University:
California State University, Northridge
Course:
ACCT 350 | Intermediate Financial Accounting I
Academic year:

2024
Views:

449

Pages:

19
Author:

Kaylah Sullivan

Accounting Changes and Error Corrections Learning Objectives 1. Understand the two different types of accounting changes that have been identified by accounting standard setters. 2. Recognize the difference between a change in accounting estimate and a change in accounting principle, and know how a change in accounting estimate is reflected in the financial statements. 3. Prepare the retrospective adjustment of prior periods’ financial statements, and any necessary cumulative adjustment, associated with a change in accounting principle. Learning Objectives 4. Report pro forma results for prior years following a business combination. 5. Recognize the various types of errors that can occur in the accounting process understand when errors counterbalance, and be able to correct errors when necessary. Effect of FASB Statement No. 106 Company One-Time Charge (in millions) IBM Gen. Electric Bell Atlantic PepsiCo The Coca-Cola Company Tiffany & Co. $2,263 1,799 1,550 357 7 6 Accounting Changes • Two main categories of accounting changes: 1. Change in accounting estimate 2. Change in accounting principle • Basic issue is if the changes should be reported as adjustments of the prior periods statements or only affect current and future years. Change in Accounting Estimate • Accounting information can not be measured precisely. • Estimates may need to be revised to give a better reflection of the business’s activities. • Examples accounting estimate changes: – – – – – Uncollectible receivables Useful lives of depreciation Residual values of depreciable assets Warranty obligations Quantities of mineral reserves to be depleted Stop and Think Why aren’t changes in estimates accounted for by restating prior years’ financial statements? Change in Accounting Estimate All changes in 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. Change in Accounting Estimate Assume Telestar Co, a telescope sales and manufacturing firm, elected in 2008 to change from double-declining balance method of depreciation to the straightline method to make it more consistent with the majority of its competitors. Depreciable assets have a cost of $500,000 and they were all acquired on 1/1/2005 and have a useful life of 10 years with a zero salvage value. The income tax rate is 30%. Change of Accounting Estimate Year Double-DecliningBalance Straight-Line Depreciation Depreciation Effect on Difference Income 2005 $ 100,000 2006 80,000 50,000 30,000 21,000 2007 64,000 50,000 14,000 9,800 $150,000 $94,000 $65,800 $ 50,000 $ 50,000 $ 35,000 Cumulative before 2008 $244,000 Income would have been $94,000 higher leaving a net income difference of $65,800. No change to depreciation for 2005,2006, 2007. 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. Change in Accounting Principle • Report current year’s income components on the new basis. • Report the cumulative effect of the adjustment, net of tax, on the income statement. • Present prior period financial statements as previously reported. • Include pro-forma information as if the change were retroactive—direct and indirect effects. • Present earnings per share data for all prior periods presented. Restatement for Prior Periods for Change in Principle • A change from LIFO method of inventory pricing to another method. • A change in the method of accounting for long-term construction contracts. • A change to or from the full cost method of accounting used in extractive industries. • Changes made at the time of an initial distribution of company stock. • A change from retirement-replacementbetterment accounting to depreciation accounting for railroads. Restatement for Prior Periods for Change in Principle • Change to LIFO—past records often inadequate to prepare pro-formas. • Beginning inventory becomes first LIFO layer. • No cumulative effect adjustment is required. Restatement for Prior Periods for Change in Principle In 2008 Forester Company changed from the LIFO inventory costing method to the FIFO method for both financial reporting and income tax purposes. At this time LIFO costing provided a pretax income of $335,000. By converting to FIFO, this pretax income is $335,000 (an $85,000 difference). Applying a tax rate of 30%, the income tax effect is $25,500. Restatement for Prior Periods for Change in Principle The entry in 2008 to record the priorperiod effects of the change in accounting principle follows: Inventory 85,000 Income Taxes Payable 25,500 Retained Earnings 59,500 To adjust the beginning 2008 inventory to its FIFO cost. Pro Forma Disclosures after a Business Combination On December 31, 2008, 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. 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. Pro Forma Disclosures after a Business Combination Information reported on the two companies for 2007 and 2008 was as follows: 2008 2007 Sump Pump Company: Revenue $3,500,000 $3,000,000 Net income 250,000 200,000 Rock Wall Company: Revenue $250,000 $400,000 Net income 40,000 75,000 Pro Forma Disclosures after a Business Combination The pro forma information included in the notes to Sump Pump Company’s 2008 financial statements is: Revenue Net income 2008 Combined Results $3,500,000 250,000 2007 Combined Results Revenue Net income $3,000,000 200,000 2008 Results for Combined Companies $3,750,000 270,000 2007 Results for Combined Companies $3,400,000 255,000

Accounting Changes and Error Corrections, Part 1

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