22-1 Prepared by Prepared by Coby Harmon Coby Harmon University of California, Santa Barbara University of California, Santa Barbara Intermedi Intermedi ate ate Accountin Accountin g g Intermedi Intermedi ate ate Accountin Accountin g g Prepared by Prepared by Coby Harmon Coby Harmon University of California, Santa Barbara University of California, Santa Barbara Westmont College Westmont College 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 Westmont College ki ki e e so so w w e e ygandt ygandt warfi warfi e e ld ld team for success team for success
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22-1
Prepared by Prepared by Coby Harmon Coby Harmon
University of California, Santa BarbaraUniversity of California, Santa Barbara
IntermediatIntermediate e
AccountingAccounting
IntermediatIntermediate e
AccountingAccounting
Prepared by Prepared by Coby Harmon Coby Harmon
University of California, Santa BarbaraUniversity of California, Santa BarbaraWestmont CollegeWestmont College
INTERMEDIATE
ACCOUNTINGF I F T E E N T H E D I T I O N
Prepared byCoby Harmon
University of California, Santa BarbaraWestmont College
kikieesosowweeygandtygandtwarfiwarfieeldld
team for successteam for success
22-2
PREVIEW OF CHAPTERPREVIEW OF CHAPTER
Intermediate Accounting15th Edition
Kieso Weygandt Warfield
2222
22-3
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:
2. Describe the accounting for changes in accounting principles.
3. Understand how to account for retrospective accounting changes.
4. Understand how to account for impracticable changes.
Accounting Changes Accounting Changes and Error Analysisand Error Analysis2222
22-36
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
22-37
Accounting Errors
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.
LO 7
Illustration 22-18Accounting-Error Types
22-38
Accounting Errors
Accounting Category
LO 7
Type of Restatement
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.
Illustration 22-18Accounting-Error Types
Source: T. Baldwin and D. Yoo, “Restatements—Traversing Shaky Ground,” Trend Alert, Glass Lewis & Co. (June 2, 2005), p. 8.
22-39
All 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 7
Accounting Errors
22-40
Illustration: In 2015 the bookkeeper for Selectro Company
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
22-41
Selectro’s income statement for 2014 with and without the error.
Illustration 22-19
LO 7
Example of Error Correction
What are the entries that Selectro should have made and did make
for recording depreciation expense and income taxes?
22-42
Entries that Selectro should have made and did make for recording
depreciation expense and income taxes.
Illustration 22-20
Example of Error CorrectionIllustration 22-19
22-43
Illustration 22-20
LO 7
Example of Error Correction
Advance slide in
presentation mode to reveal
complete illustration.
22-44
Retained Earnings 12,000Correcting Entry in
2015
Illustration 22-20
LO 7
Example of Error Correction
Prepare the proper correcting entry in 2015, that should be made
by Selectro.
22-45
Retained Earnings 12,000Correcting Entry in
2015
Reversal
LO 7
Example of Error Correction
Prepare the proper correcting entry in 2015, that should be made
by Selectro.Illustration 22-20
Deferred Tax Liability 8,000
22-46
Retained Earnings 12,000Correcting Entry in
2015
LO 7
Example of Error Correction
Prepare the proper correcting entry in 2015, that should be made
by Selectro.Illustration 22-20
Accumulated Depreciation—Buildings
20,000
Deferred Tax Liability 8,000
22-47
Illustration: Selectro Company has a beginning retained earnings
balance at January 1, 2015, of $350,000. The company reports net
income of $400,000 in 2015.Illustration 22-21
LO 7
Example of Error Correction
Single-Period Statements
22-48
Comparative Statements
Company should
1. make adjustments to correct the amounts for all affected
accounts reported in the statements for all periods
reported.
2. restate the data to the correct basis for each year
presented.
3. show any catch-up adjustment as a prior period
adjustment to retained earnings for the earliest period it
reported.
LO 7
Accounting Errors
22-49
Woods, Inc.Statement of Retained Earnings
For the Year Ended December 31, 2014
Balance, January 1 1,050,000$ Net income 360,000 Dividends (300,000) Balance, December 31 1,110,000$
Before issuing the report for the year ended December 31, 2014, you discover
a $62,500 error that caused the 2013 inventory to be overstated (overstated
inventory caused COGS to be lower and thus net income to be higher in
2013). Would this discovery have any impact on the reporting of the
Statement of Retained Earnings for 2014? Assume a 20% tax rate.
LO 7
Accounting Errors
22-50 LO 7
Accounting Errors
Woods, Inc.Statement of Retained Earnings
For the Year Ended December 31, 2014
Balance, January 1 1,050,000$ Prior period adjustment, net of tax (50,000) Balance, January 1, as restated 1,000,000 Net income 360,000 Dividends (300,000) Balance, December 31 1,060,000$
Advance slide in presentation mode to reveal answers.
22-51
Illustration 22-23
LO 7
Accounting Errors
Summary of Accounting Changes and Correction of Errors
22-52
Illustration 22-23
LO 7
Summary of Changes and Errors
22-53 LO 7
22-54
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:
2. Describe the accounting for changes in accounting principles.
3. Understand how to account for retrospective accounting changes.
4. Understand how to account for impracticable changes.
Accounting Changes Accounting Changes and Error Analysisand Error Analysis2222
22-57
Error Analysis
Companies must answer three questions:
1. What type of error is involved?
2. What entries are needed to correct for the error?
3. 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 9
22-58
Balance 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 9
Error Analysis
Balance Sheet Errors
22-59
Improper 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 9
Error Analysis
Income Statement Errors
22-60
Counterbalancing Errors
Will be offset or corrected over two periods.
1. If company has closed the books:
a. If the error is already counterbalanced, no entry is
necessary.
b. 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 9
Error Analysis
Balance Sheet and Income Statement Errors
22-61
Will be offset or corrected over two periods.
2. If company has not closed the books:
a. If error already counterbalanced, make entry to correct the
error in the current period and to adjust the beginning
balance of Retained Earnings.
b. If error not yet counterbalanced, make entry to adjust the
beginning balance of Retained Earnings.
LO 9
Counterbalancing Errors
Error Analysis
Balance Sheet and Income Statement Errors
22-62
Not offset in the next accounting period.
Companies must make correcting entries, even if they have
closed the books.
LO 9
Noncounterbalancing Errors
Error Analysis
Balance Sheet and Income Statement Errors
22-63
E22-19 (Error Analysis; Correcting Entries): A partial trial balance of
Julie Hartsack Corporation is as follows on December 31, 2015.
Dr. Cr.
Supplies 2,700$
Salaries and wages payable 1,500$
Interest receivable 5,100
Prepaid insurance 90,000
Unearned rent 0
Interest payable 15,000
Instructions: (a) Assuming that the books have not been closed, what
are the adjusting entries necessary at December 31, 2015?
LO 9
Error Analysis
22-64
1. A physical count of supplies on hand on December 31, 2015, totaled
$1,100.
2. Accrued salaries and wages on December 31, 2015, amounted to
$4,400.
(a) Assuming that the books have not been closed, what are the
adjusting entries necessary at December 31, 2015?
LO 9
Error Analysis
Supplies Expense ($2,700 – $1,100) 1,600
Supplies on Hand 1,600
Salary and Wages Expense 2,900
Accrued Salaries and Wages 2,900
22-65
3. Accrued interest on investments amounts to $4,350 on December 31,
2015.
4. The unexpired portions of the insurance policies totaled $65,000 as
of December 31, 2015.
(a) Assuming that the books have not been closed, what are the
adjusting entries necessary at December 31, 2015?
LO 9
Error Analysis
Interest Revenue ($5,100 – $4,350) 750
Interest Receivable 750
Insurance Expense 25,000
Prepaid Insurance 25,000
22-66
5. $28,000 was received on January 1, 2015 for the rent of a building for
both 2015 and 2016. 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, 2015?
LO 9
Error Analysis
Rental Income ($28,000 ÷ 2) 14,000
Unearned Rent 14,000
Depreciation Expense 45,000
Accumulated Depreciation 45,000
22-67
E22-19 (Error Analysis; Correcting Entries) A partial trial balance of
Dickinson Corporation is as follows on December 31, 2015.
Instructions: (b) Assuming that the books have been closed, what are
the adjusting entries necessary at December 31, 2015?
LO 9
Error Analysis
Dr. Cr.
Supplies 2,700$
Salaries and wages payable 1,500$
Interest receivable 5,100
Prepaid insurance 90,000
Unearned rent 0
Interest payable 15,000
22-68
(b) Assuming that the books have been closed, what are the adjusting
entries necessary at December 31, 2015?
1. A physical count of supplies on hand on December 31, 2015, totaled
$1,100.
2. Accrued salaries and wages on December 31, 2015, amounted to
$4,400.
LO 9
Error Analysis
Retained Earnings 1,600
Supplies 1,600
Retained Earnings 2,900
Accrued Salaries and Wages 2,900
22-69
3. Accrued interest on investments amounts to $4,350 on December 31,
2015.
4. The unexpired portions of the insurance policies totaled $65,000 as
of December 31, 2015.
(b) Assuming that the books have been closed, what are the adjusting
entries necessary at December 31, 2015?
LO 9
Error Analysis
Retained Earnings ($5,100 – $4,350) 750
Interest Receivable 750
Retained Earnings 25,000
Prepaid Insurance 25,000
22-70
5. $24,000 was received on January 1, 2015 for the rent of a building for
both 2015 and 2016. 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, 2015?
LO 9
Error Analysis
Retained Earnings 14,000
Unearned Rent 14,000
Retained Earnings 45,000
Accumulated Depreciation 45,000
22-71LO 10 Make the computations and prepare the entries necessary to
record a change from or to the equity method of accounting.
Change From The Equity Method
Change 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.
APPENDIXAPPENDIX 22A CHANGING FROM OR TO THE EQUITY METHOD
22-72
Accounted 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 dividend
APPENDIXAPPENDIX 22A CHANGING FROM OR TO THE EQUITY METHOD
Dividends in Excess of Earnings
LO 10
22-73
Illustration: On January 1, 2013, 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 2013, Investor reported its investment in
Investee Company at $8,780,000 at December 31, 2013. On January 2,
2014, 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.
APPENDIXAPPENDIX 22A CHANGING FROM OR TO THE EQUITY METHOD
Dividends in Excess of Earnings
LO 10
22-74
Illustration 22A-1
APPENDIXAPPENDIX 22A CHANGING FROM OR TO THE EQUITY METHOD
Dividends in Excess of Earnings
LO 10
22-75
Illustration 22A-2Impact on Investment Carrying Amount
Cash 400,000Dividend Revenue
400,000
Cash 210,000Equity Investments (AFS)
60,000Dividend Revenue
150,000
2014 and 2015
2016
APPENDIXAPPENDIX 22A CHANGING FROM OR TO THE EQUITY METHOD
LO 10
22-76
Change To The Equity Method
Companies 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 eliminate any balances in the Unrealized
Holding Gain or Loss—Equity account and the Securities
Fair Value Adjustment account.
APPENDIXAPPENDIX 22A CHANGING FROM OR TO THE EQUITY METHOD
LO 10
22-77
RELEVANT FACTS - Similarities
The 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 11 Compare the procedures for accounting changes and error analysis under GAAP and IFRS.
22-78
RELEVANT FACTS - Differences
One 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 11
22-79
ON THE HORIZON
For 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 11
22-80
Which of the following is false?
a. GAAP and IFRS have the same absolute standard regarding
the reporting of error corrections in previously issued financial
statements.
b. The accounting for changes in estimates is similar between
GAAP and IFRS.
c. Under IFRS, the impracticality exception applies both to
changes in accounting principles and to the correction of errors.
d. GAAP has detailed guidance on the accounting and reporting of
indirect effects; IFRS does not.
IFRS SELF-TEST QUESTION
LO 11
22-81
IFRS SELF-TEST QUESTION
Which of the following is not classified as an accounting change by
IFRS?
a. Change in accounting policy.
b. Change in accounting estimate.
c. Errors in financial statements.
d. None of the above.
LO 11
22-82
IFRS requires companies to use which method for reporting changes