Accounting changes and error corrections
This presentation is the property of its rightful owner.
Sponsored Links
1 / 37

Accounting Changes and Error corrections PowerPoint PPT Presentation


  • 89 Views
  • Uploaded on
  • Presentation posted in: General

Chapter 20. Accounting Changes and Error corrections . Accounting Changes. Accounting Changes and Error Corrections. Retrospective. Two Reporting Approaches. Prospective . Error Corrections and Most Changes in Principle. Retrospective.

Download Presentation

Accounting Changes and Error corrections

An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -

Presentation Transcript


Accounting changes and error corrections

Chapter 20

Accounting Changes and Error corrections


Accounting changes

Accounting Changes


Accounting changes and error corrections1

Accounting Changes and Error Corrections

Retrospective

TwoReporting Approaches

Prospective


Error corrections and most changes in principle

Error Corrections and Most Changes in Principle

Retrospective

  • Revise prior years’ statements (that arepresented for comparative purposes) to reflectthe impact of the change.

    • The balance in each account affected is revised to appear as if the newly adopted accounted method had been applied all along or that the error had never occurred.

    • Adjust the beginning balance of retained earnings for the earliest period reported.

TwoReporting Approaches

Prospective


Changes in estimates and some changes in principle

Changes in Estimates and Some Changes in Principle

  • The change is implemented in the current period, and its effects are reflected in thefinancial statements of the current andfuture years only.

    • Prior years’ statements are not revised.

    • Account balances are not revised.

Retrospective

TwoReporting Approaches

Prospective


Change in accounting principle

Change in Accounting Principle

Qualitative Characteristics

Consistency

Comparability

Although consistency and comparability are desirable, changing to a new method sometimes is appropriate.


Motivation for accounting choices

Motivation for Accounting Choices

Effect on Compensation

Changing Conditions

Motivations for Change

Effect on Debt Agreements

Effect on Union Negotiations

New Standard Issued

Effect on Income Taxes


Retrospective approach most changes in principle

Retrospective Approach – Most Changes in Principle

Let’s look at an examples of a change from LIFO to FIFO.

At the beginning of 2009, Air Parts Corporation changed from LIFO to FIFO. Air Parts has paid dividends of $40 million each year since 2002. Its income tax rate is 40 percent. Retained earnings on January 1, 2007, was $700 million; inventory was $500 million. Selected income statement amounts for 2009 and prior years are (in millions):


Retrospective approach

Retrospective Approach

For each year reported, Air Parts makes the comparativestatements appear as if the newly adopted accountingmethod (FIFO) had been in use all along.


Retrospective approach1

Comparative balance sheets will report 2007 inventory $345 million higher than it was reported in last year’s statements.

Retained earnings for 2007 will be $207 million higher.[$345 million × (1 – 40% tax rate)]

Retrospective Approach

For each year reported, Air Parts makes the comparativestatements appear as if the newly adopted accountingmethod (FIFO) had been in use all along.


Retrospective approach2

Comparative balance sheets will report 2008 inventory $400 million higher than it was reported in last year’s statements.

Retained earnings for 2008 will be $240 million higher.[$400 million × (1 – 40% tax rate)]

Retrospective Approach

For each year reported, Air Parts makes the comparativestatements appear as if the newly adopted accountingmethod (FIFO) had been in use all along.


Retrospective approach3

Comparative balance sheets will report 2009 inventory $460 million higher than it would havebeen if the change from LIFO had not occurred.

Retained earnings for 2009 will be $276 million higher.[$460 million × (1 – 40% tax rate)]

Retrospective Approach

For each year reported, Air Parts makes the comparativestatements appear as if the newly adopted accountingmethod (FIFO) had been in use all along.


Retrospective approach4

Retrospective Approach

On January 1, 2009, the date of the change,the following journal entry would be madeto record the change in principle.

40% of $400,000,000


Retrospective approach5

Retrospective Approach

In the first set of financial statements after thechange is made, a disclosure note is needed to

Providejustification for the change.

Point out thatcomparativeinformation hasbeen revised.

Report any pershare amountsaffected for thecurrent and allprior periods.


Prospective approach some changes in principle

Prospective Approach – Some Changes in Principle

The prospective approach is used for changes in principle when:

  • It is impracticable to determine some period- specific effects.

  • It is impracticable to determine the cumulative effect of prior years.

  • The change is mandated by authoritative pronouncements.

Most changes in principle are reported by the retrospective approach, but:


Prospective approach change in accounting estimate

Prospective Approach – Change in Accounting Estimate

A change in depreciation method is considered to be achange in accounting estimatethat is achieved by a change in accounting principle. It is accounted forprospectivelyas a change in accounting estimate.


Change in accounting estimate

Change in Accounting Estimate

Changes in accounting estimates are accounted for prospectively. Let’s look at an example of a change in a depreciation estimate.

On January 1, 2005, Towing, Inc. purchased specialized equipment for $243,000. The equipment has been depreciated using the straight-line method and had an estimated life of 10 years and salvage value of $3,000. In 2009 the total useful life of the equipment was revised to 6 years. The 2009 depreciation expense is

a. $24,000

b. $48,000

c. $72,000

d. $73,500

$243,000 – $3,000 = $24,000 (2005 – 2008)

10 years

$24,000 × 4 years = $96,000 Accum. Depr.

$243,000 – $96,000 = $147,000 Book Value

$147,000 – $3,000 = $72,000 (2009 – 2010)

2 years


Changing depreciation methods

Changing Depreciation Methods

Universal Semiconductors switched from SYDdepreciation to straight-line depreciation in 2009. The asset was purchased at the beginning of 2007for $63 million, has a useful life of 5 years andan estimated residual value of $3 million.


Changing depreciation methods1

Changing Depreciation Methods

÷


Changing depreciation methods2

Changing Depreciation Methods

Depreciation adjusting entryfor 2009, 2010, and 2011.


Change in reporting entity

Change in Reporting Entity

A change in reporting entity occurs as a result of:

 presenting consolidated financial statements in place of statements of individual companies, or

 changing specific companies that constitute the group for which consolidated statements are prepared.


Change in reporting entity1

Change in Reporting Entity

Summary of the Retrospective Approach for Changes in Reporting Entity

Recast all previous periods’ financial statements as if the new reporting entity existed in those periods.

In the first financial statements after the change:

 A disclosure note should describe the nature of and the reason for the change.

 The effect of the change on net income, income before extraordinary items, and related per share amounts should be shown for all periods presented.


Error correction

Error Correction

  • Examples include:

    • Use of inappropriate principle

    • Mistakes in applying GAAP

    • Arithmetic mistakes

    • Fraud or gross negligence in reporting

  • For all years disclosed, financial statements are retrospectively restatedto reflect the error correction.


Correction of accounting errors

Correction of Accounting Errors

Four-step process

  • Prepare a journal entryto correct any balances.

  • Retrospectively restateprior years’ financial statements that were incorrect.

  • Report correction as a prior period adjustmentif retained earnings is one of the incorrect accounts affected.

  • Include a disclosure note.


Prior period adjustments

Prior Period Adjustments

Prior Period Adjustment Required

Counterbalancing error discovered in the second year.

Noncounterbalancing error discovered in any year.

Use the retrospective approach


Errors occurred and discovered in the same period

Errors Occurred and Discovered in the Same Period

Corrected byreversingthe incorrect entry and then recording the correct entry (or by making an entry to correct the account balances)


Errors not affecting prior years net income

Involves incorrect classification of accounts.

Requires correction of previously issued statements(retrospective approach).

Is notclassified as a prior period adjustment since it does not affect prior income.

Disclose nature of error.

Errors Not Affecting Prior Years’ Net Income


Error affecting prior year s net income

Requires correction of previously issued statements(retrospective approach).

All incorrect account balances must be corrected.

Is classified as a prior period adjustment since it does affect prior income.

Disclose nature of error.

Error Affecting Prior Year’s Net Income


Error affecting prior year s net income1

Error Affecting Prior Year’s Net Income

In 2009, the accountant at Orion, Inc. discovered the depreciation of $50,000 on a new asset purchased in 2008 had not been recorded on the books. However, the amount was properly reported on the tax return. This is the only difference between book and tax income. Accounting income for 2008 was $275,000 and taxable income was $225,000. Orion, Inc. is subject to a 30% tax rate and prepares current period statements only.

The entry made in 2008 to record income taxes was


Error affecting prior year s net income2

Error Affecting Prior Year’s Net Income

This error affected the following accounts

Remember, the 2008 expense accounts were closed to RE.


Error affecting prior year s net income3

Error Affecting Prior Year’s Net Income

Let’s assume the following:

On 1/1/09, the retained earnings balance was $922,000. In 2009, the company paid $65,000 in dividends. Net income for 2009 was $184,000.

The Statement of Retained Earnings (or RE column of the Statement of Shareholders’ Equity) would be as follows:


Correction of accounting errors1

Correction of Accounting Errors

Identify the type of accounting error for the following item:

Ending inventory was incorrectly counted.

a.Counterbalancing error affecting net income.

b. Noncounterbalancing error affecting net income.

c. Error not affecting net income.

d. None of the above.


Correction of accounting errors2

Correction of Accounting Errors

Identify the type of accounting error for the following item:

Loss on sale of furniture was incorrectly recorded as depreciation expense.

a.Counterbalancing error affecting net income.

b. Noncounterbalancing error affecting net income.

c. Error not affecting net income.

d. None of the above.


Correction of accounting errors3

Correction of Accounting Errors

Identify the type of accounting error for the following item:

Depreciation expense was understated.

a. Counterbalancing error affecting net income.

b. Noncounterbalancing error affecting net income.

c. Error not affecting net income.

d. None of the above.


Correction of accounting errors4

Correction of Accounting Errors

A prior period adjustment is not required for a

a. Counterbalancing error affecting net income

discovered in the second year.

b. Counterbalancing error affecting net income

discovered after the second year.

c. Noncounterbalancing error affecting net

income.

d. None of the above.


Summary of accounting changes and errors

Summary of Accounting Changes and Errors


Accounting changes and error corrections

End of Chapter 20


  • Login