Intermediate accounting 15e kieso warfield chapter 22

Understand how to account for retrospective accounting changes.. Understand how to account for retrospective accounting changes.. Understand how to account for retrospective accountin

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Prepared by

Intermediat

e Accounting

Intermediat

e Accounting

Prepared by Coby Harmon

INTERMEDIATE ACCOUNTING

F I F T E E N T H E D I T I O N

Prepared by Coby Harmon University of California, Santa Barbara

kieso weygandt warfield

team for success

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PREVIEW OF CHAPTER

Intermediate Accounting

15th Edition Kieso Weygandt Warfield

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5 Describe the accounting for changes in estimates.

6 Identify changes in a reporting entity.

7 Describe the accounting for correction of errors.

8 Identify economic motives for changing accounting methods.

9 Analyze the effect of errors.

After studying this chapter, you should be able to:

LEARNING OBJECTIVES

1 Identify the types of accounting changes.

2 Describe the accounting for changes in

accounting principles.

3 Understand how to account for

retrospective accounting changes.

impracticable changes.

Accounting Changes and Error Analysis

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Types of Accounting Changes:

1 Change in Accounting Policy

2 Changes in Accounting Estimate.

3 Change in Reporting Entity

Errors are not considered an accounting change.

Accounting Alternatives:

Accounting Changes

LO 1

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 Average cost to LIFO.

 Completed-contract to percentage-of-completion method.

Change from one accepted accounting policy to another

Examples include:

Changes in Accounting Principle

Adoption of a new principle in recognition of events that have occurred

for the first time or that were previously immaterial is not an accounting

change.

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Three approaches for reporting changes:

1) Currently.

2) Retrospectively.

3) Prospectively (in the future).

FASB requires use of the retrospective approach.

Rationale - Users can then better compare results from one period to

the next.

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22-8 LO 2

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Retrospective Accounting Change Approach

Company reporting the change

presented to the same basis as the new accounting principle

of the beginning of the first year presented, plus the opening balance of retained earnings

LO 3

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Illustration: Denson Company has accounted for its income from long-term construction contracts using the completed-contract

method In 2014, the company changed to the

percentage-of-completion method Management believes this approach provides

a more appropriate measure of the income earned For tax

purposes, the company uses the completed-contract method and

plans to continue doing so in the future (Assume a 40 percent

enacted tax rate.)

Retrospective Accounting Change: Long-Term

Contracts

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Illustration 22-1

LO 3

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Data for Retrospective Change

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22-14 LO 3

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Reporting a Change in Principle

Major disclosure requirements are as follows

1 Nature of the change in accounting principle.

2 The method of applying the change, and:

a A description of the prior period information that has been

retrospectively adjusted, if any.

b The effect of the change on income from continuing operations,

net income (or other appropriate captions of changes in net assets

or performance indicators), any other affected line item.

c The cumulative effect of the change on retained earnings or other

components of equity or net assets in the balance sheet as of the beginning of the earliest period presented.

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Reporting a Change in policy

LO 3

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Retained Earnings Adjustment

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LO 3

Retained Earnings Adjustment

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E22-1 (Change in Principle—Long-Term Contracts): Pam Erickson Construction Company changed from the completed-contract to the

percentage-of-completion method of accounting for long-term

construction contracts during 2015 For tax purposes, the company

employs the completed-contract method and will continue this

approach in the future (Hint: Adjust all tax consequences through the Deferred Tax Liability account.)

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Instructions: (assume a tax rate of 35%)

(b) What entry(ies) are necessary to adjust the accounting

records for the change in accounting principle?

(a) What is the amount of net income and retained earnings that

would be reported in 2015? Assume beginning retained earnings for

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Date of-Completion Contract Difference Effect Tax

2014 $ 780,000 $ 590,000 190,000 66,500 $ 123,500

2015 700,000 480,000 220,000 77,000 143,000

E22-1: Pre-Tax Income from Long-Term Contracts

Journal entry for 2014

Construction in Process 190,000

Deferred Tax Liability 66,500Retained Earnings 123,500

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Restated Previous

2014 2013 2013 Pre-tax income $ 700,000 $ 780,000 $ 610,000 Income tax (35%) 245,000 273,000 213,500 Net income $ 455,000 $ 507,000 $ 396,500

Beg Retained earnings $ 496,500 $ 100,000 $ 100,000 Accounting change 110,500

Beg R/Es restated $ 607,000 100,000 100,000 Net income 455,000 507,000 396,500 End Retained earnings $ 1,062,000 $ 607,000 $ 496,500

E22-1: Comparative Statements

LO 3

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 Direct Effects - FASB takes the position that

companies should retrospectively apply the direct

effects of a change in accounting principle

 Indirect Effect is any change to current or future cash

flows of a company that result from making a change in accounting principle that is applied retrospectively

Direct and Indirect Effects of Changes

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Companies should not use retrospective application if one of the

following conditions exists:

1 Company cannot determine the effects of the retrospective

application.

2 Retrospective application requires assumptions about

management’s intent in a prior period.

3 Retrospective application requires significant estimates that

the company cannot develop.

If any of the above conditions exists, the company prospectively applies the

new accounting principle.

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Changes in Accounting Estimate

Examples of Estimates

1 Uncollectible receivables.

2 Inventory obsolescence.

3 Useful lives and salvage values of assets.

4 Periods benefited by deferred costs.

5 Liabilities for warranty costs and income taxes.

6 Recoverable mineral reserves.

7 Change in depreciation methods.

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Prospective Reporting

Changes in accounting estimates are reported

prospectively Account for changes in estimates in

1 the period of change if the change affects that period only,

or

2 the period of change and future periods if the change

affects both

FASB views changes in estimates as normal recurring

corrections and adjustments and prohibits retrospective

treatment

LO 5

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Illustration: Arcadia High School purchased equipment for

$510,000 which was estimated to have a useful life of 10 years

with a salvage value of $10,000 at the end of that time

Depreciation has been recorded for 7 years on a straight-line

basis In 2014 (year 8), it is determined that the total estimated life should be 15 years with a salvage value of $5,000 at the end of

that time

Required:

 What is the journal entry to correct

prior years’ depreciation expense?

No Entry Required

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Fixed Assets:

Balance Sheet (Dec 31, 2013)

After 7 years

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Net book value $160,000

Second, calculate depreciation expense

for 2014

Second, calculate depreciation expense

for 2014

Journal entry for 2014

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Disclosures

Companies need not disclose changes in accounting estimate

made as part of normal operations, such as bad debt allowances

or inventory obsolescence, unless such changes are material

However, for a change in estimate that affects several periods

(such as a change in the service lives of depreciable assets),

companies should disclose the effect on income from continuing

operations and related per-share amounts of the current period

LO 5

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Change in Reporting Entity

Examples of a change in reporting entity are:

1 Presenting consolidated statements in place of statements of

individual companies

2 Changing specific subsidiaries that constitute the group of

companies for which the entity presents consolidated financial statements

3 Changing the companies included in combined financial

statements

4 Changing the cost, equity, or consolidation method of

accounting for subsidiaries and investments

Reported by changing the financial statements of all prior periods presented.

LO 6

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Accounting Errors

Types of Accounting Errors:

1 A change from an accounting principle that is not generally

accepted to an accounting policy that is acceptable

2 Mathematical mistakes

3 Changes in estimates that occur because a company did

not prepare the estimates in good faith

4 Failure to accrue or defer certain expenses or revenues

5 Misuse of facts

6 Incorrect classification of a cost as an expense instead of

an asset, and vice versa

LO 7

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Accounting Category Type of Restatement

Expense recognition Recording expenses in the incorrect period or for an

incorrect amount.

Revenue recognition Instances in which revenue was improperly recognized,

questionable revenues were recognized, or any other number of related errors that led to misreported revenue.

Misclassification Include restatements due to misclassification of short- or

long-term accounts or those that impact cash flows from operations.

Equity—other Improper accounting for EPS, restricted stock, warrants,

and other equity instruments.

Reserves/Contingencies Errors involving accounts receivables’ bad debts, inventory

reserves, income tax allowances, and loss contingencies.

Long-lived assets Asset impairments of property, plant, and equipment;

goodwill; or other related items.

Accounting-Error Types

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Taxes Includes instances in which revenue was improperly

recognized, questionable revenues were recognized, or any other number of related errors that led to misreported revenue.

Equity—other

comprehensive income

Improper accounting for comprehensive income equity transactions including foreign currency items, minimum pension liability adjustments, unrealized gains and losses

on certain investments in debt, equity securities, and derivatives.

Inventory Inventory costing valuations, quantity issues, and cost of

sales adjustments.

Equity—stock options Improper accounting for employee stock options.

Other Any restatement not covered by the listed categories.

Accounting-Error Types

Source: T Baldwin and D Yoo, “Restatements—Traversing Shaky Ground,” Trend Alert, Glass

Lewis & Co (June 2, 2005), p 8.

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 All material errors must be corrected

adjustment to the beginning balance of retained earnings

in the current period

prior statements affected, to correct for the error

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discovered an error In 2014 the company failed to record

$20,000 of depreciation expense on a newly constructed building This building is the only depreciable asset Selectro owns The

company correctly included the depreciation expense in its tax

return and correctly reported its income taxes payable

LO 7

Example of Error Correction

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