1. 20-1 Intermediate Accounting,17E Stice | Stice | Skousen © 2010 Cengage Learning PowerPoint presented by: Douglas Cloud Professor Emeritus of Accounting, Pepperdine University Accounting Changes and Error Corrections

2. 20-2 Accounting Changes The accounting profession has identified two main categories of accounting changes : 1.Change in accounting estimate 2.Change in accounting principle The basic accounting issue is whether accounting changes should be reported as adjustments of the prior periods’ statements or whether the changes should affect only the current and future years.

3. 20-3 Change in Accounting Estimate Contrary to what many people believe, accounting information cannot always be measured precisely. To provide information on a timely basis, accounting information often must be based on estimates. Estimates may need to be revised to give a better reflection of the company’s activities. (continues)

4. 20-4 Change in Accounting Estimate Examples of areas for which changes in accounting estimates are needed include: 1.Uncollectible receivables 2.Useful lives of depreciable or intangible assets 3.Residual value of depreciable assets 4.Warranty obligations 5.Quantities of mineral reserves 6.Pensions and postemployment benefits 7.Number of periods benefited by deferred costs

5. 20-5 Change in Accounting Estimate All changes in accounting estimates should be reflected either in the current period or in current and future periods. No retroactive adjustments or pro forma statements are to be prepared for a change in estimate.

6. 20-6 Telstar Company Telstar Company, a high-power telescope sales and manufacturing firm, elected in 2011 to change from the double-declining balance method of depreciation to the straight-line method to make its financial reporting more consistent with the majority of its competitors. (continues)

7. 20-7 Depreciable assets were acquired on January 1, 2008, at a cost of $500,000. They are expected to have a ten-year life and a zero salvage value. The income tax rate is 30%. Telstar Company (continues)

8. 20-8 Telstar Company The total impact on Telstar’s balance sheet as of January 1, 2011, is as follows: (continues)

9. 20-9 Telstar Company The table below shows the depreciation amount that would be reported in the books and for income tax purposes after the accounting change.

10. 20-10 Change in Accounting Principle A change in accounting principle involves a change from one generally accepted principle or method to another. A change from a principle that is not generally accepted to one that is generally accepted is considered to be an error correction rather than a change in accounting principle. (continues)

11. 20-11 The effect of the accounting change from one accepted accounting principle to another is reflected by retrospectively adjusting the financial statements for all years reported, and reporting the cumulative effect of the change in the income for all preceding years as an adjustment to the beginning balance. IMPORTANT! Change in Accounting Principle (continues)

12. 20-12 Change in Accounting Principle On January 1, 2011, Forester Company changed from the LIFO inventory costing method to the FIFO method for both financial reporting and income tax purposes. The income tax rate is 30%. The chart in Slide 20- 13 shows financial statement data based on LIFO. (continues)

13. 20-13 Change in Accounting Principle (continues)

14. 20-14 Change in Accounting Principle Now, let’s examine the financial statements after changing to FIFO compared to the data if Forester had continued using LIFO. (continues)

15. 20-15 Change in Accounting Principle (continues)

16. 20-16 Change in Accounting Principle In addition to the preparation of retrospectively adjusted primary financial statements, a note disclosure is needed to show the impact of the change on each financial statement item in each year reported. Such disclosures are shown on Slides 20-17 and 20-18. (continues)

17. 20-17 Change in Accounting Principle (continues)

18. 20-18 Change in Accounting Principle

19. 20-19 Pro Forma Disclosures after a Business Combination The supplemental disclosure required following a business combination is explained in SFAS No.141 (R). The combined company is required to disclose pro forma results for the year of the combination as if the combination had occurred at the beginning of the year.

20. 20-20 Pro Forma Disclosures after a Business Combination On December 31, 2011, Sump Pump Company acquired Rock Wall Company for $500,000. This amount exceeded the recorded value of Rock Wall Company’s net assets by $100,000 on the acquisition date. The entire excess was attributed to a piece of Rock Wall’s equipment that had a remaining useful life of five years as of the acquisition date. (continues)

21. 20-21 Pro Forma Disclosures after a Business Combination Sump Pump Company: Revenue$3,500,000$3,000,000 Net income250,000200,000 Rock Wall Company: Revenue$250,000$400,000 Net income40,00075,000 Sump Pump Company: Revenue$3,500,000$3,000,000 Net income250,000200,000 Rock Wall Company: Revenue$250,000$400,000 Net income40,00075,000 2011 2010 Information reported on the two companies for 2010 and 2011 was as follows: (continues)

22. 20-22 Pro Forma Disclosures after a Business Combination The pro forma information included in the 2011 financial statements notes was as follows: Revenue$3,500,000$3,750,000 Net income250,000270,000 Revenue$3,500,000$3,750,000 Net income250,000270,000 20112011 Results Reportedfor Combined ResultsCompanies Revenue$3,000,000$3,400,000 Net income200,000255,000 Revenue$3,000,000$3,400,000 Net income200,000255,000 20102010 Results Reportedfor Combined ResultsCompanies

23. 20-23 Errors Discovered Currently in the Course of Normal Accounting Procedures Math errors Posting to the wrong account Misstating an account Omitting an account from the trial balance Error Corrections (continues)

24. 20-24 Error Corrections Errors Limited to Balance Sheet Accounts Debiting Accounts Receivable instead of Notes Receivable Crediting Interest Payable instead of Notes Payable Not recording the exchange of convertible bonds for stock (continues)

25. 20-25 Errors Limited to Income Statement Accounts Debiting Office Salaries instead of Sales Salaries Crediting Rent Revenue instead of Commissions Revenue Error Corrections (continues)

26. 20-26 Errors Affecting Both Income Statement Accounts and Balance Sheet Accounts Debiting Office Equipment instead of Repairs Expense Crediting Depreciation Expense instead of Accumulated Depreciation Omission of an adjusting entry Error Corrections (continues)

27. 20-27 There are errors in net income that, when not detected, are automatically counterbalanced in the following fiscal period. There are also errors in net income that, when not detected, are not automatically counterbalanced in the following fiscal period. Error Corrections (continues)

28. 20-28 If detected in current period, before books are closed:  Correct the account through normal accounting adjustment. If detected in subsequent period, after books are closed:  Adjust financial records for effect of material errors.  Make adjustment directly to Retained Earnings. Error Corrections

29. 20-29 Illustrative Example of Error Corrections Supply Master, Inc., began operations at the beginning of 2009. Before the accounts are adjusted and closed for 2011, it was discovered that merchandise inventory as of December 31, 2009, was understated by $1,000. (1) Understatement of Merchandise Inventory (continues)

30. 20-30 The effects of the misstatement were as follows: Because this type of error counterbalances after two years, no correcting entry is required in 2011. Illustrative Example of Error Corrections (continues)

31. 20-31 The correcting entry in 2010 would have been as follows: Merchandise Inventory1,000 Retained Earnings1,000 The correcting entry is the same whether the company uses a periodic or a perpetual inventory system. Illustrative Example of Error Corrections

32. 20-32 It is discovered that purchase invoices of December 28, 2009, for $850 had not been recorded until 2010. The goods had been included in the inventory at the end of 2009. (2) Failure to Record Merchandise Purchases (continues) Illustrative Example of Error Corrections

33. 20-33 The effects of the misstatement were as follows: Retained Earnings850 Purchases (periodic) or Inventory (perpetual)850 Illustrative Example of Error Corrections

34. 20-34 It is discovered that sales on account of $1,800 for the last week of December 2010 had not been recorded until 2011. The goods were not included in the inventory at the end of 2010. (3) Failure to Record Merchandise Sales (continues) Illustrative Example of Error Corrections

35. 20-35 The effects of the misstatement were as follows: When the error is discovered in 2011, the following entry is made: Sales1,800 Retained Earnings1,800 Illustrative Example of Error Corrections

36. 20-36 (4) Failure to Record Accrued Expenses Accrued sales salaries of $450 as of December 31, 2009, were overlooked in adjusting the accounts. Sales Salaries is debited for salary payments. (continues) Illustrative Example of Error Corrections

37. 20-37 The effects of the misstatement were as follows: No entry is required in 2011 to correct the accounts because the misstatement in 2009 has been counterbalanced by the misstatement in 2010. (continues) Illustrative Example of Error Corrections

38. 20-38 If this error had been discovered in 2010 instead of 2011, the following correcting entry would have to be made to correct the account balances. Retained Earnings450 Sales Salaries450 Illustrative Example of Error Corrections

39. 20-39 It is discovered that Miscellaneous General Expense for 2009 included taxes of $275 that should have been deferred in adjusting the accounts on December 31, 2009. (5) Failure to Record Prepaid Expenses (continues) Illustrative Example of Error Corrections

40. 20-40 The effects of the failure to record the prepaid expenses were as follows: Because this is a counterbalancing error, no entry to correct the accounts is required in 2011. (continues) Illustrative Example of Error Corrections

41. 20-41 If this error had been discovered in 2010 instead of 2011, the following correcting entry would be necessary to correct the accounts. Miscellaneous General Expense275 Retained Earnings275 Illustrative Example of Error Corrections

42. 20-42 Accrued interest on notes receivable of $150 was overlooked in adjusting the accounts on December 31, 2009. The revenue was recognized when the interest was collected in 2010. (6) Failure to Record Accrued Revenue (continues) Illustrative Example of Error Corrections

43. 20-43 The effects of the failure to record the accrued revenue were as follows: Because the balance sheet items at the end of 2010 were correctly stated, no entry is required in 2011. (continues) Illustrative Example of Error Corrections

44. 20-44 If this error had been discovered in 2010 instead of 2011, the following entry would be necessary to correct the account balances: Interest Revenue150 Retained Earnings150 Illustrative Example of Error Corrections

45. 20-45 (7) Failure to Record Unearned Revenue Fees of $225 received in advance for miscellaneous services as of December 31, 2010, were overlooked in adjusting the accounts. Miscellaneous Revenue had been credited when fees were received. Illustrative Example of Error Corrections (continues)

46. 20-46 The effects of the failure to record the unearned revenue were as follows: The following entry is required to correct the accounts: Retained Earnings225 Miscellaneous Revenue225 Illustrative Example of Error Corrections

47. 20-47 Delivery equipment was acquired at the beginning of 2009 at a cost of $6,000. The equipment has an estimated five-year life. Depreciation of $1,200 related to this equipment was overlooked at the end of 2009 and 2010. (8) Failure to Record Depreciation Illustrative Example of Error Corrections (continues)

48. 20-48 The effects of the failure to record depreciation for 2009 were as follows: (continues) The misstatements arising from the failure to record depreciation are not counterbalanced in the succeeding year. Illustrative Example of Error Corrections

49. 20-49 Failure to record depreciation for 2010 affected the statements as follows: The correcting entry in 2011 is as follows: Retained Earnings2,400 Accumulated Depreciation—Delivery Equipment2,400 $1,200 per year × 2 Illustrative Example of Error Corrections

50. 20-50 Operating expenses of $2,000 were paid in cash at the beginning of 2009. The payment was incorrectly debited to Equipment. The “equipment” was assumed to have an estimated five-year life and no residual value; thus, depreciation of $400 was recognized at the end of 2009 and 2010. (9) Incorrectly Capitalizing an Expenditure (continues) Illustrative Example of Error Corrections

51. 20-51 The effects of this incorrect capitalization of an expenditure were as follows: Retained Earnings1,200 Accumulated Depreciation—Equipment800 Equipment2,000 The correcting entry in 2011 is as follows: Illustrative Example of Error Corrections

52. 20-52 Required Disclosure for Error Restatements If an error is subsequently discovered that affected a prior period, the nature of the error, its effect on previously issued financial statements, and the effect of its correction on current period’s net income and EPS should be disclosed in the period in which the error is corrected.

53. 20-53 Summary of Accounting Changes and Error Corrections