Solution manual intermediate accounting IFRS volume 1 kiesoch22

a Change in accounting policy; retrospective application to prior period financial statements.. f Change in accounting policy; retrospective application to prior period financial stateme

Concepts for Analysis

1 Differences between change in

principle, change in estimate,

Learning Objectives

Brief Exercises Exercises Problems

1 Identify the two types of accounting changes

2 Describe the accounting for changes

ASSIGNMENT CHARACTERISTICS TABLE

Item

Description

Level of Difficulty

Time (minutes)

E22-1 Change in policy—long-term contracts Moderate 10–15 E22-2 Change in policy—inventory methods Moderate 10–15

E22-6 Accounting changes—depreciation Difficult 30–35 E22-7 Change in estimate and error; financial statements Moderate 25–30 E22-8 Accounting for accounting changes and errors Simple 5–10 E22-9 Error and change in estimate—depreciation Simple 15–20

E22-11 Change in estimate—depreciation Simple 10–15 E22-12 Change in estimate—depreciation Simple 20–25 E22-13 Change in policy—long-term contracts Simple 10–15 E22-14 Various changes in policy—inventory methods Moderate 20–25

E22-16 Error analysis and correcting entry Simple 10–15 E22-17 Error analysis and correcting entry Simple 10–15

E22-19 Error analysis and correcting entries Simple 20–25

P22-1 Change in estimate and error correction Moderate 30–35 P22-2 Comprehensive accounting change and error analysis problem Complex 30–40 P22-3 Error corrections and accounting changes Complex 30–40

P22-5 Change in policy—inventory—periodic Moderate 30–35 P22-6 Accounting changes and error analysis Moderate 25–30

P22-8 Comprehensive error analysis Difficult 30–35

P22-10 Error analysis and correcting entries Complex 50–60

CA22-1 Analysis of various accounting changes and errors Moderate 25–35 CA22-2 Analysis of various accounting changes and errors Moderate 20–30 CA22-3 Analysis of three accounting changes and errors Moderate 30–35 CA22-4 Analysis of various accounting changes and errors Moderate 20–30 CA22-5 Change in policy, estimate Moderate 20–30 CA22-6 Change in estimate, ethics Moderate 20–30

1. The major reasons why companies change accounting policies are:

(1) Desire to show better profit picture

(2) Desire to increase cash flows through reduction in income taxes

(3) Requirement by International Accounting Standards Board to change accounting methods (4) Desire to follow industry practices

(5) Desire to show a better measure of the company’s income

2. (a) Change in accounting policy; retrospective application to prior period financial statements (b) Correction of an error and therefore prior period adjustment; adjust the beginning balance of retained earnings

(c) Increase income for litigation settlement

(d) Change in accounting estimate; currently and prospectively Part of operating section of income statement

(e) Reduction of accounts receivable and the allowance for doubtful accounts

(f) Change in accounting policy; retrospective application to prior period financial statements

3. The three approaches suggested for reporting changes in accounting policies are:

(a) Currently—the cumulative effect of the change is reported in the current year’s income as

a special item

(b) Retrospectively—the cumulative effect of the change is reported as an adjustment to retained earnings The prior year’s statements are changed on a basis consistent with the newly adopted policy

(c) Prospectively—no adjustment is made for the cumulative effect of the change Previously reported results remain unchanged The change shall be accounted for in the period of the change and in subsequent periods if the change affects future periods

4. The IASB believes that the retrospective approach provides financial statement users the most useful information Under this approach, the prior statements are changed on a basis consistent with the newly adopted standard; any cumulative effect of the change for prior periods is recorded

as an adjustment to the beginning balance of retained earnings of the earliest period reported

5. The indirect effect of a change in accounting policy reflects any changes in current or future cash flows resulting from a change in accounting policy that is applied retrospectively An example is the change in payments to a profit-sharing plan that is based on reported net income Indirect effects are not included in the retrospective application, but instead are reported in the period in which the accounting change occurs (current period)

6. A change in an estimate is simply a change in the way an individual perceives the realizability of

an asset or liability Examples of changes in estimate are: (1) change in the realizability of trade receivables, (2) revisions of estimated lives, (3) changes in estimates of warranty costs, and (4) change in estimate of deferred charges or credits

7. This is an example of a situation in which it is difficult to differentiate between a change in ing policy and a change in estimate In such a situation, the change should be considered a change in estimate, and accordingly, should be handled currently and prospectively Thus, all costs presently capitalized and viewed as providing doubtful future values should be expensed immediately, and costs currently incurred should also be expensed immediately

account-8. (a) Charge to expense—possibly separately disclosed

(b) Change in estimate—account for currently and prospectively

(c) Charge to expense—possibly separately disclosed

(d) Correction of an error and reported as a prior period adjustment—adjust the beginning balance

of retained earnings

Questions Chapter 22 (Continued)

(e) Change in accounting policy—retrospective application to all affected prior-period financial statements

(f) Change in accounting estimate—currently and prospectively

9. This change is to be handled as a correction of an error As such, the portion of the change attributable to prior periods ($23,000) should be reported as an adjustment to the beginning balance of retained earnings in the 2010 financial statements If statements for previous years are presented for comparative purposes, these statements should be restated to correct for the error The remainder of the inventory value ($29,000) should be reported in the 2010 statements

as a reduction of materials cost

10. Preferability is a difficult concept to apply The problem is that there are no basic objectives to indicate which is the most preferable method, assuming a selection between two generally accepted practices is possible, such as cost-recovery and percentage-of-completion If an IASB standard creates a new policy or expresses preference for or rejects a specific accounting policy, a change

is considered clearly acceptable A more appropriate matching of revenues and expenses is often given as the justification for a change in accounting policy

11. When a company changes to the new policy, the base-year amounts for all subsequent calculations under the new method is the beginning balance in the year the policy is adopted This assumes that prior years’ income is not changed because it would be too impractical to do so

12. Larger companies that are more politically visible may seek to report low income numbers to avoid the scrutiny of regulators The larger the company the more likely it is to adopt income- decreasing approaches in selecting accounting methods

13. Some of the key reasons for changing accounting policies are: (1) political costs, (2) capital structure, (3) bonus payments, and (4) smoothing of earnings

14. Counterbalancing errors are errors that will be offset or corrected over two periods counterbalancing errors are errors that are not offset in the next accounting period An example

Non-of a counterbalancing error is the failure to record accrued wages or prepaid expenses Failure to capitalize equipment and record depreciation is an example of a non-counterbalancing error

15. A correction of an error in previously issued financial statements should be handled as a period adjustment Thus, such an error should be reported in the year that it is discovered as an adjustment to the beginning balance of retained earnings And, if comparative statements are presented, the prior periods affected by the error should be restated The disclosures need not be repeated in the financial statements of subsequent periods

prior-As an illustration, assume that credit sales of $40,000 were inadvertently overlooked at the end of

2010 When the error was discovered in a subsequent period, the appropriate entry to record the correction of the error would have been (ignoring income tax effects):

Accounts Receivable 40,000

Retained Earnings 40,000

16. This change represents a change from an accounting policy that is not generally accepted to an accounting policy that is acceptable As such, this change should be handled as a correction of

an error Thus, in the 2010 statements, the cumulative effect of the change should be reported as

an adjustment to the beginning balance of retained earnings If 2009 statements are presented for comparative purposes, these statements should be restated to correct for the accounting error

17. Retained earnings is correctly stated at December 31, 2012 Failure to accrue salaries in earlier years is a counterbalancing error that has no effect on 2012 ending retained earnings

Machinery 6,000

Accumulated Depreciation—Machinery 600 Retained Earnings 5,400 (To correct for the error of expensing installation costs

on machinery acquired in January, 2010)

Depreciation Expense [(£36,000 – £3,600) ÷ 20] 1,620

Accumulated Depreciation—Machinery 1,620 (To record depreciation on machinery for 2011 based

on a 20-year useful life)

19. This error has no effect on net income because both purchases and inventory were understated The entry to correct for this error, assuming a periodic inventory system, is:

22. U.S GAAP has detailed guidance on the accounting and reporting of indirect effects U.S GAAP requires that indirect effects do not change prior period amounts

23. There is a difference between U.S GAAP and IFRS related to how the investor evaluates the accounting policies of the investee For example, if the investee uses an inventory method different from the investor’s method, the investor must conform the accounting method of the investee to its own method under IFRS This involves adjusting the investee’s net income so it is reported on the same basis as the investor’s income

SOLUTIONS TO BRIEF EXERCISES

The indirect effect from prior years will be reported as a profit-sharing expense for year 2010

Depreciation in 2010 = $120,000 ÷ 8 = $15,000

Depreciation Expense 15,000

($20,000 = $50,000 X 2/5; $9,000 = $30,000 X 30%)

BRIEF EXERCISE 22-7

CHENG COMPANY Retained Earnings Statement For the Year Ended December 31, 2010

Retained earnings, January 1, as previously reported ¥20,000,000 Less: Correction of depreciation error, net of tax 2,400,000* Retained earnings, January 1, as adjusted 17,600,000 Add: Net income 9,000,000 Less: Dividends 2,500,000 Retained earnings, December 31 ¥24,100,000

*¥4,000,000 X (1 – 4)

depreciation on production equipment is a change in estimate due to a change in conditions

use of the building for a different purpose Thus, it is not a change in policy, a change in estimate, or an error

one year as opposed to several years) is a change in estimate due to a change in conditions

BRIEF EXERCISE 22-10

policies; thus, this item is a change in accounting policy

2 This oversight is a mistake that should be corrected Such a correction

is considered a change due to error

method are generally accepted policies; thus, such a change is a change in accounting policy

EXERCISE 22-3 (25–30 minutes)

Income Statement For the Year Ended December 31

Average Cost

2008 2009 2010 Sales $4,000 $4,000 $4,000 Cost of goods sold 800 1,000 1,130 Operating expenses 1,000 1,000 1,000 Net income $2,200 $2,000 $1,870

Income Statement For the Year Ended December 31

FIFO

2008 2009 2010 Sales $4,000 $4,000 $4,000 Cost of goods sold 820 940 1,100 Operating expenses 1,000 1,000 1,000 Net income $2,180 $2,060 $1,900

Income Statement For the Year Ended December 31

As adjusted (Note A) Sales $4,000 $4,000

Cost of goods sold 1,100 940

Operating expenses 1,000 1,000

Net income $1,900 $2,060

(c) Note A:

Change in Method of Accounting for Inventory Valuation

On January 1, 2010, Ramirez elected to change its method of valuing its inventory to the FIFO method, whereas in all prior years inventory was valued using the Average Cost method The new method of accounting for inventory was adopted because it better reflects the current cost of the inventory on the statement of financial position and comparative financial statements of prior years have been adjusted to apply the new method retrospectively The following financial statement line items for fiscal years 2010 and 2009 were affected by the change in accounting policy

Less: Adjustment for cumulative effect

of applying new accounting

EXERCISE 22-4 (25–30 minutes)

2008 (a) Retained earnings, January 1, as reported £160,000 Cumulative effect of change in accounting

policy to average cost (13,000)* Retained earnings, January 1, as adjusted £147,000

*[£8,000 (2006) + £5,000 (2007)]

2011 (b) Retained earnings, January 1, as reported £590,000 Cumulative effect of change in accounting

policy to average cost (20,000)* Retained earnings, January 1, as adjusted £570,000

*[£8,000 (2006) + £5,000 (2007) + £10,000

(2008) – £10,000 (2009) + £7,000 (2010)]

2012 (c) Retained earnings, January 1, as reported £780,000 Cumulative effect of change in accounting

policy to average cost (15,000)* Retained earnings, January 1, as adjusted £765,000

*[£20,000 at 12/31/2010 – £5,000 (2011)]

2009 2010 2011 (d) Net Income £130,000 £293,000 £310,000

(a) CARLTON COMPANY

Income Statement For the Year Ended

Sales $3,000 $3,000 Cost of goods sold 1,100 940 Operating expenses 1,000 1,000 Income before profit sharing $ 900 $1,060 Profit sharing expense 48 50 Net income $ 852 $1,010

Carlton Company should report $50 as the profit sharing expense in

2009, even though the profit sharing expense would be $53 if FIFO had been used in 2009

(b) The profit sharing expense reflects an indirect effect of the change in accounting policy Under IFRS, indirect effects from periods before the change are recorded in the year of the change In this case, profit sharing expense recorded in 2010 is composed of:

$900 X 5% = $45 (2010 under FIFO)

$ 60 X 5% = 3 (difference in profit sharing for 2009)

$48 (profit sharing expense for FIFO in 2010)

2010 Retained earnings, January 1, as reported $8,000

Retained earnings, January 1, as adjusted 8,057 Add: Net Income 855* Deduct: Dividends 2,500 Retained earnings, December 31 $6,412

*The difference in net income for 2010 compared to (a) is due to the $3 indirect effect of profit sharing expense

Book value (December 31, 2009) $105,000

Book value – Residual value = Depreciable cost

$105,000 – $15,000 = $90,000

Depreciation for 2010: $90,000/2 = $45,000

Depreciation Expense 45,000

(b) Depreciation to date on building

$780,000/30 years = $26,000 per year

$26,000 X 3 = $78,000 depreciation to date

Cost of building $780,000

Depreciation to date (78,000)

Book value (December 31, 2009) $702,000

Depreciation for 2010: $702,000/(40 – 3) = $18,973 (rounded)

Depreciation Expense 18,973

Change from sum-of-the-years-digits to straight-line

Cost of depreciable assets $90,000

Depreciation for 2010 using straight-line depreciation

Estimated useful life ÷ 3 years

Less: Correction of error for inventory

overstatement (20,000) Retained earnings, January 1, adjusted 105,000 $ 72,000 Add: Net income 81,000 58,000 Less: Dividends 30,000 25,000 Retained earnings, December 31 $156,000 $105,000

Note to instructor:

1 2009 Cost of sales increased $20,000; 2010 cost of sales decreased

$20,000 As a result, net income for 2009 is overstated $20,000 and net income for 2010 is understated $20,000 as a result of the inventory error

3 2010 expenses decreased $9,000 ($27,000 – $18,000) Net income

in 2010 is therefore $81,000 ($52,000 + $20,000 + $9,000)

4 Additional disclosures would be as necessitated as indicated in the chapter

Add: Net Income 81,000 Less: Dividends 30,000 Retained earnings, December 31 $156,000

(a) Computation of depreciation for 2010:

[(£130,000 – £10,000) ÷ 12] X 4 years (40,000) Book value, January 1, 2010 £ 90,000

Remaining useful life

EXERCISE 22-12 (20–25 minutes)

Less: Depreciation prior to 2010

(b) Construction in Process 250,000

Retained Earnings 150,000*

*($250,000 X 60% = $150,000)

(a) Retained Earnings 10,000

EXERCISE 22-15 (Continued)

4 Amortization Expense—Copyright 2,500

Retained Earnings 5,000

Copyright 7,500 ($50,000 ÷ 20 = $2,500;

( $2,500 X 2 = $5,000)

(or Cost of Goods Sold) 87,000

Retained Earnings 87,000

EXERCISE 22-16 (10–15 minutes)

1 Wages Expense 3,400

Wages Payable 3,400

2 Vacation Wages Expense 31,100

Vacation Wages Payable 31,100

($38,500 – $19,000) 19,500 Computations:

Effect on retained earnings over (under) statement

Note: The understatement of inventory in 2010 was a self-correcting error at the end of 2011

(a) Effect of errors on 2010 net income: £21,700 overstatement

Computations:

Effect on 2010 net income over (under) statement

Expensing of insurance premium in 2009

Expensing of insurance premium in 2009

Sale of fully depreciated machine

(c) Effect of errors on retained earnings: £25,600 understatement

Computations:

Effect on retained earnings over (under) statement

Understatement of depreciation expense

Failure to record sale of fully depreciated

Total effect on retained earnings

2010 2011

Corrections:

Repairs erroneously charged to the

Depreciation recorded on improperly

*Bond interest expense for 2010 and 2011 was computed as follows:

Under-No Effect

statement

Over- statement

Under-No Effect

Problem 22-1 (Time 30–35 minutes)

Purpose—to provide a problem that requires the student to: (1) account for a change in estimate, (2) record a correction of an error, and (3) account for a change in accounting policy The student is also required to compute corrected/adjusted net income amounts

Problem 22-2 (Time 30–40 minutes)

Purpose—to develop an understanding of the way in which accounting changes and error corrections are handled in accounting records The problem presents descriptions of various situations for which the student is required to indicate the correct accounting treatment and to prepare comparative income statements for a four-year period

Problem 22-3 (Time 30–40 minutes)

Purpose—to provide a problem that requires the student to: (1) prepare correcting entries for two years’ unrecorded sales commissions, (2) three years’ inventory errors, and (3) prepare entries for two different accounting changes

Problem 22-4 (Time 40–50 minutes)

Purpose—to allow the student to see the impact of accounting changes on income and to examine an ethical situation related to the motivation for change

Problem 22-5 (Time 30–35 minutes)

Purpose—to develop an understanding of the impact which a change in the method of inventory pricing (from FIFO to average cost) has on the financial statements during a five-year period The student

is required to prepare a comparative statement of income and retained earnings for the five years assuming the change in inventory pricing with an indication of the effects on net income and earnings per share for the years involved

Problem 22-6 (Time 25–30 minutes)

Purpose—to develop an understanding of the journal entries and the reporting which are necessitated

by an accounting change or correction of an error The student is required to prepare the entries to reflect such changes or errors and the comparative income statements and retained earnings state- ments for a two-year period

Problem 22-7 (Time 25–30 minutes)

Purpose—to provide a problem that requires the student to analyze ten transactions and to prepare adjusting or correcting entries for these transactions

Problem 22-8 (Time 30–35 minutes)

Purpose—to help a student understand the effect of errors on income and retained earnings The student must analyze the effects of errors on the current year’s net income and on the next year’s ending retained earnings balance

Problem 22-9 (Time 20–25 minutes)

Purpose—to develop an understanding of the effect that errors have on the financial statements The student is required to prepare a schedule portraying the corrected net income for the years involved with this error analysis

Time and Purpose of Problems (Continued)

Problem 22-10 (Time 50–60 minutes)

Purpose—to develop an understanding of the correcting entries and income statement adjustments that are required for changes in accounting policies and accounting errors This comprehensive problem involves many different concepts such as consignment sales, bonus computations, warranty costs, and bank funding reserves The student is required to prepare the necessary journal entries to correct the accounting records and a schedule showing the revised income before taxes for each of the three years involved

PROBLEM 22-1

(a) 1 Cost of equipment $85,000

Less: Residual value 5,000

Depreciation in 2010

($162,000/8) = $20,250

Depreciation Expense 20,250

([$120,000 – $16,000] ÷ 8) X 1

2 = 6,500 Depreciation recorded in 2009:

($120,000 ÷ 8) = $15,000 Depreciation that should be recorded in 2009:

($120,000 – $16,000) ÷ 8 = $13,000

Depreciation taken

Depreciation that should be taken Differences

Equipment $14,500 $ 8,000 Building 20,250 48,000 Machine 13,000 13,000

(a) 1 Bad debt expense for 2008 should not have been reduced by

€10,000 A change in the experience rate is considered a change in estimate, which should be handled prospectively

2 A change from Average Cost to FIFO is considered a change in accounting policy, which must be handled retrospectively

3 (a) The inventory error in 2010 is a prior period adjustment and

the 2010 and 2011 financial statements should be restated

(b) The lawsuit settlement is correctly treated

1 Bad debt expense