Kế toán tài chính - Accounting changes and error analysis

PREVIEW OF CHAPTER 22Intermediate Accounting16th EditionKieso ● Weygandt ● Warfield Identify types of accounting changes and understand the accounting for changes in accounting principles.Describe the accounting for changes in estimates and changes in the reporting entity.LEARNING OBJECTIVESDescribe the accounting for correction of errors.Analyze the effect of errors.After studying this chapter, you should be able to:Accounting Changes and Error Analysis22LO 1Types of Accounting Changes:Change in Accounting Policy.Changes in Accounting Estimate.Change in Reporting Entity.Errors are not considered an accounting change.Accounting Alternatives: Diminish the comparability of financial information.Obscure useful historical trend data.ACCOUNTING CHANGESLO 1Average cost to LIFO.Completed-contract to percentage-of-completion method.Change from one accepted accounting policy to another. Examples include:Changes in Accounting PrincipleAdoption 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.LO 1Three approaches for reporting changes: Currently.Retrospectively.Prospectively (in the future).FASB requires use of the retrospective approach.Rationale - Users can then better compare results from one period to the next.LO 1Changes in Accounting PrincipleThe cumulative-effect approach results in a loss of comparability. Also, reporting the cumulative adjustment in the period of the change can significantly affect net income, resulting in a misleading income fi example, at one time Chrysler Corporation changed its inventory accounting from LIFO to FIFO. If Chrysler had used the cumulative-effect approach, it would have reported a $53,500,000 adjustment to net income. That adjustment would have resulted in net income of $45,900,000, instead of a net loss of $7,600,000. A second case: In the early 1980s, the railroad industry switched from the retirement-replacement method of depreciating railroad equipment to more generally used methods such as straight-line depreciation. Using cumulative treatment, railroad companies would have made substantial adjustments to income in the period of change. Many in the industry argued that including such large cumulative-effect adjustments in the current year would distort the information and make it less useful. Such situations lend support to retrospective application so that comparability is maintained. WHAT’S YOUR PRINCIPLEWHAT DO THE NUMBERS MEAN? QUITE A CHANGELO 1Retrospective Accounting Change ApproachCompany reporting the changeAdjusts its financial statements for each prior period presented to the same basis as the new accounting principle.Adjusts the carrying amounts of assets and liabilities as of the beginning of the first year presented, plus the opening balance of retained earnings.Changes in Accounting PrincipleLO 1Illustration: Denson Company has accounted for its income from long-term construction contracts using the completed-contract method. In 2017, 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 ContractsChanges in Accounting PrincipleLO 1ILLUSTRATION 22-1Comparative Income Statements for Completed-Contract versus Percentage-of-Completion MethodsLO 1Data for Retrospective ChangeILLUSTRATION 22-2Construction in Process 220,000 Deferred Tax Liability 88,000 Retained Earnings 132,000Journal entry beginning of 2017Changes in Accounting PrincipleLO 1Halliburton offers a case study in the importance of good reporting of an accounting change. Note that Halliburton uses percentage-of-completion accounting for its long-term construction-services contracts. The SEC questioned the company about its change in accounting for disputed claims. Prior to the year of the change, Halliburton took a very conservative approach to its accounting for disputed claims. That is, the company waited until all disputes were resolved before recognizing associated revenues. In contrast, in the year of the change, the company recognized revenue for disputed claims before their resolution, using estimates of amounts expected to be recovered. Such revenue and its related profit are more tentative and subject to possible later adjustment. The accounting method adopted is more aggressive than the company’s former policy but is within the boundaries of GAAP. It appears that the problem with Halliburton’s accounting stems more from how the company handled its accounting change than from the new method itself. That is, Halliburton did not provide in its annual report in the year of the change an explicit reference to its change in accounting method. WHAT’S YOUR PRINCIPLEWHAT DO THE NUMBERS MEAN? CHANGE MANAGEMENTLO 1In fact, rather than stating its new policy, the company simply deleted the sentence that described how it accounted for disputed claims. Then later, in its next year’s annual report, the company stated its new accounting policy. Similar transparency concerns have been raised when companies, like Hawthorn Bancshares, did not provide sufficient explanation about their changes to fair value accounting for their mortgage servicing rights. When companies make such changes in accounting, investors need to be informed about the change and about its effects on the financial results. With such information, investors and analysts can compare current results with those of prior periods and can make a more informed assessment about the company’s future prospects.Sources: Adapted from “Accounting Ace Charles Mulford Answers Accounting Questions,” Wall Street Journal Online (June 7, 2002); and J. Arnold, B. Blisard, and J. Duggan, “Dealing with the Implications of Accounting Change,” FEI Magazine (November 2012).WHAT’S YOUR PRINCIPLEWHAT DO THE NUMBERS MEAN? CHANGE MANAGEMENTLO 1Reporting a Change in PrincipleMajor disclosure requirements are as follows.Nature of the change in accounting principle.The method of applying the change, and:A description of the prior period information that has been retrospectively adjusted, if any.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.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.Changes in Accounting PrincipleLO 1LO 1ILLUSTRATION 22-3Comparative Information Related to Accounting Change (Percentage-of-Completion)Retained Earnings AdjustmentILLUSTRATION 22-4Retained earnings balance is $1,360,000 at the beginning of 2015.Before ChangeChanges in Accounting PrincipleLO 1Illustration 22-5After ChangeChanges in Accounting PrincipleLO 1Retained Earnings AdjustmentIllustration (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 2018. 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.)Changes in Accounting PrincipleLO 1Instructions: (assume a tax rate of 35%)(a) What entry(ies) are necessary to adjust the accounting records for the change in accounting principle?(b) What is the amount of net income and retained earnings that would be reported in 2018? Assume beginning retained earnings for 2017 to be $100,000.Changes in Accounting PrincipleLO 1Illustration (Change in Principle—Long-Term Contracts):Illustration: Pre-Tax Income from Long-Term ContractsChanges in Accounting PrincipleLO 1Journal entry (recorded in 2018)Construction in Process 190,000 Deferred Tax Liability 66,500 Retained Earnings 123,500Income StatementStatement of Retained EarningsIllustration: Comparative StatementsChanges in Accounting PrincipleLO 1Direct 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 ChangesChanges in Accounting PrincipleLO 1ImpracticabilityCompanies should not use retrospective application if one of the following conditions exists:Company cannot determine the effects of the retrospective application.Retrospective application requires assumptions about management’s intent in a prior period.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.Changes in Accounting PrincipleLO 1Identify types of accounting changes and understand the accounting for changes in accounting principles.Describe the accounting for changes in estimates and changes in the reporting entity.LEARNING OBJECTIVESDescribe the accounting for correction of errors.Analyze the effect of errors.After studying this chapter, you should be able to:Accounting Changes and Error Analysis22LO 2Changes in Accounting EstimateExamples of EstimatesUncollectible receivables.Inventory obsolescence.Useful lives and salvage values of assets.Periods benefited by deferred costs.Liabilities for warranty costs and income taxes.Recoverable mineral reserves.Change in depreciation methods.LO 2Prospective ReportingChanges in accounting estimates are reported prospectively. Account for changes in estimates in the period of change if the change affects that period only, or 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.Changes in Accounting EstimateLO 2Illustration: 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 2017 (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?Calculate depreciation expense for 2017.No Entry RequiredChanges in Accounting EstimateLO 2Equipment$510,000Fixed Assets:Accumulated depreciation 350,000 Net book value (NBV)$160,000Balance Sheet (Dec. 31, 2016)After 7 yearsEquipment cost $510,000Salvage value - 10,000Depreciable base 500,000Useful life (original) 10 yearsAnnual depreciation $ 50,000x 7 years = $350,000 First, establish NBV at date of change in estimate.Changes in Accounting EstimateLO 2Net book value $160,000Salvage value (if any) 5,000Depreciable base 155,000Useful life 8 yearsAnnual depreciation $ 19,375Second, calculate depreciation expense for 2017.Depreciation expense 19,375 Accumulated depreciation 19,375Journal entry for 2017Changes in Accounting EstimateLO 2DisclosuresCompanies 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.Changes in Accounting EstimateLO 2Change in Reporting EntityExamples of a change in reporting entity are:Presenting consolidated statements in place of statements of individual companies.Changing specific subsidiaries that constitute the group of companies for which the entity presents consolidated financial statements.Changing the companies included in combined financial statements.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 2Identify types of accounting changes and understand the accounting for changes in accounting principles.Describe the accounting for changes in estimates and changes in the reporting entity.LEARNING OBJECTIVESDescribe the accounting for correction of errors.Analyze the effect of errors.After studying this chapter, you should be able to:Accounting Changes and Error Analysis22LO 3ACCOUNTING ERRORSTypes of Accounting Errors:A change from an accounting principle that is not generally accepted to an accounting policy that is acceptable. Mathematical mistakes.Changes in estimates that occur because a company did not prepare the estimates in good faith. Failure to accrue or defer certain expenses or revenues.Misuse of facts.Incorrect classification of a cost as an expense instead of an asset, and vice versa.LO 3Accounting CategoryType of RestatementExpense recognitionRecording expenses in the incorrect period or for an incorrect amount.Revenue recognitionInstances in which revenue was improperly recognized, questionable revenues were recognized, or any other number of related errors that led to misreported revenue.MisclassificationInclude restatements due to misclassification of short- or long-term accounts or those that impact cash flows from operations.Equity—otherImproper accounting for EPS, restricted stock, warrants, and other equity instruments.Allowances/contingenciesErrors involving accounts receivables’ bad debts, inventory reserves, income tax allowances, and loss contingencies.Long-lived assetsAsset impairments of property, plant, and equipment; goodwill; or other related items.LO 3ILLUSTRATION 22-18Accounting-Error TypesACCOUNTING ERRORSAccounting CategoryLO 3Type of RestatementTaxesErrors involving correction of tax provision, improper treatment of tax liabilities, and other tax-related items. Equity—other comprehensive incomeImproper 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.InventoryInventory costing valuations, quantity issues, and cost of sales adjustments.Equity—stock optionsImproper accounting for employee stock options.OtherAny restatement not covered by the listed categories.Source: T. Baldwin and D. Yoo, “Restatements—Traversing Shaky Ground,” Trend Alert, Glass Lewis & Co. (June 2, 2005), p. 8.ILLUSTRATION 22-18Accounting-Error TypesACCOUNTING ERRORSAll material errors must be corrected. Record corrections of errors from prior periods as an adjustment to the beginning balance of retained earnings in the current period. Such corrections are called prior period adjustments.For comparative statements, a company should restate the prior statements affected, to correct for the error.LO 3ACCOUNTING ERRORSIllustration: In 2018 the bookkeeper for Selectro Company discovered an error. In 2017 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 3Example of Error CorrectionSelectro’s income statement for 2017 with and without the error.ILLUSTRATION 22-19LO 3Example of Error CorrectionWhat are the entries that Selectro should have made and did make for recording depreciation expense and income taxes?Entries that Selectro should have made and did make for recording depreciation expense and income taxes.ILLUSTRATION 22-20Example of Error CorrectionILLUSTRATION 22-19ILLUSTRATION 22-20LO 3Example of Error CorrectionRetained Earnings 12,000Correcting Entry in 2018ILLUSTRATION 22-20LO 3Example of Error CorrectionPrepare the proper correcting entry in 2018, that should be made by Selectro.Retained Earnings 12,000 Correcting Entry in 2018ReversalLO 3Example of Error CorrectionPrepare the proper correcting entry in 2018, that should be made by Selectro.Deferred Tax Liability 8,000ILLUSTRATION 22-20Retained Earnings 12,000Correcting Entry in 2018LO 3Example of Error CorrectionPrepare the proper correcting entry in 2018, that should be made by Selectro. Accumulated Depreciation—Buildings 20,000Deferred Tax Liability 8,000ILLUSTRATION 22-20Illustration: Selectro Company has a beginning retained earnings balance at January 1, 2018, of $350,000. The company reports net income of $400,000 in 2018.ILLUSTRATION 22-21LO 3Example of Error CorrectionSingle-Period StatementsComparative StatementsCompany should make adjustments to correct the amounts for all affected accounts reported in the statements for all periods reported. restate the data to the correct basis for each year presented.show any catch-up adjustment as a prior period adjustment to retained earnings for the earliest period it reported. LO 3ACCOUNTING ERRORSBefore issuing the report for the year ended December 31, 2017, you discover a $62,500 error that caused the 2016 inventory to be overstated (overstated inventory caused COGS to be lower and thus net income to be higher in 2016). Would this discovery have any impact on the reporting of the Statement of Retained Earnings for 2017? Assume a 20% tax rate. LO 3ACCOUNTING ERRORSLO 3ACCOUNTING ERRORSILLUSTRATION 22-23LO 3Summary of Accounting Changes and Correction of ErrorsACCOUNTING ERRORSILLUSTRATION 22-23LO 3Summary of Changes and ErrorsWhy companies may prefer certain accounting methods. Some reasons are:Political costs.Capital Structure.Bonus Payments.Smooth Earnings.ACCOUNTING ERRORSMotivations for Changes of Accounting MethodLO 3Identify types of accounting changes and understand the accounting for changes in accounting principles.Describe the accounting for changes in estimates and changes in the reporting entity.LEARNING OBJECTIVESDescribe the accounting for correction of errors.Analyze the effect of errors.After studying this chapter, you should be able to:Accounting Changes and Error Analysis22LO 4ERROR ANALYSISCompanies must answer three questions:What type of error is involved?What entries are needed to correct for the error?After discovery of the error, how are financial statements to be restated?Companies treat errors as prior-period adjustments and report them in the current year as adjustments to the beginning balance of Retained Earnings.LO 4Balance sheet errors affect only the presentation of an asset, liability, or stockholders’ equity account.Current year error - reclassify item to its proper position.Prior year error - restate the balance sheet of the prior year for comparative purposes.LO 4Balance Sheet ErrorsERROR ANALYSISImproper classification of revenues or expenses.Current year error - reclassify item to its proper position.Prior year error - restate the income statement of the prior year for comparative purposes.LO 4Income Statement ErrorsERROR ANALYSISCounterbalancing ErrorsWill be offset or corrected over two periods.1. If company has closed the books:If the error is already counterbalanced, no entry is necessary.If the error is not yet counterbalanced, make entry to adjust the present balance of retained earnings.For comparative purposes, restatement is necessary even if a correcting journal entry is not required.LO 4Balance Sheet and Income Statement ErrorsERROR ANALYSISWill be offset or corrected over two periods.2. If company has not closed the books:If error already counterbalanced, make entry to correct the error in the current period and to adjust the beginning balance of Retained Earnings.If error not yet counterbalanced, make entry to adjust the beginning balance of Retained Earnings.LO 4Counterbalancing ErrorsBalance Sheet and Income Statement ErrorsERROR ANALYSISNot offset in the next accounting period.Companies must make correcting entries, even if they have closed the books.LO 4Noncounterbalancing ErrorsBalance Sheet and Income Statement ErrorsERROR ANALYSISE22-19 (Error Analysis; Correcting Entries): A partial trial balance of Julie Hartsack Corporation is as follows on December 31, 2018.Instructions: (a) Assuming that the books have not been closed, what are the adjusting entries necessary at December 31, 2018? LO 4ERROR ANALYSIS1. A physical count of supplies on hand on December 31, 2018, totaled $1,100.2. Accrued salaries and wages on December 31, 2018, amounted to $4,400.(a) Assuming that the books have not been closed, what are the adjusting entries necessary at December 31, 2018?LO 4Supplies Expense ($2,700 – $1,100) 1,600 Supplies 1,600Salary and Wages Expense 2,900 Salaries and Wages Payable 2,900ERROR ANALYSIS3. Accrued interest on investments amounts to $4,350 on December 31, 2018.4. The unexpired portions of the insurance policies totaled $65,000 as of December 31, 2018. (a) Assuming that the books have not been closed, what are the adjusting entries necessary at December 31, 2018?LO 4Interest Revenue ($5,100 – $4,350) 750 Interest Receivable 750Insurance Expense 25,000 Prepaid Insurance 25,000ERROR ANALYSIS5. $28,000 was received on January 1, 2018 for the rent of a building for both 2018 and 2019. The entire amount was credited to rental income.6. Depreciation for the year was erroneously recorded as $5,000 rather than the correct figure of $50,000.(a) Assuming that the books have not been closed, what are the adjusting entries necessary at December 31, 2018?LO 4Rental Income ($28,000 ÷ 2) 14,000 Unearned Rent Revenue 14,000Depreciation Expense 45,000 Accumulated Depreciation 45,000ERROR ANALYSISE22-19 (Error Analysis; Correcting Entries) A partial trial balance of Dickinson Corporation is as follows on December 31, 2018.Instructions: (b) Assuming that the books have been closed, what are the adjusting entries necessary at December 31, 2018?LO 4ERROR ANALYSIS(b) Assuming that the books have been closed, what are the adjusting entries necessary at December 31, 2018?1. A physical count of supplies on hand on December 31, 2018, totaled $1,100.2. Accrued salaries and wages on December 31, 2018, amounted to $4,400.LO 4Retained Earnings 1,600 Supplies 1,600Retained Earnings 2,900 Salaries and Wages Payable 2,900ERROR ANALYSIS3. Accrued interest on investments amounts to $4,350 on December 31, 2018.4. The unexpired portions of the insurance policies totaled $65,000 as of December 31, 2018.(b) Assuming that the books have been closed, what are the adjusting entries necessary at December 31, 2018?LO 4Retained Earnings ($5,100 – $4,350) 750 Interest Receivable 750Retained Earnings 25,000 Prepaid Insurance 25,000ERROR ANALYSIS5. $24,000 was received on January 1, 2018 for the rent of a building for both 2018 and 2019. The entire amount was credited to rental income.6. Depreciation for the year was erroneously recorded as $5,000 rather than the correct figure of $50,000.(b) Assuming that the books have been closed, what are the adjusting entries necessary at December 31, 2018?LO 4Retained Earnings 14,000 Unearned Rent Revenue 14,000Retained Earnings 45,000 Accumulated Depreciation 45,000ERROR ANALYSISLO 5 Make the computations and prepare the entries necessary to record a change from or to the equity method of accounting.CHANGE FROM THE EQUITY METHODChange from the equity method to the fair-value method. Earnings or losses previously recognized under the equity method should remain as part of the carrying amount of the investment.The cost basis is the carrying amount of the investment at the date of the change. The investor applies the new method in its entirety. At the next reporting date, the investor should record the unrealized holding gain or loss to recognize the difference between the carrying amount and fair value.CHANGING FROM OR TO THE EQUITY METHODAPPENDIX 22AAccounted for such dividends as a reduction of the investment carrying amount, rather than as revenue.Reason: Dividends in excess of earnings are viewed as a ________________ with this excess then accounted for as a reduction of the equity investment. liquidating dividendCHANGING FROM OR TO THE EQUITY METHODDividends in Excess of EarningsLO 5APPENDIX 22AIllustration: On January 1, 2016, Investor Company purchased 250,000 shares of Investee Company’s 1,000,000 shares of outstanding stock for $8,500,000. Investor correctly accounted for this investment using the equity method. After accounting for dividends received and investee net income, in 2016, Investor reported its investment in Investee Company at $8,780,000 at December 31, 2016. On January 2, 2017, Investee Company sold 1,500,000 additional shares of its own common stock to the public, thereby reducing Investor Company’s ownership from 25 percent to 10 percent.CHANGING FROM OR TO THE EQUITY METHODDividends in Excess of EarningsLO 5APPENDIX 22AILLUSTRATION 22A-1Income Earned and Dividends ReceivedCHANGING FROM OR TO THE EQUITY METHODDividends in Excess of EarningsLO 5APPENDIX 22AILLUSTRATION 22A-2Impact on Investment Carrying AmountCash 400,000 Dividend Revenue 400,000Cash 210,000 Equity Investments 60,000 Dividend Revenue 150,0002017 and 20182019CHANGING FROM OR TO THE EQUITY METHODLO 5APPENDIX 22ACHANGE TO THE EQUITY METHODCompanies use retrospective application. The carrying amount of the investment, results of current and prior operations, and retained earnings of the investor are adjusted as if the equity method has been in effect during all of the previous periods.Companies also adjust for any Unrealized Holding Gain or Loss—Income amounts in Retained Earnings and the Fair Value Adjustment account.CHANGING FROM OR TO THE EQUITY METHODLO 5APPENDIX 22ARELEVANT FACTS - SimilaritiesThe accounting for changes in estimates is similar between GAAP and IFRS.Under GAAP and IFRS, if determining the effect of a change in accounting policy is considered impracticable, then a company should report the effect of the change in the period in which it believes it practicable to do so, which may be the current period.LO 6 Compare the procedures for accounting changes and error analysis under GAAP and IFRS.RELEVANT FACTS - DifferencesOne area in which GAAP and IFRS differ is the reporting of error corrections in previously issued financial statements. While both sets of standards require restatement, GAAP is an absolute standard—that is, there is no exception to this rule.Under IFRS, the impracticality exception applies both to changes in accounting principles and to the correction of errors. Under GAAP, this exception applies only to changes in accounting principle.IFRS (IAS 8) does not specifically address the accounting and reporting for indirect effects of changes in accounting principles. As indicated in the chapter, GAAP has detailed guidance on the accounting and reporting of indirect effects.LO 6ON THE HORIZONFor the most part, IFRS and GAAP are similar in the area of accounting changes and reporting the effects of errors. Thus, there is no active project in this area. A related development involves the presentation of comparative data. Under IFRS, when a company prepares financial statements on a new basis, two years of comparative data are reported. GAAP requires comparative information for a three-year period. Use of the shorter comparative data period must be addressed before U.S. companies can adopt IFRS.LO 6Which of the following is false?GAAP and IFRS have the same absolute standard regarding the reporting of error corrections in previously issued financial statements.The accounting for changes in estimates is similar between GAAP and IFRS.Under IFRS, the impracticality exception applies both to changes in accounting principles and to the correction of errors.GAAP has detailed guidance on the accounting and reporting of indirect effects; IFRS does not.IFRS SELF-TEST QUESTIONLO 6Which of the following is not classified as an accounting change by IFRS?Change in accounting policy.Change in accounting estimate.Errors in financial statements.None of the above.IFRS SELF-TEST QUESTIONLO 6IFRS requires companies to use which method for reporting changes in accounting policies?Cumulative effect approach.Retrospective approach.Prospective approach.Averaging approach.IFRS SELF-TEST QUESTIONLO 6“Copyright © 2016 John Wiley & Sons, Inc. 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