1. Additional Reporting Issues
Fundamentals of Intermediate Accounting
Weygandt, Kieso and Warfield
Chapter 17:
Additional Reporting Issues
Prepared by
Bonnie Harrison, College of Southern Maryland
LaPlata, Maryland

2. Chapter 17 Additional Reporting Issues
After studying this chapter, you should be able to:
Describe various accounting changes.
Understand how to account for cumulative-effect accounting changes.
Understand how to account for retroactive accounting changes.
Describe the accounting for changes of estimates. 1 2 3 4

3. Chapter 17 Additional Reporting Issues
After studying this chapter, you should be able to:
Describe the accounting for correction of errors.
Compute earnings per share in a simple capital structure.
Compute earnings per share in a complex capital structure. 5 6 7

4. Types of Accounting Changes
The types of accounting changes are:
Changes in Accounting Principle
Changes in Accounting Estimates
Errors in Financial Statements

5. Changes in Accounting Principle
A change in principle involves a change from one generally accepted principle to another
A change in principle does not result from the adoption of a new accounting principle
A change to a generally accepted principle (from an incorrect principle) is a correction of an error

6. Changes in Accounting Principle
Changes in accounting principle are classified into:
Cumulative-effect type of accounting change
Retroactive-effect type of accounting change
Change to the LIFO method of inventory

7. Cumulative-Effect Type of Accounting Change
The catch up method should be used to account for these changes
Financial statements for prior periods are not restated
For all prior periods, the following items are shown on an as-if basis (as if the new principle had been applied):
income before extraordinary items
net income

8. Cumulative-Effect Type of Accounting Change
The adjusting entry is effective as of the beginning of the year
Pro forma information is shown only as supplementary information
Such information may be reported:
in the income statement
in a separate schedule
in the notes to the financial statements

9. Cumulative Effect: Example
XYZ company changes from the sum-of-the-years’ digits method to the straight line method of depreciation.
The depreciation amounts are: Year SYD ST.LINE $15,000 $8, $14,000 $8,000
The company’s tax rate is 40%
Record the change as of the beginning of 2004

10. Cumulative Effect: Example
Year SYD SL Diff Tax Effect
2002 $15,000 $8, $7,000 $2,800
2003 $14,000 $8, $6,000 $2, $13,000 $5,
Tax effect is the difference times the tax rate

11. Cumulative Effect: Example
Journal Entry:
Accumulated Depreciation $13, Deferred Tax Asset $5, Cumulative Effect of Change in Principle $7,800
The debit to accumulated depreciation is the excess of SYD over the straight line basis
The credit to Cumulative Effect is the income effect (net of tax effect)

12. Income Statement Presentation
The following information must be presented in whole dollar amounts and as per share amounts:
Income before Extraordinary Item and Cumulative Effect of Change :$ XXX
Extraordinary Item (Net of Tax) :$ XX
Cumulative Effect on Prior Years of Retroactive Application :$ XX
Net Income :$ XX

13. Retroactive-Effect Type of Accounting Change
The cumulative effect of the new method at the beginning of the period is determined
Prior period statements are recast based on the new principle
Any cumulative effect of prior periods is adjusted to the beginning retained earnings balance

14. Retroactive-Effect Type of Accounting Change
The five situations requiring restatement of all prior period statements are:
A change from the LIFO inventory method to another method
A change in the method of accounting for long term construction type contracts
A change from or to the full cost method in extractive industries
Issue of financials to obtain first time financing
A pronouncement recommending retroactive adjustment

15. Retained Earnings Presentation
Retained Earnings account is shown as follows:
Balance at beginning of year :$ XXX
Adjustment for the Cumulative Effect on Prior Years :$ XX
Balance at beginning (as adjusted) :$ XX
Net Income :$ XXX
Balance at end of year :$ XXX

16. Reporting a Change in Estimate
Changes in estimates are accounted for on a prospective basis
Such changes are viewed as normal, recurrent adjustments
When uncertainty exists as to whether a change in principle or a change in estimate has occurred:
the change should be treated as a change in estimate
Estimates that are later determined to be incorrect should be corrected as changes in estimates
Examples of changes in estimates involve:
inventory obsolescence; salvage values of assets, uncollectible receivables, liability for warranties and taxes

17. When is a Change in Accounting Principle Appropriate?
Changes are appropriate when the changed principle is preferable to the existing accounting principle
The changed principle should result in improved financial reporting
A change is considered preferable if a FASB standard:
creates a new accounting principle, or
expresses preference for a new principle, or
rejects a specific accounting principle

18. Reporting the Correction of an Error
Corrections are treated as prior period adjustments to retained earnings for the earliest period being reported
Examples of accounting errors are:
A change from an accounting principle that is not generally accepted to one that is accepted
Mathematical errors
Changes in estimates that were not prepared in good faith
A failure to properly accrue or defer expenses or revenues
A misapplication or omission of relevant facts
Incorrect classification of cost as expense or asset

19. Earnings Per Share
EPS indicates the income earned by each share of common stock.
Reported only for common stock.
Dilution of EPS means reduction in EPS.
Reduction in EPS results from potential conversion of dilutive securities into common stock.
Shareholders want to know the extent of reduction in EPS, if dilution takes place.

20. E.P.S BASIC E.P.S: NET INCOME - PREFERRED DIVIDEND
WEIGHT.AVERAGE OUTSTANDING. COMMON SHARES

21. Basic EPS Computations: Example
Given:
Jan 1: 500,000 shares outstanding.
May 1: Issued 84,000 shares.
Sept 1: Reacquired 42,000 shares.
Nov 1: Issued 36,000 shares.
N.Inc [to common stock]: $654,000.
Determine the earnings per share.

22. Basic EPS Computations: Example
Jan 1: 500,000 * 4/12 = 166,667
May: ,000 * 4/12 = 194,666
Sept 1: 542,000 * 2/12 = 90,333
Nov 1: 578,000 * 2/12 = 96,334
Total W.Avg.shares ,000
Earnings per Share = $654,000 / 548,000 shares
= $1.19

23. Stock Dividends and Splits
Stock dividends and stock splits require restatement of weighted shares outstanding before the dividend or split.
Stock dividends or splits during the year are deemed to have been outstanding since the beginning of the year.
Stock dividends or splits after end of the year but before issue of the financials are likewise deemed to be outstanding since the beginning of the year.

24. What is “DILUTION?”
“DILUTION” is the reduction in E.P.S, if: securities, potentially convertible into common stock, are converted [assumed at beginning of the year].
Two EPS amounts are important: Basic and Diluted

25. Complex Capital Structures
Complex structures have convertible securities, options, warrants, or other rights that reduce earnings per share.
Only securities that reduce earnings per share (dilutive) are considered.
Securities that increase earnings per share (antidilutive) are ignored.

26. Diluted Earnings per Share: Methods
The dilutive effect of convertible securities is measured by the if-converted method
The dilutive effect of options and warrants is measured by the treasury stock method
For computing dilution, the rate of conversion most advantageous to the security holder is used (maximum dilutive conversion rate)

27. The If-Converted Method
The conversion of the securities into common stock is assumed to occur at the beginning of the year
The related interest effect (net of tax) is removed from net income
The weighted average number of shares is increased by the additional common shares assumed issued (at the beginning)

28. The Treasury Stock Method
Options and warrants (and their equivalents) are included in EPS computations
Options and warrants are assumed exercised at the beginning of the year
The proceeds from the exercise of options are assumed used to buy back common shares
The exercise price per share must be less than the market price per share for dilution to occur

29. Options and Warrants: Treasury Stock Method
Given:
Exercise price of an option :
[for one share of stock] $ 10
Market price of one share
at Exercise date: $ 40
Options deemed exercised: 1,000
Compute the number of weighted shares for determining
diluted earnings per share

30. Options and Warrants: Treasury Stock Method
Total proceeds from exercise: $10,000
Shares assumed issued upon exercise: 1,000
Assumed reacquisition of shares:
DILUTION: 1, = 750 SHARES (increase in outstanding shares)

31. Earnings per Share: Simple Capital Structures - Summary
Single Presentation of EPS 1
Net Income less Preferred Dividends 2
Weighted Average Number of Common Shares Outstanding 3
EPS = Result in Step 2
Result in Step 3 4

32. Earnings per Share: Complex Structures - Summary
Dual EPS Presentation
Basic EPS
Diluted EPS
Dilutive Convertibles
Dilutive Options and
Warrants
Dilutive Contingent
Issues
Net Income adjusted for interest
(net of tax) and preferred dividends
Weighted average number of
common shares assuming maximum
dilution

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