Chapter 20 AC311 Accounting Changes and Error Corrections

change from reporting as one type of entity to another type of entity occurs as a result of:

-Presenting consolidated financial statements in place of statements of individual companies, -Changing specific companies that constitute the group for which consolidated or combined statements are prepared, -Changes in accounting rules, or -One company acquiring another a disclosure note should describe the nature of the change and the reason it occurred

Retrospective approach

-financial statements issued In previous years are revised -statements are made to appear as if the newly adopted accounting method had been applied all along or that the error had never occurred -then, a journal entry is created to adjust all account balances effective (MOST voluntary changes in accounting principles are reported this way)

Modified retrospective approach

-new standard applied only to the current period -adjust retained earnings balance at beginning of year

Change in accounting estimate:

-revision of an estimate may result from new info or new experience -there are accounted for prospectively -disclosure note should describe the effect of a change in estimate on income from continuing operations, net income, and related per share amounts for the current period

three approaches

1) retrospective approach 2) modified retrospective approach 3)prospective approach (NOT going to be asked to determine how to account ... retro, modified, or prospec)

In 2021, it was discovered that Hines 55 had debited expense for the full cost of an asset purchased on January 1, 2018. The cost was $24 million with no expected residual value. Its useful life was 5 years and straight-line depreciation is used by the company. The correcting entry assuming the error was discovered in 2021 before the adjusting and closing entries includes: a) A credit to accumulated depreciation of $14.4 million b) A debit to accumulated depreciation of $9.6 million c) A debit to retained earnings of $9.6 million d) A credit to an asset of $24 million

A) A credit to accumulated depreciation of $14.4 million

Which of the following is not a change in accounting principle usually accounted for by retrospectively revising prior financial statements? a) Change from sum-of-the-years'-digits to double-declining balance depreciation method b) Change from FIFO to the average method c) Change from the average method to FIFO d) Change from LIFO to FIFO

A) Change from sum-of-the-years'-digits to double-declining balance depreciation method

the prospective approach usually is required for: a) a change in reporting entity b) a change in estimate c) a change in accounting principle d) a correction of an error

B) a change in estimate

which of the following is NOT a change in accounting principle? a) a change from the LIFO to the average cost inventory costing method b) a change in the useful life of a depreciable asset c) a change to implement a new FSB accounting standard d) a change from the equity method ton the cost method to value investments in subsidiaries

B) a change in the useful life of a depreciable asset

a change in accounting principle that usually should not be reported by revising the financial statements of prior periods is a change from: a) The weighted-average method to the FIFO method b) The weighted-average method to the LIFO method c) FIFO method to the weighted-average method d) LIFO method to the weighted-average method

B) the weighted-average method to the LIFO method

The retrospective approach: Big merchandisers changed from FIFO method of costing inventories to the weighted-average method during 2021. when reported in the 2021 comparative financial statements, the 2020 inventory amount will be: a) Increased b) Decreased c) Increased or decreased, depending on how prices changed during 2021 d) Unaffected

C) increased or decreased, depending on how prices changed during 2021

Lamont Communications has amortized a patent on a straight-line basis since it was acquired at the beginning of 2018 at a cost of $50 million. During 2021, management decided that the benefits from the patent would be received over a total period of 8 years rather than the 20-year legal life being used to amortize the cost. Lamont's 2021 financial statements should include: a) A patent balance of $50 million b) Patent amortization expense of $2.5 million c) Patent amortization expense of $5 million d) A patent balance of $34 million

D) A patent balance of $34 million

which of the following constitutes a change in reporting entity? a) Hunt Corporation launches a new product line b) Hunt Corporation reports a net loss after reporting net income for five consecutive years c) Hunt Corporation converts from a simple capital structure to a complex capital structure d) Hunt Corporation acquires ownership of Outdoors Unlimited

D) Hunt Corporation acquires ownership of Outdoors Unlimited

Global Products overstated its inventory by $30 million at the end of 2020. The discovery of this error during 2021, before adjusting or closing entries, would require: a) A debit to inventory of $30 million b) A prospective adjustment in the 2021 income statement c) An increase in retained earnings d) None of the above

D) None of the above

Steps to correct an error

Step 1 A journal entry is made to correct any account balances that are incorrect as a result of the error. Step 2 Previous years' financial statements that were incorrect as a result of the error are retrospectively restated to reflect the correction (for all years reported for comparative purposes). Step 3 If retained earnings is one of the accounts incorrect as a result of the error, the correction is reported as a prior period adjustment to the beginning balance in a statement of shareholders' equity (or statement of retained earnings if that's presented instead). Step 4 A disclosure note should describe the nature of the error and the impact of its correction on net income.

disclosure notes

must be provided in the first set of financial statements after the change to justify the application of the new method.

can errors that eventually correct themselves cause financial statements to be misstated in the meantime?

yes

do most errors eventually self-correct?

yes

are income taxes affected by income errors?

yes, and amended tax returns are prepared: -either to pay additional taxes; or -to claim a tax refund for taxes overpaid

do most errors affect net income?

yes, and when they do they affect the balance sheet as well -both statements must be retrospectively restated -the statement of cash flows sometimes is affected too

errors are cause by:

- a transaction being recorded incorrectly or not recorded at all -previous years' financial statements are retrospectively restated

the modified retrospective approach must apply and adjust

-APPLY the new standard only to the adoption period (the current period) -ADJUST the balance of retained earnings at the beginning of the adoption period to capture the cumulative effects of the prior periods without actually adjusting the numbers in the prior periods reported.

disclosure note must:

-explain why the change was needed as well as its effects on items not reported on the face of the primary financial statements -point out the comparative info has been revised -report any per share amounts affected for the current period and all prior periods presented

Which of the following is NOT true regarding the correction of an error? a) A journal entry is made to correct any account balances that are incorrect as a result of the error b) Prior years' financial statements are restated to reflect the correction of the error (if the error affected those statements) c) The correction is reported prospectively; previous financial statements are not revised d) A disclosure note should describe the nature of the error and the impact of its correction on each financial statement line item and any per-share amounts affected for each prior period presented.

C) The correction is reported prospectively; previous financial statements are not revised

Which of the following statements is true regarding correcting errors in previously issued financial statements prepared in accordance with International Financial Reporting Standards? a) The error can be reported in the current period if it's not considered practicable to report it prospectively b) The error can be reported prospectively if it's not considered practicable to report it retrospectively c) The error can be reported in the current period if it's not considered practicable to report it retrospectively d) Retrospective application is required with no exception

C) The error can be reported in the current period if it's not considered practicable to report it retrospectively

What does the FASB sometimes allow?

a modified retrospective approach

prior period adjustment

addition to or reduction in the beginning retained earnings balance in a statement of shareholders' equity due to a correction of an error.

change in accounting principle

change from one generally accepted accounting principle to another

change in reporting entity

change from reporting as one type of entity to another type of entity

error corrections

correct an error caused by a transaction being recorded incorrectly or not at all

prospective approach

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

change in accounting estimate

revise an estimate because of new information of=r new experience