price for the year
Treasury Stock Method assumes what? (2)
- The difference between the number of shares assumed issued minus the number of treasury shares assumed repurchased is added to the denominator in calculating diluted EPS (Note) - The assumed exercise happens at the beginning of the year or when the option, warrant, or right was issued, whichever comes later
Treasury Stock Method assumes what? (3)
Journal Entry: 1 - Debit Cash: 17,000 - Credit Office Supplies: 17,000 Journal Entry: 2 - Debit Tools: 17,000 - Credit Cash: 17,000
Two weeks prior to the audit, the company paid $17,000 for assembly tools and recorded the expenditure as office supplies. The error was discovered a week later
Journal Entry: 1 - Debit Retained Earnings: ((12 x 2,000) - 2,000) = 22,000 - Credit Paid-in Capital-Excess of Par: 22,000 Journal Entry: 2 - No Entry Required
Two years earlier, the company recorded a 4% stock dividend (2,000 common shares, $1 par) as follows: - Debit Retained Earnings: 2,000 - Credit Common Stock: 2,000 The shares had a market price at the time of $12 per share
Beginning of the year or when the convertible security was issued, whichever is later
Under the if-converted method, convertible securities are assumed converted at the
- Pension Related Asset/Liability Account for Year 4: (104 + 236 + 383 + 546) = $1,269 Funded Status Year 4 End: (546 + 723) = $1,269
Using the journal entries prepared in #7, calculate the balance in the Pension-Related Asset/Liability account at the end of year 4 and verify that it equals the funded status at the end of year 4 (calculated in #8above). [Note: Although this is true for this problem, it won't necessarily be true in general if the other potential components of pension expense, which we are not discussing, are included.]
- PBO at Year 4 End: (6,580 + (3,290 x 1.06) + (6,580 x 6%)) = $10,462 "Don't match" - PBO at age 38: $14,787 "Don't match" o N = 20 o I = 6% o PMT = (1.5% x (38 - 34) x 87,000) = -5,220 o PV = 59,873 § N = 24 § I = 6% § FV = -59,873 § PV = 14,787
Verify that the PBO at the end of year 4 (from #5 above) equals the PBO at the end of year 4 (from #3 in the in-class portion of this problem) within rounding error.
- Change in Funded Status from Year 3 End and Year 4 End: (1,269 - 723) = $546 - Net of Year 4 Pension Expense & Cash Contributions: (3,546 - 3,000) = $546
Verify that the change in the funded status from the end of year 3 to the end of year 4 equals the net of the year 4 pension expense and the year 4 cash contributions (from the year 4 journal entry in #7)
Since the exercise price is higher than the average market price, the warrants are antidilutive and therefore ignored when calculating diluted EPS
Warrants for 1,000 common shares with an exercise price of $35 per share
Treasury Stock Method (Note) - This will occur only when the average market price of the stock for the year exceeds the exercise price of the option, warrant, or right
What Method would you use if options, warrants or rights are dilutive in calculating diluted EPS?
Recording a balance sheet item in the wrong account (Note) Since this error does not affect income, no prior period adjustment would be needed
What are 3 examples of an error affecting previous financial statements, but not net income? (Example 1)
Recording an income statement item in the wrong account without affecting net income (Note) Since this error does not affect income, no prior period adjustment would be needed
What are 3 examples of an error affecting previous financial statements, but not net income? (Example 2)
Classifying a cash flow incorrectly in the statement of cash flows (Note) Since this error does not affect income, no prior period adjustment would be needed
What are 3 examples of an error affecting previous financial statements, but not net income? (Example 3)
- Accumulated Benefit Obligation (ABO) - Vested Benefit Obligation (VBO) - Projected Benefit Obligation (PBO)
What are 3 ways that The Pension Obligation can be measured?
- Service Cost - Interest Cost - Expected Return on the planned asset
What are the 3 out of 5 Pension Expense components that we need to know?
Simply reverse the incorrect entry and make the correct entry; or make a correcting entry to get to the correct account balances
What do you do when discovering an error in the same reporting period that it occurred?
- Overstated - Understated - No Effect
What does "O", "U", "NE" stand for in this class
- It is also affecting the balance sheet - May affect income statement - It is also affecting taxes
What does it mean when an error affects net income?
- The amount of the payments to be made to the employees during retirement is defined in the pension plan
What is a Defined Benefit Pension Plan?
The amount of the employer contribution is defined by the plan
What is a Defined Contribution Pension Plan?
Accumulated Benefit Obligation 2021: $56,148 o N = 18 o I = 7% o PMT = -21,600 o FV = 0 o PV = 217,276 § N = 20 § I = 7% § PMT = 0 § FV = -217,276 § PV = 56,148
What is the company's accumulated benefit obligation at the end of 2021 with respect to Davenport?
Interest Cost: (130,603 X 7%) = $9,142
What is the company's interest cost for 2021 with respect to Davenport?
Beginning PBO: $130,603 o Annual Retirement Payments: (1.6% x 14 years x $240,000) = 53,760 o N = 18 o I = 7% o PMT = -53,760 o FV = 0 o PV = 540,777 § N = 21 § I = 7% § PMT = 0 § FV = -540,777 § PV = 130,603
What is the company's projected benefit obligation at the beginning of 2021 (after 14 years' service) with respect to Davenport?
Projected Benefit Obligation 2021: $149,730 o N = 18 o I = 7% o PMT = -57,600 o FV = 0 o PV = 579,404 § N = 20 § I = 7% § PMT = 0 § FV = -579,404 § PV = 149,730
What is the company's projected benefit obligation at the end of 2021 with respect to Davenport?
Service Cost: $9,982 o N = 18 o I = 7% o PMT = -3,840 o FV = 0 o PV = 38,627 § N = 20 § I = 7% § PMT = 0 § FV = -38,627 PV = 9,982
What is the company's service cost for 2021 with respect to Davenport?
- Service Cost (Increases Pension Expense) - Interest Cost (Increases Pension Expense)
What will be included in Pension Expense from PBO?
- Expected Return on Plan Assets (Decreases Pension Expense)
What will be included in Pension Expense from Plan Assets?
FASB may specify the approach for handling the change or may give companies a choice of how to handle the change, using the: - Retrospective Method - Prospective Method - The Modified Retrospective Method
When a new accounting standard mandates a change in accounting principle
There wouldn't be any justification to do so
Why would we not expect companies to switch back and forth accounting changes?
It would reduce comparability
Why would we not expect to see a lot of accounting changes?