Kế toán, kiểm toán - Chapter 20: Accounting changes and error

McGraw-Hill/IrwinACCOUNTING CHANGES AND ERRORChapter 20© 2013 The McGraw-Hill Companies, Inc.Accounting ChangesCorrection of an ErrorAccounting Changesand Error CorrectionsRetrospectiveTwoReporting ApproachesProspective Error Corrections and Most Changes in PoliciesRetrospectiveTwoReporting ApproachesProspective 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 accounting policy had been applied all along or that the error had never occurred. Adjust the beginning balance of retained earnings for the earliest period reported.The Retrospective ApproachPrior period errors must be corrected retrospectively so as to produce correct comparative information in the current set of financial statementsA retrospective application of a policy is a retrospective adjustment to effect a change in policyWhile a retrospective restatement of the comparative information is used to correct a prior period errorIn normal circumstances, only one year’s comparative information needs to be provided. But, when a company makes one of the above two retrospective adjustments, it has to present an additional statement of financial position as at the beginning of the earliest period presentedSince the earliest period presented in a normal situation is the previous period, the beginning of the earliest period would be two periods before the current periodChanges in EstimatesRetrospectiveTwoReporting ApproachesProspective 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.Qualitative CharacteristicsAlthough consistency and comparability are desirable, changing to a new policy sometimes is appropriate.Change in Accounting PolicyConsistencyComparabilityCompanies may change them if required by the standards or if the change results in more reliable or relevant information about transactions or events.The second situation entails voluntary changes and the reasons for the changes should be explained in the footnotes.Accounting standards present some choices to companies with respect to accounting policies.Change in Accounting PolicyMotivation for Accounting ChoicesChanging ConditionsNew AccountingStandard IssuedEffect on CompensationEffect on Debt AgreementsEffect on Union NegotiationsMotivations for ChangeEffect on Income TaxesRetrospective Approach Most Changes in Accounting PoliciesLet’s look at an examples of a change from Weighted Average (WA) costing method to the FIFO method.At the beginning of 2012, Air Parts Corporation changed from WA to FIFO. Air Parts has paid dividends of $40 million each year since 2004. Its income tax rate is 20 percent. Retained earnings on January 1, 2010, was $700 million; inventory was $500 million. Selected income statement amounts for 2012 and prior years are (in millions): Revise Comparative Financial StatementsFor each year reported, Air Parts makes the comparativestatements appear as if the newly adopted accountingmethod (FIFO) had been in use all along.Note: only two periods need to be reported for statements, with the exception of the statement of financial position.Comparative statements will report 2010 inventory $345 million higher than it was reported in last year’s statements.Retained earnings for 2010 will be $276 million higher.[$345 million × (1 – 20% tax rate)]Revise Comparative Financial StatementsFor each year reported, Air Parts makes the comparativestatements appear as if the newly adopted accountingmethod (FIFO) had been in use all along.Comparative statements will report 2011 inventory $400 million higher than it was reported in last year’s statements.Retained earnings for 2011 will be $320 million higher.[$400 million × (1 – 20% tax rate)]For each year reported, Air Parts makes the comparativestatements appear as if the newly adopted accountingmethod (FIFO) had been in use all along.Revise Comparative Financial StatementsComparative statements will report 2012 inventory $460 million higher than it would havebeen if the change from WA had not occurred.Retained earnings for 2012 will be $368 million higher.[$460 million × (1 – 20% tax rate)]For each year reported, Air Parts makes the comparativestatements appear as if the newly adopted accountingmethod (FIFO) had been in use all along.Revise Comparative Financial StatementsJanuary 1, 2011:Inventory ....................................................... 400,000,000 Retained earnings ............................... 320,000,000 Deferred tax liability.... 80,000,000 To increase inventory, retained earnings, and deferred tax liability as a result of the change from weighted average to FIFO.Adjust Accounts for the ChangeOn January 1, 2012, the date of the change,the following journal entry would be madeto record the change in Policy.20% of $400,000,000 Disclosure NotesIn the first set of financial statements after the changeA disclosure note is needed to describe the nature of the change and to explain its justification. Point out the effect on affected accounts and per share amounts for the current period and all prior periods presented. If retrospective revision has not been made because it is impracticable, a description of the circumstances and when the change in accounting policy started to apply should be disclosed.Prospective Approach Some Changes in PoliciesSometimes a lack of information makes it impracticable to report a change retrospectively so the new policy is simply applied prospectively. For example:A US company switching from FIFO to LIFO may not have kept records of the required information to restate past periods.A company adopting the fair value option for an amortized cost debt instrument would not be able to fathom the manager’s intent in past periods.A company moving to adopt the fair value model for its investment properties (which are thinly traded) would not be able to guess what their discounted cash flow projections would have been like in the past periods.Most changes in policies are reported by the retrospective approach, but:In these cases, the new policy is simply applied prospectively. If it’s impracticable to adjust each year reported, the change is applied retrospectively as of the earliest year practicable. If full retrospective application isn’t possible, the new method is applied prospectively beginning in the earliest year practicable. Footnote disclosure should indicate reasons why retrospective application was impracticable.When it is impracticable to determine the cumulative effect of applying a new policy, the company should apply the new policy prospectively from the earliest date possible.Prospective Approach Some Changes in PoliciesProspective Approach Some Changes in PoliciesThere is another exception to retrospective application. That is when an IASB Statement or another authoritative pronouncement requires prospective application for specific changes in accounting policies: The entity is required to follow the IFRS prescribed transitional provisions when it first applies the changes in a new or amended standard. In certain instances, prospective application of the new IFRS is required. An example would be the implementation of IFRS No. 3, “Business Combinations”.Most changes in policies are reported by the retrospective approach, however:A change in depreciation method is not a change in policy but a change in the expected pattern of consumption of benefits of an asset, therefore, we account for such a change prospectively; that is, precisely the way we account for changes in estimates.Note: A disclosure note should describe the nature and effect of the change in the accounting estimate in the current as well as future periods affected by the change. If the amount of effect in future periods could not be determined, the company should disclose that fact.Prospective Approach Change in Accounting Estimate On January 1, 2008, Towing Ltd 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. At the end of 2011 the total useful life of the equipment was revised to 6 years. Calculate the 2012 depreciation expense. Change in Accounting Estimate$243,000 – $3,000 = $24,000 (2008 – 2011) 10 years$24,000 × 4 years = $96,000 Accum. Depr.$243,000 – $96,000 = $147,000 Book Value$147,000 – $3,000 = $72,000 (2012 & 2013) 2 yearsChanges in accounting estimates are accounted for prospectively. Let’s look at an example of a change in a depreciation estimate.Universal Semiconductors switched from SYDdepreciation to straight-line depreciation in 2012. The asset was purchased at the beginning of 2010for $63 million, has a useful life of 5 years andan estimated residual value of $3 million.Changing Depreciation MethodsChanging Depreciation Methods÷Depreciation adjusting entryfor 2012, 2013, and 2014.Changing Depreciation MethodsDepreciation expense ................................... 8,000,000 Accumulated depreciation .................. 8,000,000To record depreciation expense.APPLICATION OF ACCOUNTING POLICIES TO DIFFERENT OR NEW TRANSACTIONS, CONDITIONS, AND EVENTSFor example, a start-up company that has only land and buildings applies the revaluation method to its property assets. Subsequently, the company purchases equipment and furniture and fittings on commencement of operations and applies the cost method to its new assets. The application of the cost method is not a change of an existing policy but the application of a new policy to a new class of assets. The application of a policy to a new condition is also not a change in policyThese should be accounted for prospectivelyAPPLICATION OF ACCOUNTING POLICIES TO DIFFERENT OR NEW TRANSACTIONS, CONDITIONS, AND EVENTSIn another example, a company has investments in unquoted equity securities that it carries at cost as permitted by IAS No. 39, “Financial Instruments: Recognition and Measurement” for investments whose fair value is not reliably measurable. Subsequently, the company was able to determine reliable measures of fair value for the unquoted securities. The change of measurement basis from cost to fair value is not a change in accounting policy but a new policy that is applied to a new condition of the securities, and retrospective application is inappropriate in this situation.Error CorrectionErrors arise from the misuse of or the failure to use available information that could have been reasonably obtained as of the date when the financial statements were authorized for issueExamples include:Use of inappropriate policiesMistakes in applying IFRSArithmetic mistakesFraud or gross negligence in reportingFor all years disclosed, financial statements are retrospectively restated to reflect the error correction.Correction of Accounting ErrorsFour-step processPrepare a journal entry to correct any balances.Retrospectively restate prior years’ financial statements that were incorrect.Report correction as a prior period adjustment if retained earnings is one of the incorrect accounts affected.Include a disclosure note that should describe the nature of the error and the impact on each line item affected and earnings per share for each prior period presentedCorrection of Accounting Errors Retrospectively restate prior years’ financial statements that were incorrect.The “prior period adjustment” is made to the beginning balance in a statement of changes in equity for the earliest year being reported in the comparative financial statements.Errors Occurred and Discoveredin the Same PeriodCorrected by reversing the incorrect entry and then recording the correct entry (or by making an entry to correct the account balances)Errors Not AffectingPrior Years’ Net IncomeInvolves incorrect classification of accounts.Requires correction of previously issued statements (retrospective approach).Is not classified as a prior period adjustment since it does not affect prior income.Disclose nature of error.Error Affecting Prior Year’s Net IncomeRequires 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.In 2012, internal auditors discovered that Seidman Distribution Ltd. had debited an expense account for the $7 million cost of sorting equipment purchased at the beginning of 2010. The equipment’s useful life was expected to be 5 years with no residual value. Straight-line depreciation is used by Seidman. Analysis ($ in millions):Error Affecting Prior Year’s Net IncomeCorrectDecember 31, 2010:Equipment ................ 7.0 Cash ..................... 7.0Expense ............... 1.4 Accum. Depr ........ 1.4December 31, 2011:Expense ............... 1.4 Accum. Depr ........ 1.4CorrectDecember 31, 2010:Expense ................. 7.0 Cash ..................... 7.0Depreciation entry omittedDecember 31, 2011:Depreciation entry omittedTo correct incorrect accounts Error Affecting Prior Year’s Net Income2011 ($ in millions):Equipment .................... 7.0 Accumulated Depreciation.............. 2.8 Retained Earnings ........ 4.21:The 2010 and 2011 financial statements are retrospectively restated.2:The correction is reported as a “prior period adjustment.” 3:And a disclosure note describing the error and the impact of its correction on each line item affected and earnings per share is presentedLet’s assume the following for Orion Ltd: On Jan 1, 2011, the retained earnings balance was $922,000. In 2011, the company paid $65,000 in dividends. Net income for 2011 was $184,000. Correction of error for 2010 was $50,000.Error Affecting Prior Year’s Net IncomeThe Statement of Retained Earnings (or RE column of the Statement of Shareholders’ Equity) would be as follows:Correction of Accounting Errors Identify the type of accounting error for the following item: Ending inventory was incorrectly counted. Counterbalancing error affecting net incomeThe ending inventory in one period will be incorrect and the beginning inventory in the next period will also be incorrect. Since the inventory balance effects cost of goods sold, income will also be incorrect in the two periods, by the same amount. At the end of the two periods, if no other errors are made, the balances in inventory and retained earnings are correct.Correction of Accounting Errors Identify the type of accounting error for the following item: Loss on sale of furniture was incorrectlyrecorded as depreciation expense. Error not affecting net income.When the furniture sale transaction was recorded, depreciation expense was debited for the amount that should have been a debit to loss on sale. Since both expenses and losses reduce income, the error does not effect income.Correction of Accounting Errors Identify the type of accounting error for the following item: Depreciation expense was understated. Noncounterbalancing error affecting net income.An expense is understated, so income is understated. The error affects only the year in which the error was made. It is a noncounterbalancing error since only one period’s income is affected.Summary of AccountingChanges and ErrorsIFRS versus U.S. GAAPWhen correcting errors in previously issued financial statements, IFRS (IAS No. 8), unlike U.S. GAAP permits the effect of the error to be reported in the current period if it’s not considered practicable to report it retrospectively as is required by U.S. GAAP.End of Chapter 20