HAPTER C 22
Accounting Changes and Error Analysis
ASSIGNMENT CLASSIFICAT ION TABLE (BY TOPIC)
Topics Brief Questions E xercise Exercises s 2, 4, 6, 7, 8, 9, 12, 13, 15, 21, 22, 23 8 Problems Concepts for Analysis 1. Differences between change in principle, change in estimate, change in entity, errors. Accounting changes: a. b. Comprehensive. Changes in estimate, changes in depreciation methods. Changes in accounting for long-term construction contracts. Change from FIFO to average cost. Change from FIFO to L IFO. Change from LIFO. Miscellaneous. 2, 11 8 1, 3, 4, 5, 8, 24 10 3 8, 9, 10 8, 9 4, 5, 9 3, 4, 6, 7, 8, 9, 10, 11, 12, 16, 17 1, 8, 13 3, 6, 7 1, 2, 4, 6, 7 1, 2, 4, 5 1, 2, 3, 4, 5, 6 3 1, 2, 3, 4
2.
c.
2, 10
1, 2, 10
3
1, 2
d. e. f. g. 3.
2, 8, 14 9 2, 3, 5, 8, 14 2, 5
3 1, 2
1, 5
Correction of an error. a. Comprehensive. 8, 14, 15, 17, 19 2, 18, 21 9, 16, 20 8, 9, 10 8, 15, 16, 18, 19, 20, 21 9, 15, 17, 18 7, 17, 18 22, 23 3, 6, 7, 8, 9, 10 1, 6, 8 2, 10 11, 12 1, 2 2, 3, 4
b. c.
Depreciation. Inventory.
6, 7 10 11, 12
*4. Changes between fair value and equity methods.
*This material is dealt with in an Appendix to the chapter.
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ASSIGNMENT CLASSIFICAT ION TABLE (BY LEARNI NG OBJECTIVE)
Learning Objectives B rief E xercises Exercises
Problem s
1. Identify the types of accounting changes. 2. Describe the accounting for changes i n accounting principles. 3. Understand how to account for retrospective accounting changes. 4. Understand how to account for impracticable changes. 5. Describe the accounting for changes of 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. 18, 19, 20, 21 6, 7, 8, 9, 10 11, 12 6, 7, 8, 10 7, 8, 9, 15, 16, 17, 18, 19, 20, 21 1, 2, 3, 6, 7, 8, 9, 10 4, 5, 9 6, 7, 8, 9, 10, 11, 12 1, 2, 3, 4, 6 1, 2, 3, 9, 10 1, 2, 3, 4, 5, 8, 13, 14 1 2, 3, 5
*10. Make the computations and prepare the entries necessary to record a change from or to t he equity method of accounting.
11, 12
22, 23
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ASSIGNMENT CHARACTERIST ICS TABLE
Item E22-1 E22-2 E22-3 E22-4 E22-5 E22-6 E22-7 E22-8 E22-9 E22-10 E22-11 E22-12 E22-13 E22-14 E22-15 E22-16 E22-17 E22-18 E22-19 E22-20 E22-21 *E22-22 *E22-23 P22-1 P22-2 P22-3 P22-4 P22-5 P22-6 P22-7 P22-8 P22-9 Description Change in principlelong-term contracts. Change in principleinventory methods. Accounting change. Accounting change. Accounting change. Accounting changesdepreciation. Change in estimate and error; financial statements. Accounting for accounting changes and errors. Error and change in estimatedepreciation. Depreciation changes. Change in estimatedepreciation. Change in estimatedepreciation. Change in principlelong-term contracts. Various changes in principleinventory methods. Error correction entries. Error analysis and correcting entry. Error analysis and correcting entry. Error analysis. Error analysis and correcting entries. Error analysis. Error analysis. Change from fair value to equity. Change from equity to fair value. Change in estimate and error correction. Comprehensive accounting change and error analysis p roblem. Error corrections and accounting changes. Accounting changes. Change in principleinventoryperiodic. Accounting changes and error analysis. Error corrections. Comprehensive error analysis. Error analysis. Level of Difficulty Moderate Moderate Difficult Difficult Difficult Difficult Moderate Simple Simple Moderate Simple Simple Simple Moderate Simple Simple Simple Moderate Simple Moderate Moderate Complex Moderate Moderate Complex Complex Moderate Moderate Moderate Moderate Difficult Moderate Time (minutes) 1015 1015 2530 2530 3035 3035 2530 510 1520 2025 1015 2025 1015 2025 1520 1015 1015 2530 2025 2025 1015 2530 1520 3035 3040 3040 4050 3035 2530 2530 3035 2025
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P22-10 *P22-11 *P22-12 CA22-1 CA22-2 CA22-3 CA22-4 CA22-5 CA22-6
Error analysis and correcting entries. Fair value to equity method with goodwill. Change from fair value to equity method. Analysis of various accounting changes and errors. Analysis of various accounting changes and errors. Analysis of three accounting changes and errors. Analysis of various accounting changes and errors. Change in principle, estimate. Change in estimate, ethics.
Complex Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate
5060 2025 2025 2535 2030 3035 2030 2030 2030
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SOLUTIONS TO CODIF ICAT IO N EXERCISES
CE22-1
Master Glossary (a) A change that has the effect of adjusting the carrying amount of an existing asset or liability or altering the subsequent accounting for existing or future assets or liabilities. A change in accounting estimate is a necessary consequence of the assessment, in conjunction with the periodic presentation of financial statements, of the present status and expected future benefits and obligations associated with assets and liabilities. Changes in accounting estimates result from new information . Examples of items for which estimates are necessary are uncollectible receivables, inventory obsolescence, service lives and salvage values of depreciable assets, and warranty obligations. A change from one generally accepted accounting principle to another generally accepted accounting principle when there are two or more generally accepted accounting principles t hat apply or when the accounting principle formerly used is no longer generally accepted. A change in the method of applying an accounting principle also is considered a change in accounting principle. The process of revising previously issued financial statements to reflect the correction of an error in those financial statements. The application of a different accounting principle to one or more previously issued financial statements, or to the statement of financial position at the beginning of the current period, as if that principle had always been used, or a change to financial statements of prior accounting periods to present the financial statements of a new reporting entity as if it had existed in those prior years.
(b)
(c) (d)
CE22-2
According to FASB ASC 250-10-50-7 (Accounting Changes and Error CorrectionsDisclosure): When financial statements are restated to correct an error, the entity shall disclose that its p reviously issued financial statements have been restated, along with a description of the nature of the error. The entity also shall disclose both of the following: (a) (b) The effect of the correction on each financial statement line item and any per-share amounts affected for each prior period presented. The cumulative effect of the change on retained earnings or other appropriate components of equity or net assets in the statement of financial position, as of the beginning of the earliest period presented.
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C E22-3
According to FASB ASC 250-10-45-5 (Accounting Changes and Error CorrectionsOther Presentation Matters): Retrospective application requires all of the following: (a) The cumulative effect of the change to the new accounting principle on periods prior to those presented shall be reflected in the carrying amounts of assets and liabilities as of the beginning of the first period presented. An offsetting adjustment, if any, shall be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period. Financial statements for each individual prior period presented shall be adjusted to reflect t he period-specific effects of applying the new accounting principle.
(b)
(c)
CE22-4
According to FASB ASC 250-10-S99-4 (Accounting Changes and Error CorrectionsSEC Materials): Question 5: If a registrant justified a change in accounting method as preferable under the circum stances, and the circumstances change, may the registrant revert to the method of accounting used before the change? Any time a registrant makes a change in accounting method, the change must be justified as p referable under the circumstances. Thus, a registrant may not change back to a principle p reviously used unless it can justify that the previously used principle is preferable in the circumstances as they currently exist.
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A NSWERS TO QUESTIONS
1. The major reasons why companies change accounting methods are: (1) Desire to show better profit picture. (2) Desire to increase cash flows through reduction in income taxes. (3) Requirement by Financial Accounting Standards Board to change accounting methods. (4) Desire to follow industry practices. (5) Desire to show a better measure of the companys income. (a) Change in accounting principle; retrospective application is generally not made because it is impracticable to determine the effect of the change on prior years. The FIFO inventory amount is therefore generally the beginning inventory in the current period. (b) Correction of an error and therefore prior period adjustment; adjust the beginning balance of retained earnings. (c) Increase income for litigation settlement. (d) Change in accounting estimate; currently and prospectively. Part of operating section of income statement. (e) Reduction of accounts receivable and the allowance for doubtful accounts. (f) Change in accounting principle; retrospective application to prior period f inancial statements. The three approaches suggested for reporting changes in accounting principles are: (a) Currentlythe cumulative effect of the change is reported in the current years i ncome as a special item. (b) Retrospectivelythe cumulative effect of the change is reported as an adjustment to retained earnings. The prior years statements are changed on a basis consistent with t he newly adopted principle. (c) Prospectivelyno adjustment is made for the cumulative effect of the change. Previously reported results remain unchanged. The change shall be accounted for in the period of the change and in subsequent periods if the change affects future periods. The FASB believes that the retrospective approach provides financial statement users the most useful information. Under this approach, the prior statements are changed on a basis consistent with the newly adopted standard; any cumulative effect of the change for prior periods is recorded as an adjustment to the beginning balance of retained earnings of the earliest period reported. The indirect effect of a change in accounting principle reflects any changes in current or f uture cash flows resulting from a change in accounting principle that is applied retrospectively. An example is the change in payments to a profit- sharing plan that is based on reported net income. Indirect effects are not included in the retrospective application, but i nstead are reported in the period in which the accounting change occurs (current period). A change in an estimate is simply a change in the way an individual perceives the realizability of an asset or liability. Examples of changes in estimate are: (1) change in the realizability of trade receivables, (2) revisions of estimated lives, (3) changes in estimates of warranty costs, and (4) change in estimate of deferred charges or credits. A change in accounting estimate effected by a change in accounting principle occurs when a change in accounting estimate is i nseparable from the effect of a related change in accounting principle. An example would be switching from capitalizing advertising expenditures to expensing them if the future benefit of the expenditures can no longer be estimated with reasonable certainty.
2.
3.
4.
5.
6.
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Q uestions Chapter 22 (Continued) 7. This is an example of a situation in which it is difficult to differentiate between a change in account ing principle and a change in estimate. In such a situation, the change should be considered a change in estimate, and accordingly, should be handled currently and p rospectively. Thus, all costs presently capitalized and viewed as providing doubtful future values should be expensed immediately, and costs currently incurred should also be expensed immediately. (a) Charge to expensepossibly separately disclosed. (b) Change in estimate that is effected by a change in accounting principle currently and prospectively. (c) Charge to expensepossibly separately disclosed. (d) Correction of an error and reported as a prior period adjustmentadjust the beginning balance of retained earnings. (e) Change in accounting principleretrospective application to all affected priorperiod financial statements. Change in accounting estimatecurrently and prospectively.
8.
(f) 9.
This change is to be handled as a correction of an error. As such, the portion of the change attributable to prior periods ($23,000) should be reported as an adjustment to the beginning balance of retained earnings in the 2010 financial statements. If statements for previous years are presented for comparative purposes, these statements should be restated to correct for the error. The remainder of the inventory value ($29,000) should be reported in the 2010 statements as a reduction of materials cost. Preferability is a difficult concept to apply. The problem is that there are no basic objectives to indicate which is the most preferable method, assuming a selection between two generally accepted accounting practices is possible, such as completed-contract and percentage-ofcompletion. If a FASB standard creates a new principle or expresses preference for or rejects a specific accounting p rinciple, a change is considered clearly acceptable. A more appropriate matching of revenues and expenses is often given as the justification for a change in accounting principle. When a company changes to the LIFO method, the base-year inventory for all subsequent L IFO calculations is the beginning inventory in the year the method is adopted. This assumes that prior years income is not changed because it would be too impractical to do so. The only adjustment necessary may be to adjust the beginning inventory from a lower-ofcost-or-market approach to a cost basis. Where individual company statements were reported in prior years and consolidated f inancial statements are to be prepared this year, the following reporting and disclosure p ractices should be implemented: (1) The financial statements of all prior periods presented should be restated to show the financial information for the new reporting entity for all periods. (2) The financial statements of the year in which the change in reporting entity is made should describe the nature of the change and the reason for it. (3) The effect of the change on income before extraordinary items, net income, and earnings per share amounts should be disclosed for all periods presented. This change represents a change in reporting entity. This type of change should be reported by restating the financial statements of all prior periods presented to show the financial i nformation for the new reporting entity for all periods. The financial statements of the year i n which the change in reporting entity is made should describe the nature of the change and t he reason for it. The effect of the change on income before extraordinary items, net income,
10.
11.
12.
13.
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and earnings per share amounts should be disclosed for all periods presented.
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Q uestions Chapter 22 (Continued) 14. Counterbalancing errors are errors that will be offset or corrected over two periods. Noncounterbalancing errors are errors that are not offset in the next accounting period. An example of a counterbalancing error is the failure to record accrued wages or prepaid expenses. Failure to capitalize equipment and record depreciation is an example of a noncounterbalancing error. A correction of an error in previously issued financial statements should be handled as a p rior- period adjustment. Thus, such an error should be reported in the year that it is discovered as an adjustment to the beginning balance of retained earnings. And, if comparative statements are presented, the prior periods affected by the error should be restated. The disclosures need not be repeated in the financial statements of subsequent periods. As an illustration, assume that credit sales of $40,000 were inadvertently overlooked at the end of 2010. When the error was discovered in a subsequent period, the appropriate entry to record the correction of the error would have been (ignoring income tax effects): Accounts Receivable.................................................................................... Retained Earnings .............................................................................. 16. 40,000 40,000
15.
This change represents a change from an accounting principle that is not generally accepted to an accounting principle that is acceptable. As such, this change should be handled as a correction of an error. Thus, in the 2010 statements, the cumulative effect of the change should be reported as an adjustment to the beginning balance of retained earnings. If 2009 statements are presented for comparative purposes, these statements should be restated to correct for the accounting error. Retained earnings is correctly stated at December 31, 2012. Failure to accrue salaries in earlier years is a counterbalancing error that has no effect on 2012 ending retained earnings. December 31, 2011 Machinery .................................................................................................... Accumulated DepreciationMachinery ............................................ Retained Earnings .............................................................................. (To correct for the error of expensing installation costs on machinery acquired in January, 2010) Depreciation Expense [($36,000 $3,600) 20]....................................... Accumulated DepreciationMachinery ............................................ (To record depreciation on machinery for 2011 based on a 20-year useful life) 6,000 600 5,400
17. 18.
1,620 1,620
19.
The amortization error decreases net income by $2,700 in 2010. Interest expense related to t he discount should have been charged for $300, but was charged for $3,000. The entry to correct for this error is as follows: Discount on Bonds Payable........................................................................ Interest Expense................................................................................. 2,700 2,700
The entry to record accrued interest on the $100,000 of principal at 11% for 6 months is: Interest Expense......................................................................................... Interest Payable.................................................................................. 5,500 5,500
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Q uestions Chapter 22 (Continued) 20. This error has no effect on net income because both purchases and inventory were understated. The entry to correct for this error, assuming a periodic inventory system, is: Purchases.................................................................................................... Accounts Payable................................................................................ 21. 13,000 13,000
This error increases net income by $2,400 in 2010. Depreciation should have been charged to net income. The entry to correct for this error is as follows: Depreciation Expense................................................................................. Accumulated DepreciationEquipment ........................................... 2,400 2,400
22.
The iGAAP standard addressing accounting and reporting for changes in accounting p rinciples, changes in estimates, and errors is IAS 8 (Accounting Policies, Changes in Accounting Estimates and Errors). Various presentation issues related to restatements are addressed in IAS 1. As indicated in the chapter, the FASB has issued guidance on changes in accounting p rinciples, changes in estimates, and corrections of errors, which essentially converges U.S. GAAP to IAS 8. Key remaining differences are as follows. One area in which iGAAP and U.S. GAAP differ is the reporting of error corrections in pre viously issued financial statements. While both GAAPs require restatement, U.S. GAAP is an absolute standardthat is, there is no exception to this rule. U nder U.S. GAAP and iGAAP, if determining the effect of a change in accounting principle is considered impracticable, then a company should report t he effect of the change in the period in which it believes it practicable to do so, which may be the current period. Under iGAAP, the impracticality exception applies to both changes in accounting principles and to the correction of errors. U nder U.S. GAAP, this exception only applies to changes in accounting p rinciple. I AS 8 does not specifically address the accounting and reporting for indirect effects of changes in accounting principles. As indicated in the chapter, U.S. GAAP has detailed guidance on the accounting and reporting of indirect effects.
23.
24.
Currently, under U.S. GAAP, when a company prepares financial statements on a new basis, comparative information must be provided for a three-year period. Under iGAAP, up to two years of comparative data must be provided. Use of the shorter comparative data period m ust be addressed before U.S. companies can adopt iGAAP.
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SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 22-1 Construction in Process ($120,000 $80,000) ...... Deferred Tax Liability [($120,000 $80,000) X 35%].......................... Retained Earnings ............................................. BRIEF EXERCISE 22-2 Difference in profit- sharing expenseprior years Pre- tax incomepercentage-of-completion ....... Pre- tax incomecompleted- contract ................... $120,000 80,000 $ 40,000 X 1% $ 400 40,000 14,000 26,000
I ndirect effect ..........................................
The indirect effect from prior years will be reported as a profit- sharing expense for year (2011). BRIEF EXERCISE 22-3 Inventory ...................................................................... Deferred Tax Liability ($1,200,000 X 40%).... Retained Earnings ............................................. BRIEF EXERCISE 22-4 This is a change in estimate effected by a change in accounting p rinciple. Cost of depreciable assets........................................ Accumulated depreciation ...................................... Carrying value at January 1, 2010 ......................... Salvage value .............................................................. Depreciable base........................................................ Depreciation in 2010 = $120,000 8 = $15,000. Depreciation Expense ............................................... 15,000
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1,200,000 480,000 720,000
$250,000 (90,000 ) 160,000 (40,000 ) $120,000
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Accumulated Depreciation ..............................
15,000
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BRIEF EXERCISE 22-5
Depreciation Expense..................................................... 24,000 Accumulated Depreciation .....................................
*Book value before change
Cost......................................................
Accumulated depreciation ............ **[($74,000 $18,000) 7] X 2
1 $, 5 8 , 0 *$ $ 0 ,2 0 = 4 4 2
$74,000 $58,000 16,000** BEIDLER COMPANY Retained Earnings Statement For the Year Ended December 31, 2010
24,000
BRIEF EXERCISE 22-6 Equipment .......................................................................... 50,000 Accumulated Depreciation ..................................... Deferred Tax Liability ............................................. Retained Earnings .................................................... ($20,000 = $50,000 X 2/5; $9,000 = $30,000 X 30%) 20,000 9,000 21,000
BRIEF EXERCISE 22-7
Retained earnings, January 1, as previously reported $2,000,000 Less: Correction of depreciation error, net of tax . . Retained earnings, January 1, as adjusted ................ Add: Net income .............................................................. Less: Dividends ................................................................. Retained earnings, December 31..................................
240,000 * 1,760,000 900,000 250,000 $2,410,000
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*$400,000 X (1 .4)
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BRIEF EXERCISE 22-8 2010 a. b. c. d. e. Overstated Overstated Understate d Overstated No effect 2011 Overstated Understated Overstated Understated Overstated
BRIEF EXERCISE 22-9 1. The change to a three-year remaining life for the purpose of computing depreciation on production equipment is a change in estimate due to a change in conditions. This is an expense classification change arising from a change in the use of the building for a different purpose. Thus, it is not a change in principle, a change in estimate, or an error. The change to expensing preproduction costs (writing the costs off in one year as opposed to several years) is a change in estimate due to a change in conditions.
2.
3.
BRIEF EXERCISE 22-10 1. 2. 3. Both FIFO and LIFO are generally accepted accounting principles; thus, this item is a change in accounting principle. This oversight is a mistake that should be corrected. Such a correction is considered a change due to error. Both the completed-contract method and the percentage-ofcompletion method are generally accepted accounting principles; thus, such a change is a change in accounting principle.
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*BRIEF EXERCISE 22-11 Cash ($95,000 X 10%)................................................... Available-for-Sale Securities .............................. Dividend Revenue ($80,000 X 10%).................... *BRIEF EXERCISE 22-12 Investment in Conrad Stock ($475,000 + $33,000). Cash.......................................................................... Retained Earnings ................................................ Investment in Conrad Stock...................................... Available-for-Sale Securities .............................. Unrealized Holding Gain or LossEquity ............. Securities Fair Value Adjustment (Available-for-Sale)........................................... 508,000 475,000 33,000 185,000 9,500 1,500 8,000
185,000 34,000
34,000
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SOLUTIONS TO EXERCISES
EXERCISE 22-1 (1015 minutes) (a) The net income to be reported in 2010, using the retrospective approach, would be computed as follows: Income before income tax ......................... $700,000 Income tax (35% X $700,000) ...................... 245,000 Net income ..................................................... $455,000 (b) Construction in Process..................................... Deferred Tax Liability ($170,000 X 35%)... Retained Earnings ....................................... *($170,000 X 65% = $110,500) 170,000 59,500 110,500*
EXERCISE 22-2 (1015 minutes) (a) Inventory .................................................................... Retained Earnings ............................................ 11,000* 11,000
*($19,000 + $21,000 + $25,000) ($16,000 + $18,000 + $20,000) (b) Net Income (FIFO) 2009 2010 2011 $19,000 21,000 25,000 22,000* 22,000
(c) Inventory ................................................................... Retained Earnings ...........................................
*($19,000 + $21,000 + $25,000) ($12,000 + $14,000 + $17,000)
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EXERCISE 22-3 (2530 minutes) (a) RAMIREZ CO. Income Statement For the Year Ended December 31 L IFO 2008 Sales........................................................ $4,000 Cost of goods sold................................ Operating expenses............................. 800 1,000 2009 $4,000 1,000 1,000 $2,000 2010 $4,000 1,130 1,000 $1,870
Net income..................................... $2,200
Income Statement For the Year Ended December 31 FIFO 2008 Sales....................................................... $4,000 Cost of goods sold............................... Operating expenses............................ 820 1,000 2009 $4,000 940 1,000 $2,060 2010 $4,000 1,100 1,000 $1,900
Net income..................................... $2,180
(b)
RAMIREZ CO. Income Statement For the Year Ended December 31 2010 2009 As adjusted (Note A) Sales....................................................... $4,000 $4,000
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Cost of goods sold............................... Operating expenses............................
1,100 1,000
940 1,000 $2,060
Net income..................................... $1,900
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EXERCISE 22-3 (Continued) (c) Note A: Change in Method of Accounting for Inventory Valuation On January 1, 2010, Ramirez elected to change its method of valuing its inventory to the FIFO method, whereas in all prior years inventory was valued using the LIFO method. The new method of accounting for inventory was adopted because it better reflects the current cost of the inventory on the balance sheet and comparative financial statements of prior years have been adjusted to apply the new method retrospectively . The following financial statement line items for fiscal years 2010 and 2009 were affected by the change in accounting principle.
2010 Balance Sheet Inventory Retained Earnings Income Statement Cost of Goods Sold Net Income Statement of Cash F lows (no effect) $1,13 0 1,870 $1,10 0 1,900 $30 30 $1,00 0 2,000 L IFO $ 320 6,070 F IFO $ 390 6,140 D ifferenc e $70 70 L IFO $ 200 4,200
2009 F IFO $ 240 4,240 D ifferenc e $40 40
$940 2,060
$60 60
(d) Retained earnings statements after retrospective application. 2010 Retained earnings, January 1, as r eported
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2009 $2,200
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Less: Adjustment for cumulative effect of applying new accounting method (FIFO) 20 Retained earnings, J anuary 1, as adjusted Net Income Retained earnings, December 31 $4,240 1,900 $6,140 2,180 2,060 $4,240
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EXERCISE 22-4 (2530 minutes) (a) Retained earnings, J anuary 1, as reported .......... Cumulative effect of change in accounting principle to average cost....................................... Retained earnings, J anuary 1, as adjusted........... *[$8,000 (2006) + $5,000 (2007)] (b) Retained earnings, J anuary 1, as reported .......... Cumulative effect of change in accounting principle to average cost....................................... Retained earnings, J anuary 1, as adjusted........... 2011 $590,000 (20,000)* $570,000 2008 $160,000 (13,000)* $147,000
*[$8,000 (2006) + $5,000 (2007) + $10,000 (2008) $10,000 (2009) + $7,000 (2010)] (c) Retained earnings, J anuary 1, as reported .......... Cumulative effect of change in accounting principle to average cost....................................... Retained earnings, J anuary 1, as adjusted........... *[$20,000 at 12/31/2010 $5,000 (2011)] (d) Net Income............................. 2009 $130,000 2010 $293,000 2011 $310,000 2012 $780,000 (15,000)* $765,000
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EXERCISE 22-5 (3035 minutes) (a) CARLTON COMPANY Income Statement For the Year Ended 2010 Sales................................................................. Cost of goods sold......................................... Operating expenses Income before profit sharing............. Profit sharing expense................................ Net income.............................................. $3,000 1,100 1,000 $ 900 48 $ 852 2009 $3,000 940 1,000 $1,060 50 $1,010
Carlton Company should report $50 as the profit sharing expense in 2009, even though the profit sharing expense would be $53 if FIFO had been used in 2009. (b) The profit sharing expense reflects an indirect effect of the change in accounting principle. Under GAAP, indirect effects from periods before the change are recorded in the year of the change. In this case, profit sharing expense recorded in 2010 is composed of: $900 X 5% = $45 (2010 under FIFO) $ 60 X 5% = 3 (difference in profit sharing for 2009) $48 (profit sharing expense for FIFO in 2010) (c) Retained Earnings Statement Retained earnings, J anuary 1, as reported .......... Cumulative effect of change to FIFO ($1,007 $950) 57 Retained earnings, J anuary 1, as adjusted........... Add: Net Income........................................................... Deduct: Dividends ....................................................... Retained earnings, December 31............................. 2010 $8,000 8,057 855 2,500 $6,412
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EXERCISE 22-6 (3035 minutes) (a) Depreciation to date on equipment Sum-of-the-years-digits depreciation 2007 (5/15 X $450,000) 2008 (4/15 X $450,000) 2009 (3/15 X $450,000) $150,000 120,000 90,000 $360,000 $465,000 360,000 $105,000
Cost of equipment .............................. Depreciation to date.......................... Book value (December 31, 2009).....
Book value Salvage value = Depreciable cost $105,000 $15,000 = $90,000 Depreciation for 2010: $90,000/2 = $45,000 Depreciation Expense.......................................... Accumulated DepreciationEquipment . (b) Depreciation to date on building $780,000/30 years = $26,000 per year $26,000 X 3 = $78,000 depreciation to date Cost of building .................................. Depreciation to date.......................... Book value (December 31, 2009)..... $780,000 78,000 $702,000 45,000 45,000
Depreciation for 2010: $702,000/(40 3) = $18,973 Depreciation Expense.......................................... Accumulated DepreciationBuildings ... 18,973 18,973
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EXERCISE 22-7 (2530 minutes) (a) Change from sum-of-the-years-digits to straight-line Cost of depreciable assets................................ Depreciation in 2009 ($90,000 X 4/10)............ Book value at December 31, 2009................... Depreciation for 2010 using straight-line depreciation Book value at December 31, 2009................... Estimated useful life......................................... Depreciation for 2010 ($54,000 3)................ PANNEBECKER INC. Retained Earnings Statement For the Year Ended 2010 Retained earnings, J anuary 1, unadjusted Less: Correction of error for inventory overstatement ......................................... Retained earnings, J anuary 1, adjusted..... Add: Net income............................................... Less: Dividends ................................................. Retained earnings, December 31................... Note to instructor: 1. 2009 Cost of sales increased $20,000; 2010 cost of sales decreased $20,000. As a result, net income for 2009 is overstated $20,000 and net income for 2010 is understated $20,000 as a result of the inventory error. 2009 expenses remained unchanged. 2010 expenses decreased $9,000 ($27,000 $18,000). Net
Copyright 2010 John Wiley & Sons, Inc.Kieso, I ntermediate Accounting, 13/e, Solutions Manual (For Instructor Use
$90,000 36,000 $54,000
$54,000 3 years $18,000
2009
$125,000 (20,000) 105,000 81,000 30,000 $156,000
$ 72,000 58,000 25,000 $105,000
2. 3.
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income in 2010 is therefore $81,000 ($52,000 + $20,000 + $9,000). 4. Additional disclosures would be a necessitated as indicated in the chapter.
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EXERCISE 22-7 (Continued) 5. Another acceptable presentation for the retained earnings statement for 2010 is: Retained earnings, J anuary 1, as reported ... Prior period adjustmentinventory error ... Retained earnings, J anuary 1, as adjusted... Add: Net Income................................................. Less: Dividends ................................................... Retained earnings, December 31..................... EXERCISE 22-8 (510 minutes) 1. 2. 3. 4. 5. b. b. a. b. b. 6. 7. 8. 9. 10. a. b. a. b. a. $125,000 20,000 105,000 81,000 30,000 $156,000
EXERCISE 22-9 (1520 minutes) December 31, 2010 Retained Earnings ($440,000 X 9/55)......................... Accumulated DepreciationMachinery ......... (To correct for the omission of depreciation expense in 2008) 72,000
72,000
Cost of Machine $440,000 Less: Depreciation prior to 2010 2007 ($440,000 X 10/55) $80,000 2008 ($440,000 X 9/55) 72,000 2009 ($440,000 X 8/55) 64,000 216,000 Book Value at J anuary 1, 2010 $224,000 Depreciation for 2010: $224,000 7 = $32,000 Depreciation Expense.................................................. Accumulated DepreciationMachinery .........
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32,000
32,000
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(To record depreciation expense for 2010)
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EXERCISE 22-10 (2025 minutes) (a) Computation of depreciation for 2010: Cost of building Less: Depreciation prior to 2010 2006 ($1,200,000 $0) X .05* 2007 ($1,200,000 $60,000) X .05 2008 ($1,200,000 $117,000) X .05 2009 ($1,200,000 $171,150) X .05 Book value, J anuary 1, 2010 *(1 40) X 2 $1,200,000 $60,000 57,000 54,150 51,443
Depreciation expense for 2010: $25,761 [($977,407 $50,000) 36] Depreciation Expense.......................................... Accumulated DepreciationBuilding ..... 25,761
(b) Computation of 2010 depreciation expense on the equipment: Cost of equipment ................................................. Accumulated depreciation [($130,000 $10,000) 12] X 4 years ............... Book value, J anuary 1, 2010...............................
2010 Depreciation expense:
EXERCISE 22-11 (1015 minutes)
(a) No entry necessary. Changes in estimates are treated p rospectively. (b) Depreciation Expense ............................................. Accumulated DepreciationEquipment .... *Original cost Accumulated depreciation [($710,000 $10,000) 10] X 7 Book value (1/1/11) Estimated salvage value Remaining depreciable basis Remaining useful life
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$ 9 0 ,4 $ 5 ,$ 0 8 5 , 0 = ( )
222,593 $ 977,407 25,761 $130,000 40,000 $ 90,000 = $17,000 27,000* 27,000 $710,000 (490,000 ) 220,000 (4,000 ) 216,000
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(15 years 7 years) Depreciation expense2010
8 $ 27,000
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EXERCISE 22-12 (2025 minutes) (a) Cost of plant assets Less: Depreciation prior to 2010 2007 ($2,400,000 X .25) $600,000 2008 ($1,800,000 X .25) 450,000 2009 ($1,350,000 X .25) 337,500 Book value at J anuary 1, 2010 $2,400,000
1,387,500 $1,012,500
2010 Depreciation: ($1,012,500 $100,000) 5 = $182,500 Depreciation Expense.......................................... Accumulated DepreciationPlant Assets 182,500 182,500
2010 (b) Income before depreciation expense Depreciation expense Net income $300,000 182,500 $117,500
2009 $370,000 337,500 $ 32,500
EXERCISE 22-13 (1015 minutes) (a) The net income to be reported in 2010, using the retrospective approach , would be computed as follows: Income before income tax........................... $900,000 Income tax (40% X $900,000)........................ 360,000 Net income....................................................... $540,000 (b) Construction in Process...................................... 250,000 Deferred Tax Liability (40% X $250,000).. Retained Earnings ........................................ *($250,000 X 60% = $150,000) 100,000 150,000*
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EXERCISE 22-14 (2025 minutes) (a) Retained Earnings ................................................... Inventory ............................................................ *2008 *2009 *2010 $ 3,000 5,000 2,000 $10,000 ($26,000 $23,000) ($30,000 $25,000) ($29,000 $27,000) 2011 Net income ($30,00 0 2010 $27,00 0 2009 $25,00 0 20,000 2008 $23,00 0 20,000* 10,000 10,000*
(b) Inventory .................................................................... Retained Earnings ............................................ *2008 *2009 *2010 $ 6,000 9,000 5,000 $20,000 ($26,000 $20,000) ($30,000 $21,000) ($29,000 $24,000) 2011 Net income ($34,00 0 2010 $29,00 0
2009 $30,00 0
2008 $26,00 0
EXERCISE 22-15 (1520 minutes) 1. Accumulated DepreciationMachinery ........... Depreciation Expense..................................... Retained Earnings ........................................... 30,600 10,200 20,400 2010 $102,000 91,800 $ 10,200
20082009 Depreciation taken ...................................... $204,000* Depreciation (correct)................................. * 183,600 *$ 20,400 *$510,000 X 1/5 X 2
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2. 3.
Retained Earnings ................................................... Sales Salaries Expense................................... No entry necessary.
45,000
45,000
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EXERCISE 22-15 (Continued) 4. Amortization ExpenseCopyright ................... Retained Earnings ................................................. Copyright ......................................................... ($50,000 20 = $2,500; ($2,500 X 2 = $5,000) Loss on Write-down of Inventories (or Cost of Goods Sold)...................................... Retained Earnings ......................................... 2,500 5,000
7,500
5.
87,000
87,000
EXERCISE 22-16 (1015 minutes) 1. 2. 3. 4. Wages Expense....................................................... Wages Payable................................................ Vacation Wages Expense..................................... Vacation Wages Payable.............................. Prepaid Insurance ($3,300 X 10/12)................... Insurance Expense........................................ Sales Revenue [$1,908,000 (1.00 + .06)] X 6%........................ Sales Tax Payable.......................................... Sales Tax Payable.................................................. Sales Tax Expense......................................... EXERCISE 22-17 (1015 minutes) Retained Earnings ........................................................ Inventory ................................................................. Accumulated DepreciationEquipment ($38,500 $19,000).............................................. Computations: 33,700 14,200 19,500 3,400 31,100 2,750 3,400 31,100 2,750
108,000 103,400
108,000 103,400
Effect on retained earnings over (under) statement ($14,200 ( (19,000) ( 38,500 ($33,700
Overstatement of 2011 ending inventory Overstatement of 2010 depreciation Understatement of 2011 depreciation Total effect of errors on retained earnings
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Note: The understatement of inventory in 2010 was a self-correcting error at the end of 2011.
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EXERCISE 22-18 (2530 minutes) (a) Effect of errors on 2010 net income: $21,700 overstatement Computations: Effect on 2010 net income over (under) statement Understatement of 2009 ending inventory Overstatement of 2010 ending inventory Expensing of insurance premium in 2009 ($60,000 3) Failure to record sale of fully depreciated machine in 2010 Total effect of errors on net income (overstated) ($ 9,600 7,100 20,000 ( (15,000) ( $21,700
(b) Effect of errors on working capital: $27,900 understatement Computations: Effect on working capital over (under) statement Overstatement of 2010 ending inventory Expensing of insurance premium in 2009 (prepaid insurance) Sale of fully depreciated machine unrecorded (cash) Total effect on working capital (understated) $( 7,100 (20,000) (15,000) $(27,900)
(c) Effect of errors on retained earnings: $25,600 understatement
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Computations: Effect on retained earnings over (under) statement Overstatement of 2010 ending inventory Understatement of depreciation expense in 2009 Expensing of insurance premium in 2009 Failure to record sale of fully depreciated machine in 2010 Total effect on retained earnings (understated) $( 7,100 2,300 (20,000) (15,000) $(25,600)
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EXERCISE 22-19 (2025 minutes) (a) 1. Supplies Expense ($2,500 $1,100)................ Supplies on Hand ....................................... 2. Salary and Wages Expense ($4,400 $1,500).............................................. Accrued Salaries and Wages................... 3. Interest Revenue ($5,100 $4,350)................. Interest Receivable................................... 4. Insurance Expense ($90,000 $65,000)......... Prepaid Insurance..................................... 5. Rental Income ($24,000 2)............................ Unearned Rent........................................... 6. Depreciation Expense ($50,000 $5,000)..... Accumulated Depreciation ..................... 7. Retained Earnings ............................................ Accumulated Depreciation ..................... (b) 1. Retained Earnings ............................................ Supplies on Hand ....................................... 2. Retained Earnings ............................................ Accrued Salaries and Wages................... 3. Retained Earnings ............................................ Interest Receivable................................... 4. Retained Earnings ............................................ Prepaid Insurance..................................... 5. Retained Earnings ............................................ Unearned Rent........................................... 6. Retained Earnings ............................................ Accumulated Depreciation ..................... 7. Same as in (a). 1,400 1,400
2,900 750 25,000 12,000 45,000 7,200 1,400 2,900 750 25,000 12,000 45,000
2,900 750 25,000 12,000 45,000 7,200 1,400 2,900 750 25,000 12,000 45,000
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EXERCISE 22-20 (2025 minutes) 2010 Income before tax Corrections: Sales erroneously included in 2010 income Understatement of 2010 ending inventory Adjustment to bond interest expense* Repairs erroneously charged to the Equipment account Depreciation recorded on improperly capitalized repairs (10%)*** Corrected income before tax $101,000 (38,200) 8,640 (1,800) (8,000) 800 $ 62,440 2011 $77,400 38,200 (8,640) (1,926) (9,400) 1,740 $97,374
*Bond interest expense for 2010 and 2011 was computed as follows: Book Value of Bonds 2010 2011 $240,000 241,800 Stated Interest $15,000 15,000 Effective Interest $16,800** 16,926*
**$240,000 X 7% Difference between effective interest at 7% and stated interest (6%): 2010: $1,800 2011: 1,926 ***Erroneous depreciation taken in 2011: on 2010 addition ($8,000 10)....................................... on 2011 addition ($9,400 10)....................................... Total excess depreciation 2011......................................... $ 800 940 $1,740
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EXERCISE 22-21 (1015 minutes) 2010 Item (1) (2) (3) (4) (5) X X X Overstateme nt Understateme nt X X No Effect Overstateme nt X X 2011 Understateme nt No Effect
X X
X
*EXERCISE 22-22 (2530 minutes) Because Sandburg Co. now has a 30% interest in Yevette Corp. as of 7/1/11, it is necessary to first adjust the investment in Yevette to the equity method in prior periods. The following schedule provides this information: 12/31/10 Sandburgs equity in earnings of Yevette Corp. (10%) Dividends received Adjustment ($90,000 0 ($90,000 6/30/11 ($50,000 ( 0
($50,000
Note to instructor : Under GAAP, goodwill is not amortized. A computation of the ending balance in the investment account of Yevette Corp. can now be made as follows: Investment in Yevette Corp. 1/1/10.............................. Additional purchase 7/1/11............................................. Adjustment for 2010 income (prior period)............... Adjustment for 2011 income to 6/30 (prior period).. Income (7/1/1112/31/11) $815,000 X 30%..................... Dividends (7/1/1112/31/11) $1.40 X 75,000 shares..... $1,400,000 3,040,000 90,000 50,000 244,500 (105,000)
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Investment in Yevette Corp. 12/31/11..........................
$4,719,500
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*EXERCISE 22-23 (1520 minutes) (a) Prior to J anuary 2, 2011, Gamble Corp. carried the investment in Sabrina Company under the equity method of accounting as evidenced from the entries in the investment account. Use of the equity method was appropriate because Gambles interest in Sabrina exceeded 20%. With the sale of 126,000 shares, Gambles interest dropped to 12% and it could no longer use the equity method of accounting for the investment. Gamble must change to the fair value method. Cessation of the equity method (increasing the investment for the proportionate share of earnings and decreasing it for dividends received) occurs immediately. The carrying value of the remaining 12% interest becomes the carrying amount for the fair value method with adjustments for cumulative excess dividends received after the change from the equity method over its share of Sabrina Companys earnings. That carrying amount is transferred from the Investment in Sabrina account to the Available-for-Sale Securities account.
(b) The carrying amount of the investment in Sabrina as of December 31, 2011, would be computed as follows: Carrying amount, 12/31/10 (from the given account information) .................................................. Less portion attributable to 126,000 shares sold 1/2/11....................................................................... Balance, 1/2/11................................................................... Less cumulative excess dividends received over share of Sabrina earnings ................................ Carrying amount, 12/31/11 .............................................
a
$3,730,000 (2,238,000 ) a 1,492,000 (8,400 ) b $1,483,600
$3,730,000 X 126/210 of Excess Dividends Received over Share of
b
Computation E arnings:
Dividend s Received
Share of Sabrina Co. Income
Excess Dividends Received Over Share of E arnings
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2011
c
$50,400
$42,000c
$(8,400)
$350,000 X 12% = $42,000
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*EXERCISE 22-23 (Continued) Note to instructor : The entry in 2011 to record the receipt of the dividend would be: Cash.......................................................................... Available-for-Sale Securities ..................... Dividend Revenue........................................ 50,400 8,400 42,000
(c) The entry to recognize the excess of fair value over the carrying amount of the securities is as follows: December 31, 2011 Securities Fair Value Adjustment (Available-for-Sale)........................................... Unrealized Holding Gain or Loss Equity ($1,570,000 $1,483,600)..............
86,400 86,400
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T IME AND PURPOSE OF PROBLEMS
Problem 22-1 (Time 3035 minutes) Purposeto provide a problem t hat requires t he student to: (1) account for a change in estimate, (2) r ecord a correction of an error, and (3) account for a change in accounting principle. The student is also required to compute corrected/adjusted net income amounts. Problem 22-2 (Time 3040 minutes) Purposeto develop an understanding of the way in which accounting changes and error corrections are handled in accounting records. The problem presents descriptions of various situations for which the student is required to indicate the correct accounting treatment and to p repare comparative income statements for a four-year period. Problem 22-3 (Time 3040 minutes) Purposeto provide a problem that requires the student to: (1) prepare correcting entries for two years unrecorded sales commissions, (2) three years inventory errors, and (3) prepare entries for t wo different accounting changes. Problem 22-4 (Time 4050 minutes) Purposeto allow the student to see the impact of accounting changes on income and to examine an ethical situation related to the motivation for change. Problem 22-5 (Time 3035 minutes) Purposeto develop an understanding of the impact which a change in the method of inventory p ricing (from LIFO to average cost) has on the financial statements during a five-year period. The student is required to prepare a comparative statement of income and retained earnings for the five years assuming the change in inventory pricing with an indication of the effects on net income and earnings per share for the years involved. Problem 22-6 (Time 2530 minutes) Purposeto develop an understanding of the journal entries and the reporting which are necessitated by an accounting change or correction of an error. The student is required to prepare t he entries to reflect such changes or errors and the comparative income statements and retained earnings state ments for a two-year period. Problem 22-7 (Time 2530 minutes) Purposeto provide a problem that requires the student to analyze eleven transactions and to p repare adjusting or correcting entries for these transactions. Problem 22-8 (Time 3035 minutes) Purposeto help a student understand the effect of errors on income and retained earnings. The student must analyze the effects of errors on the current years net income and on the next years ending retained earnings balance. Problem 22-9 (Time 2025 minutes) Purposeto develop an understanding of the effect that errors have on the financial statements. The student is required to prepare a schedule portraying the corrected net income for the years i nvolved with this error analysis.
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T ime and Purpose of Problems ( Cont inued) Problem 22-10 (Time 5060 minutes) Purposeto develop an understanding of t he correcting entries and income statement adjustments t hat are required for changes in accounting policies and accounting errors. This comprehensive p roblem involves m any different concepts such as consignment sales, bonus computations, w arranty costs, and bank funding reserves. The student is required to prepare t he necessary j ournal ent ries to correct t he accounting records and a schedule showing t he revised income before t axes for each of t he t hree years involved. *Problem 22-11 (Time 2025 minutes) Purposeto provide the student with a problem involving an investment that grows from 10% to 40% (from lack of significant influence to significant influence). The student is required to account for the effect of this change on income. *Problem 22-12 (Time 2025 minutes) Purposeto provide the student with an understanding of the proper entries to reflect a change f rom the cost method to the equity method in accounting for an investment. The student is required to prepare the necessary journal entries for a three-year period with respect to this stock i nvestment and the change in reporting methods.
Copyright 2010 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only)
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SOLUTIONS TO PROBLEMS
PROBLEM 22-1
(a) 1.
Cost of equipment .......................................................... Less: Salvage value ........................................................ D epreciable cost ............................................................. Depreciation to 2010 2007 ($80,000/10) ......................... 2008 ($80,000/10) ......................... 2009 ($80,000/10) .........................
$85,000 5,000 $80,000
$ 8,000 8,000 8,000 $24,000
Depreciation in 2010 Cost of equipment ..................... Less: Depreciation to 2010..... Book value (January 1, 2010) . Less: Salvage value .................. Depreciable cost ........................ Depreciation in 2010 $58,000/4 = $14,500
$85,000 24,000 61,000 3,000 $58,000
Depreciation Expense .......................................... Accumulated DepreciationEquipment . 2. Cost of Building .................................. $300,000 Less: Depreciation to 2010 2008 ............................................. 60,000 2009 ............................................. 48,000 Book value (January 1, 2010) Less: Salvage value ................ 30,000 Depreciable cost ...................... $162,000 Depreciation in 2010 ($162,000/8) = $20,250 Depreciation Expense ..........................................
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14,500 14,500
$192,000
20,250
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Accumulated DepreciationBuilding .....
20,250
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PROBLEM 22-1 (Continued)
3. Depreciation Expense ($120,000 $16,000) 8. 13,000 Accumulated DepreciationMachine ....... 13,000 Accumulated DepreciationMachine ............... 3,000 Retained Earnings .......................................... 3,000 Depreciation recorded in 2008:
($120,000 8) X = 7,500 Depreciation that should be recorded in 2008: ([$120,000 $16,000] 8) X = 6,500
Depreciation recorded in 2009: (120,000 8) = $15,000
Depreciation that should be recorded in 2009: (120,000 $16,000) 8 = 13,000 Depreciat ion t aken 20 08 20 09 $7,500 15,000 22,500
1 2 1 2
D ifferen ces $6,500 13,000 19,500 $1,000 2,000 $3,000 2010 2009 $310,000 $300,000
D epreciation t hat should be t aken
(b)
HOLTZMAN COMPANY Comparative Income Statements For the Years 2010 and 2009
Income before depreciation expense ...........
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Copyright 2010 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use
Depreciation expense*..................................... Net income.......................................................... *Depreciation Expense Equipment..................................... Building......................................... Machine.........................................
47,750 $252,250 2010 $14,500 20,250 13,000 $47,750
69,000 $241,000 2009 $ 8,000 48,000 13,000 $69,000
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P ROBLEM 22-2
(a) 1.
Bad debt expense for 2008 should not have been reduced by $10,000. A change in the experience rate is considered a change in estimate, which should be handled prospectively. A change from LIFO to FIFO is considered a change in accounting principle, which must be handled r etrospectively. (a) The inventory error in 2010 is a prior period adjustment and the 2010 and 2011 financial statements should be r estated. (b) The lawsuit settlement is correctly treated.
2.
3.
(b)
BOTTICELL I INC. Comparative Income Statements For the Years 2008 through 2011 2008 Income before extraordinary item $145,00 0 2009 $135,000* 2010 $201,000
2011 $274,00 0
Extraordinary gain N et income (see below) $145,00 0 2008 Net income ( unadjusted) 1. Bad debt expense
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30,000 $165,000 $201,000 $274,00 0 2009 $160,000 2010 $205,000 2011 $276,00 0
$140,00 0
Copyright 2010 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use
adjustment 2. Inventory adjustment (FIFO) 3. Inventory overstatement Net income (adjusted)
(10,000) 15,000 5,000 10,000 (14,000 ) $145,00 0 $165,000* $201,000 (16,000) 14,00 0 $274,00 0
*The income before extraordinary item in 2009 is $135,000 ($165,000 $30,000).
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P ROBLEM 22-3
1.
Retained Earnings ................................................... Sales Commissions Payable ........................... Sales Commissions Expense .......................... Cost of Goods Sold ($19,000 + $6,700) .................. Retained Earnings ............................................ Inventory ............................................................
3,500 2,500 1,000 25,700 19,000 6,700
2.
Income Overstated (Understated) 2008 Beginning inventory Ending inventory $(16,000 ) $(16,000 ) 3. 2009 $ 16,000 (19,000 ) $ (3,000 ) 2010 $19,000 6,700 $25,700 4,800 4,800*
Accumulated DepreciationEquipment ............ Depreciation Expense ..................................... *Equipment cost....................................... $100,000 Depreciation before 2010...................... (36,000 ) Book value ................................................ $ 64,000 Depreciation to be taken ($64,000/8) .. Depreciation recorded .......................... Difference ................................................. $ 8,000 12,800 $ 4,800
4.
Construction in Process......................................... Deferred Tax Liability ..................................... Retained Earnings ............................................ *($150,000 $105,000) X 40%
45,000 18,000* 27,000
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P ROBLEM 22-4
(a)
ASTON CORPORAT ION Projected Income Statement For the Year Ended December 31, 2010 Sales....................................................... Cost of goods sold ............................... $14,000,000 Depreciation expense ........................ 1,600,000 a Operating expenses........................... 6,400,000 Income before income taxes ............ Unrealized holding gain ................... Income before taxes and bonus ...... Presidents bonus ............................... Income before income taxes ............ Income taxes Current .......................................... $ 3,000,000 Deferred ........................................ 500,000 c Net income ........................................... Conditions met: 1. 2.
a
$29,000,000
22,000,000 $ 7,000,000 1,000,000 b $ 8,000,000 1,000,000 $ 7,000,000
3,500,000 $ 3,500,000
Net income before taxes and bonus > $7,000,000. Payable for income taxes does not exceed $3,000,000.
Depreciation for the current year includes $600,000 for the old equip ment and $2,000,000 for the robotic equipment. If the robotic equipment is changed to straight- line, its depreciation is only $1,000,000 and the total is $1,600,000. By urging the Board of Directors to change the classification of Securi ties A and D to Trading securities, income is increased by a $1,000,000 recognition of a holding gain. The unrealized holding gain is not currently taxable until the securities a re sold.
b
c
(b) Students answers will vary. There is nothing unethical about changing the first- year election of depreciation back to the straight- line method provided that it
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meets with the approval of appropriate corporate decision makers. Considering the
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PROBLEM 22-4 (Continued) immediate needs for cash of $1,000,000 for the presidents bonus and $3,000,000 for income taxes, there may be a need to sell some of the marketable securities. Therefore, the transfer of $3,000,000 of available-for-sale securities to trading securities may also be appropriate. It is naive to believe that corporate officers do no planning for year-end (or interim) financial statements. The slippery slope arises with manipula tion of financial statements. The security reclassification for the selected securities clearly manipulates the income to the benefit of the president. While legal and within GAAP guidelines, the ethics of this situation are borderline. Any auditor would automatically bring this transaction to the attention of the board of directors. Some stakeholders and their interests are: Stakeholder President CFO Interests Personal gain of $1,000,000 bonus. Placed in ethical dilemma between the interests of the president and the corporation. Board of Directors Stockholders May be subject to the manipulations of the CEO for his personal gain. Increased income from higher (paper)
income may increase demand for dividends. Also, paying a bonus may decrease cash available for dividends. Employees President takes over 25% of net income for himself. This could have been used to start a pension plan for all of the employees.
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C reditors
The increased income represents a 17% inflation of the true net income of the corporation. This may lead to a missrepresentation of creditworthiness.
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P ROBLEM 22-5
UTRI LLO INSTRUME NT COMPANY Statement of Income and Retained Earnings For the Years Ended May 31
2006 Salesnet Cost of goods sold Beginning inventory Purchases Ending inventory Total Gross profit Administrative expenses Income before taxes Income taxes (50%) Net income Retained earnings beginning: As originally reported Adjustment (See note* and schedule) As restated Retained earningsending 5 1,21 1 $ 1,400 $ 1.89 $13,96 4 1,010 13,000 (1,124 ) 12,88 6 1,078 70 0 378 18 9 18 9 2007 $15,50 6 1,124 13,900 (1,101 ) 13,92 3 1,583 76 3 820 41 0 41 0 2008 $16,67 3 1,101 15,000 (1,270 ) 14,83 1 1,842 83 2 1,010 50 5 50 5 2009 $18,22 1 1,270 15,900 (1,500 ) 15,67 0 2,551 90 7 1,644 82 2 82 2 2010 $18,898
1,500 17,100 (1,720 ) 16,880 2,018 989 1,029 515 514
1,206
1,388 1 2 1,40 0 $ 1,810 $ 4.10
1,759 5 1 1,81 0 $ 2,315 $ 5.05
2,237 7 8 2,31 5 $ 3,137 $ 8.22
3,005 132 3,137 $ 3,651
Earnings per share (100 shares)
$
5.14
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*Note to instructor : The retained earnings balances are usually reported in the above manner. If desired, only the restated balances might be reported. The adjustments are simply the cumulative difference in income between the two inventory methods, net of tax. For example, the $5 in 2006 reflects the difference in ending inventories in 2005 ($1,000 $1,010) times the tax rate 50%. In 2007, the difference in income of $7 between the two methods in 2006 is added to the $5 to arrive at a $12 adjustment to the beginning balance of retained earnings in 2007.
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PROBLEM 22-5 (Continued) In 2010, the Company changed its method of pricing inventory from the last-in, first out (LIFO) to the average cost method in order to more fairly present the financial operations of the company. The financial statements for prior years have been restated to retrospectively reflect this change, resulting in the following effects on net income and related per share amounts: Increase in 2006 Net income Earnings per share $ 7 $0.07 2007 $ 39 $0.39 2008 $ 27 $0.27 2009 $ 54 $0.54 2010 $ 44 $0.44
Schedule of Income Reconciliation and Retained Earnings Adjustments 20062010
2005 Beginning Inventory L IFO Average Cost Difference Tax Effect (50%) Effect on Income* 2006 $1,000 1,010 (10) 5 $ (5 ) $1,000 1,010 (10) 5 $ 5 $ $1,100 1,124 (24) 12 12 2007 $1,100.00 1,124.00 (24.00) 12.00 $ (12.00 ) $1,000.00 1,101.00 (101.00) 50.50
2008 $1,000.0 0 1,101.0 0 (101.00) 50.50
2009 $1,115.0 0 1,270.0 0 (155.00) 77.5 0 $ (77.50 ) $1,237.0 0 1,500.0 0 (263.00) 131.5 0 $ 131.50
2010 $1,237. 00 1,500. 00 (263.00) 131. 50 $ (131.50 ) $1,369. 00 1,720. 00 (351.00) 175. 50 $ 175.50 2263
$ (50.50 ) $1,115.0 0 1,270.0 0 (155.00) 77.50
Ending Inventory LIFO Average Cost Difference Tax Effect (50%) Effect on Income**
$ 50.50
$ 77.50
Copyright 2010 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only)
N et Effect on Income Cumulative Effect on Beginning Retained E arnings
$
5
$
7
$ 38.50
$ 27.00
$ 54.00
$ 44.00
$
12
$ 50.50
$ 77.50
$ 131.50
$ 175.50
*Larger (smaller) beginning inventory has negative (positive) effect on net income. **Larger (smaller) ending inventory has positive (negative) effect on net income.
The tax effects are rounded up to the next whole dollar in the problem. Therefore, the net effects on income and retained earnings are effectively rounded down to the next w hole dollar.
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P ROBLEM 22-6
(a) 1.
Depreciation Expense ..................................... Accumulated DepreciationAsset A. . Computations: Cost of Asset A.............................................. Less: Depreciation prior to 2010 .............. Book value, January 1, 2010 ...................... *($540,000 10) X 3
94,500 94,500
$540,000 162,000 * $378,000
Depreciation for 2010: $378,000 X 7/28** = $94,500 **[7(7 + 1)] 2 = 28 2. Depreciation Expense ..................................... Accumulated DepreciationAsset B . . Computations: Original cost .............................................. Accumulated depreciation (1/1/10) $12,000 X 4.............................................. Book value (1/1/10) ................................... Estimated salvage value ......................... Remaining depreciable base................. Remaining useful life (9 years4 years taken) ..................... D epreciation expense2010 ................. 3. Asset C ................................................................ Accumulated DepreciationAsset C (4 X $16,000) ........................................... Retained Earnings ................................... Depreciation Expense ..................................... Accumulated DepreciationAsset C . . 160,000 64,000 96,000 16,000 16,000 25,800 25,800
$180,000 48,000 132,000 3,000 129,000 5 $ 25,800
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PROBLEM 22-6 (Continued) (b) MADRASA INC. Comparative Retained Earnings Statements For the Years Ended 2010 Retained earnings, J anuary 1, as previously reported Add: Error in recording Asset C Retained earnings, J anuary 1, as adjusted Add: Net income Retained earnings, December 31 $666,000 208,700** $874,700 2009 $200,000 112,000* 312,000 354,000*** $666,000 $160,000 48,000 $112,000 $400,000
*Amount expensed incorrectly in 2006............... Depreciation to be taken to J anuary 1, 2009 ($16,000 X 3).......................................................... Prior period adjustment for income.................. **Income before depreciation expense (2010) Depreciation for 2010 Asset A $94,500 Asset B 25,800 Asset C 16,000 Other 55,000 Income after depreciation expense ***Net income as reported ....................................... DepreciationAsset C ........................................... Net income as adjusted .........................................
(191,300 ) $208,700 $370,000 (16,000 ) $354,000
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P ROBLEM 22-7
(1) Depreciation Expense .................................................. Accumulated DepreciationDelivery Vehicles 3,200 (2) Income Summary .......................................................... Retained Earnings ................................................ (3) Cash .................................................................................. Accounts Receivable ............................................. (4) Accumulated DepreciationEquipment ................ Equipment ............................................................... Gain on Sale of Equipment ................................. (5) Estimated Litigation Loss........................................... Estimated Litigation Liability ........................... (6) Unrealized Holding Gain or LossIncome ............ Securities Fair Value Adjustment (Trading) .. (7) Accrued Salaries Payable ($16,000 $12,200) ........ Salaries Expense ................................................... (8) Depreciation Expense .................................................. Equipment ...................................................................... Repairs Expense .................................................... Accumulated DepreciationEquipment ........
3,200
19,000 19,000
5,600 5,600
25,000 21,300 3,700
125,000 125,000
2,000 2,000
3,800 3,800
5,000 40,000 40,000 5,000
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PROBLEM 22-7 (Continued) (9) Insurance Expense ($12,000 3).................................... Prepaid Insurance............................................................. Retained Earnings ..................................................... (10) Amortization Expense ($50,000 10)............................ Retained Earnings ............................................................. Trademark ................................................................... 4,000 6,000
10,000
5,000 5,000
10,000
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P ROBLEM 22-8
Net Income for 2009
Retained Earnings 12/31/10 Understated 0 $ 2,500 0 $28,000 0 0 0 $11,000 0 $12,000 0
Item 1. 2. 3. 4. 5. 6.
Understated $14,100 $ 3,500 0 $28,000 0 $18,200
Overstated 0 0 $22,000 0 $24,000 0
Overstated 0
Although explanations were not required in answering the question, t hey are included below for your interest. Explanations : 1. The net income would be understated in 2009 because interest i ncome is understated. The net income would be overstated in 2010 because interest income is overstated. The errors, however, would counter- balance (wash) so that the Balance Sheet ( Retained Earnings) would be correct at the end of 2010. The depreciation expense in 2009 should be $500 for this m achine. Since the machine was bought on July 1, 2009, only one-half of a years depreciation should be taken in 2009 ($4,000/4 X 1/2 = $500). The company expensed $4,000 instead of $500 so net income is understated by $3,500 in 2010. An additional $1,000 of depreciation expense should have been t aken in 2010. At the end of 2010, retained earnings would be understated by $2,500 ($3,500 $1,000). GAAP requires that all research and development costs should be ex pensed when incurred. Net income in 2009 is overstated $22,000 ($33,000 research and development costs capitalized less
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3.
Copyright 2010 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only)
$11,000 amortized). By the end of 2010, only $11,000 of the research and development costs would remain as an asset. Therefore, retained earnings would be over stated by $11,000 ($33,000 research and development costs $22,000 amortized).
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PROBLEM 22-8 (Continued) 4. The security deposit should be a long-term asset, called r efundable deposits. The $8,000 of the last months rent is also an asset, called prepaid r ent. The net income of 2009 is understated by $28,000 ($20,000 + $8,000) because these amounts were expensed. Retained earnings will continue to be understated by $28,000 until the last year of the lease. The security deposit will t hen be refunded, and the last months rent should be expensed. $12,000 or one-third of $36,000 should be reported as income each year. In 2009, $36,000 was reported as income when only $12,000 should have been reported. Because $24,000 too much was reported, the net income of 2009 is overstated. At COM PAN Y of 2010, ( a) ROBERT S the end $24,000 should have been Revised N et I ncome income, so retained Schedule of reported as earnings is still the Year s Ended M ar ch 31, 2009, 2010, and $24,000). F or overstated by $12,000 ($36,000 2011 The ending inventory would be understated since the COM Because merchandise was omitted. PU T AT I ON S ending inventory and net SU ship, income have a direct relationM M ARY net income in 2009 would be I ncr eases (D ecr eases) o 2009 u nderstated. The ending inventory infI ncome becomes the beginning inventory of 2010. If beginning inventory of 2010 is understated, t hen net income of 2010 is overstated (inverse relationship). The 2009 omission in inventory over the two-year period w ill 2010 counterbalance, and retained earnings at the end of 2010 will be 2011 correct .
2009 2010 2011 1. N et income as r epor ted
5.
6.
$71,600 $111,400 $103,580 2. Elimination of pr ofit on consignments:
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Billed $ 6,500
$
5,590
a t 125% of cost
PROBLEM 22-9
/ / 125% 125%
2009 Net income, as reported Rent received in 2009, earned in 2010
Cost
2010 $37,000 1,000
5,200 4,472
$29,000 (1,000) 1,100 (1,200) (1,300) 940
$
Wages not accrued, 12/31/08 Wages not accrued, 12/31/09 Wages not accrued, 12/31/10 Inventory of supplies, 12/31/08 Inventory of supplies, 12/31/09
Pr ofit er r or
1,200 (940) (940)
Inventory of supplies, 12/31/10 Corrected net income $27,540
$
1,300 1,118
1,420
$
1,300 (1,300)
$38,740
1,300 (1,118) 3. T o cor r ect C.O.D . sale
6,100 (6,100) 4. Adjustment of w ar r anty expense:
Sales per book s $940,000 $1,010,000 $1,795,000
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(6,500) 6,500 (5,590)
Cor r ection for C.O.D . sale 6,100 ( 6,100)
Cor r ected sales $933,500 $1,022,600 $1,783,310
A ccounti ng, 13/e, Solut ions M anual (For I nst r uct or Use Only)
N or mal w ar r anty2-49 2 expense, one-half of 1% $ $ $ 4,668 5,113 8,917
PROBL EM 22-10
L ess costs char ged to expense 760 1,670 3,850
Additional expense $ $ $ 3,908 3,443 5,067 (3,908) (3,443) (5,067) 5. Bad debt adjustments:
PROBLEM 22-10 (Continued) (b)
N or mal bad debt expense, one-quar ter of ROBERTS COMPANY 1% of sales
Journal Entries March 31, 2011
$ 2,334 $ ,590 5 2,557
Sales............................................................................. Merchandise on Consignment .............................. Cost of Goods Sold ............................................ Accounts Receivable ........................................ ( To adjust for consignments treated as sales, 3/31/11)
L ess pr evious w r ite-offs
4,472
$ 4,458
4,472 5,590
Sales............................................................................. Retained Earnings ............................................ ( To adjust for C.O.D. sales not r ecorded, 3/31/10) Warranty Expense .................................................... Additional expense Retained Earnings ($3,908 + $3,443) .................... Estimated Liability Under Warranties ....... ( To set up allowance for warranty expense) Retained Earnings ($664 + $1,185) ....................... Managers Bonus Expense ...................................... 6. Adjustment for contr act financing Accrued Bonus Payable .................................. ( To set up accrued bonus payable to manager) Retained Earnings ($1,584 + $1,237) .................... Bad Debt Expense .................................................... Allowance for Doubtful Accounts ................. 7.( To set upfor commissionsfor uncollectible Adjustment allowance accounts) Dealers Fund Reserve (held by bank) ................ Finance Expense ............................................... Retained Earnings ($3,000 + $3,900) ............ ( To record finance charge reserve
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750 6,100 1,320 3,850
6,100
5,067 7,351
$ $ $ 1,584 1,237 608 (1,584) (1,237) 1,849 (608) 956
12,418
2,805
3,000 2,821 3,900 608 5,100
3,429
12,000
( 1,400) 500* ( 220)* *
5,100 6,900
Copyright 2010 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use
66,408 118,520
8. Adjustment for bonus, 1% of income befor e taxes and bonus
held by bank)
( 664) ( 1,185) ( 956)
I ncome befor e income taxes
$65,744 $117,335 $ 94,611 * $1,400 $900 * * $900 $1,120
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PROBLEM 22-10 (Continued) Commissions Expense................................................... Retained Earnings ($1,400 $500).............................. Accrued Commissions Payable........................... (To adjust for accrued commissions) 220 900
1,120
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* PROBLEM 22-11
(a)
MILLAY INC. Schedule of Income or Loss from Investment For Year Ending December 31, 2010 D ividend revenue ...................................................................... (10,000 shares X $1.50 dividend/share) $15,000
(b)
MILLAY INC. Schedule of Income or Loss from Investment For Years Ending December 31, 2011 and 2010 2011 Income from investment in Genso (Schedule 1) Schedule 1 $170,000
2010 $55,000
Millays Share of Investees Income 2011 2010 $55,000 $ 30,000 140,000 $170,000 $55,000
Income for 2010 ($550,000 X 10%) Income for 2011 First half ($300,000* X 10%) Second half ($350,000 X 40%)
*($650,000 $350,000)
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* PROBLEM 22-12
January 3, 2009 Available- for-Sale Securities ...................................... 500,000 Cash .......................................................................... ( To record the purchase of a 10% interest in Renner Corp.) December 31, 2009 Cash .................................................................................. 15,000 Dividend Revenue ................................................. ( To record the receipt of cash dividends from Renner Corp.) December 31, 2009 Securities Fair Value Adjustment (Available- for-Sale) ................................................... 60,000 Unrealized Holding Gain or LossEquity ..... ( To recognize as part of stockholders equity t he increase in fair value of available- for-sale securities) December 31, 2010 Cash .................................................................................. 20,000 Dividend Revenue ................................................. ( To record the receipt of cash dividends from Renner Corp.) December 31, 2010 Unrealized Holding Gain or LossEquity ............. 45,000 Securities Fair Value Adjustment (Available- for-Sale) ........................................... ( To recognize as part of stockholders equity t he decrease in fair value of available- for-sale securities)
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500,000
15,000
60,000
20,000
45,000
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*PROBLEM 22-12 (Continued) J anuary 2, 2011 Investment in Renner Corp................................. 1,564,000 Cash.................................................................... Retained Earnings .......................................... (To record purchase of additional interest in Renner and to reflect retroactively a change from the fair value to the equity method) Computation of Prior Period Adjustment 2009 Martin equity in earnings of Renner (10%) Amortization of excess of purchase price over underlying equity [$500,000 ($3,700,000 X 10%) 10] Dividend received Prior period adjustment *$350,000 X 10% J anuary 2, 2011 Investment in Renner Corp................................. Available-for-Sale Securities ........................ (To reclassify investment carried under fair value method to investment carried under equity method) Unrealized Holding Gain or LossEquity ....... Securities Fair Value Adjustment (Available-for-Sale)..................................... (To eliminate accounts and balances used under fair value method accounting) 500,000 500,000 $35,000* 2010 $45,000 Total $80,000 1,545,000 19,000
(13,000) (15,000) $ 7,000
(13,000) (20,000) $12,000
(26,000) (35,000) $19,000
15,000 15,000
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*PROBLEM 22-12 (Continued) December 31, 2011 Investment in Renner Corp........................................ Revenue from Investment ................................... (To record equity in net income of Renner40% of $550,000 less $50,500 amortization of excess cost over underlying equity) Computation of amortization: 2009 purchase ($130,000 10 years) 2011 purchase [$1,545,000 ($4,150,000 X 30%) 8 years] Total 169,500 169,500
$13,000 37,500 $50,500 70,000 70,000
Cash.................................................................................. Investment in Renner Corp................................ (To record the receipt of cash dividends from Renner Corp.)
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T IME AND PURPOSE OF CONCEPTS FOR A NALYSIS
CA 22-1 (Time 2535 minutes) Purposeto provide t he student wit h some fam iliarit y wit h t he applications of GAAP related to accounting changes. This case describes several proposed accounting changes wit h which t he student is required to ident ify whether t he change involves an accounting principle, accounting estim ate, or correction of an error, plus t he necessary report ing requirements for each proposal. CA 22-2 (Time 2030 minutes) Purposeto provide the student with an understanding of the application and reporting requirements of SFAS No. 154. This case describes many different accounting changes with which the student is required to identify the type of change involved and to indicate which changes necessitate the restatement of prior years financial statements when presented in comparative form with the current years statement. CA 22-3 (Time 3035 minutes) Purposeto provide the stu dent with an understanding of GAAP and its respective applications . This case describes three independent situations with which the student is required to identify the type of accounting change involved, the reporting which is necessitated under current generally accepted accounting principles, and the effects of each change on the financial statements. CA 22-4 (Time 2030 minutes) Purposeto provide the student with an understanding of how changes in accounting can be reflected in the accounting records to facilitate analysis and understanding of financial statements. This case involves several situations with which the student is required to indicate the appropriate accounting treatment that each should be given. CA 22-5 (Time 2030 minutes) Purposeto provide the student with an opportunity to explain how to account for various accounting change situations. Explanations for a change in estimate, change in principle, and change in entity are communicated in a written letter. CA 22-6 (Time 2030 minutes) Purposeto provide the student with an opportunity to explain the ethical issues related to changes in estimates.
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SOLUTIONS TO CONCEPTS FOR ANALYSIS
CA 22-1
(a) 1. 2. Uncollectible Accounts Receivable. This is a change in accounting estimate. Restatement of prior periods is not appropriate. Depreciation. a. This is a change in accounting estimate. Restatement of opening retained earnings is not appropriate. b. This is a new method for a new class of assets. No change is involved. 3. 4. Mathematical Error. This is a correction of an error and prior period treatment would be in order. Preproduction CostsFurniture Division. This should probably be construed as an inseparability situation in that the change in accounting estimate (period benefited by deferred costs) has been affected by a change in accounting principle (amortization on a per-unit basis). Consequently, it is treated as a change in accounting estimate. Restatement of opening retained earnings is not appropriate. FIFO to LIFO Change. This is a change in accounting principle. Restatement of December 31, 2009 retained earnings is not appropriate, given that the effect on net income in prior periods cannot be determined. Note that a LIFO to FIFO change does qualify for restatement of opening retained earnings, but FIFO to LIFO does not qualify in most cases because it is impracticable to determine prior years income under L IFO. Percentage of Completion. This is a change in accounting principle. Retained earnings should be adjusted.
5.
6. (b)
The adjustment to the December 31, 2009 retained earnings balance would be computed as follows: Item 3.................................................................................................... Item 6.................................................................................................... Increase in 12/31/09Retained Earnings..................................... $ (235,000) 1 ,075,000 $ 840,000
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CA 22-2
Should Prior Years Statements Be Retrospectively Applied or Restated? 1. 2. 3. A change in accounting principle. A change in an accounting estimate. An accounting change involving both a change in accounting p rinciple and a change in accounting estimate. Referred to as an change in accounting estimate effected by a change in p rinciple. Handle as a change in estimate. Not an accounting classification. change but rather a change in Yes No No
Item Chang e
Type of Change
4. 5. 6.
Yes Yes Yes
An error correction not involving a change in accounting p rinciple. An accounting change involving a change in the reporting entity which is a special type of change in accounting p rinciple. Not a change in accounting principle. Simply, a change in tax accounting. An accounting change from one generally accepted accounting p rinciple to another generally accepted accounting principle. *Generally impracticable to determine what LIFO inventory would be in prior periods.
7. 8.
No No*
CA 22-3
Situation 1. (a) (b) A change from an accounting principle not generally accepted to one generally accepted is a correction of an error. When comparative statements are presented, net income, components of net income, retained earnings, and any other affected balances for all periods presented should be restated to correct for the error. When single period statements are presented, the required adjustments should be reported in the opening balance of retained earnings. A description of t he change and its effect on income before extraordinary items, net income, and the related per share amounts should be disclosed in the period of the change. Financial statements of subsequent periods need not repeat the disclosures. The beginning balance of retained earnings in the balance sheet is restated. The income 2283
(c)
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statement for the current year should report the correct approach for revenue recognition. If prior years financial statements are presented, they should be restated directly.
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CA 22-3 (Continued)
Situation 2. (a) (b) The change in method of inventory pricing represents a change in accounting principle, as defined by GAAP. Changes in accounting principle are accounted for through retrospective application. Under t his approach, the cumulative effect of the new method on the financial statements at the beginning of the period is computed (and recorded in retained earnings at the beginning of t he period). Prior statements are changed to be reported on a basis consistent with the new standard. As a result of the change to weighted-average costing, the current year balance sheet will reflect weighted-average costing (at relatively higher prices in times of rising prices). Cost of goods sold will also be different (higher), resulting in lower income.
(c)
Situation 3. (a) (b) A change in the depreciable lives of fixed assets is a change in accounting estimate. In accordance with GAAP, the change in estimate should be reported in the current period and in future periods. Unlike a change in accounting principle, the change in accounting estimate should not be accounted for by presenting prior earnings data giving effect to the change as if it had been applied retrospectively. This change in accounting estimate will affect the balance sheet in that the accumulated depreciation in the current and future years will increase at a different rate than previously reported, and this will also be reflected in depreciation expense in the income statement in t he current and future years.
(c)
CA 22-4
1. This situation is a change in estimate. Whenever it is impossible to determine whether a change in principle or a change in estimate has occurred, the change should be considered a change in estimate. This is often referred to as a change in accounting estimate effected by a change in accounting principle. A change in estimate employs the current and prospective approach by: (a) (b) (c) 2. 3. Reporting current and future financial statements on the new basis. Presenting prior periods financial statements as previously reported. Making no adjustments to current opening balances for purposes of catch-up.
This situation is considered a change in estimate because new events have occurred which call for a change in estimate. The accounting should be the same as discussed in 1. This situation is considered a correction of an error. The general rule is that careful estimates which later prove to be incorrect should be considered changes in estimates. Where the estimate was obviously computed incorrectly because of lack of expertise or in bad faith, the adjustment should be considered an error. Changes due to error should employ the retroactive approach by: 2285
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(a)
Restating, via a prior period adjustment, the beginning balance of retained earnings for t he current period.
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CA 22-4 (Continued)
(b) Correcting all prior period statements presented in comparative financial statements. The amount of the error related to periods prior to the earliest years statement p resented for comparative purposes should be included as an adjustment to the beginning balance of retained earnings of that earliest years statement.
4.
No adjustment is necessarya change in accounting principle is not considered to have happened i f a new principle is adopted in recognition of events that have occurred for the f irst time. This situation is considered a change in estimate because new events have occurred which call for a change in estimate. The accounting should be the same as discussed in 1. This situation is considered a change in accounting principle. A change in accounting p rinciple should employ the retrospective approach by: (a) (b) (c) Reporting current results on the new basis. Presenting prior period financial statements on a basis consistent with the newly adopted method. Computing the cumulative effect of the new method in beginning retained earnings on t he earliest year presented.
5. 6.
CA 22-5
Mr. Joe Davison, CEO Sports-Pro Athletics Dear Mr. Davison: You recently contacted me about several accounting changes made at Sports-Pro Athletics, Inc. in 2010. This letter details how you should account for each change. Your change from one method of depreciation to another constitutes a change in accounting estimate effected by a change in accounting principle. A change in estimate employs the current and prospective approach by reporting current and future financial statements on the new basis. Prior periods financial statements are presented as previously reported. Your change in salvage values for your office equipment is considered a change in estimate. This t ype of change does not really affect previous financial statements and is thus accounted for currently and prospectively. The change is included in the most current period being reported. There is no need to restate prior periods financial statements. Finally, your change in specific subsidiaries results in a change in reporting entity which must be reported by restating the financial statements for all periods presented. The effect of this change should be shown on income before extraordinary items, net income, and earnings per share amounts. I n addition, you must disclose in a footnote the nature of the change as well as the reasons for it. I hope that this information helps you account for the various changes which have taken place at Sports-Pro Athletics. If you need further information, please contact me. Sincerely,
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CA 22-6
(a) The ethical issues are the honesty and integrity of Frosts financial reporting practices versus the Corporations and the accounting managers profit motives. Shortening the life of f ixed assets from 10 to 6 years may be evidence that depreciation expense during the first f ive years were understated. Such a practice distorts Frosts operating results and misleads users of Frosts financial statements. If this practice is intentional, it is unethical. The primary stakeholders in the above situation include Frosts stockholders and creditors. Crane and his auditing firm are stakeholders because they know of the depreciation p ractices at Frost. Crane should report his finding to the partner- in-charge of the Frost engagement. If this p ractice is deemed to be intentional and fraudulent, then Cranes firm has a professional responsibility to report this incident to the highest levels of management within Frost (the Audit Committee of the Board of Directors).
(b)
(c)
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F INANCIAL REPORT I NG PROBLEM
(a) New Pronouncements and Reclassifications P&G reported the following changes in accounting principles: ADOPTION OF SFAS 158, EMPLOYERS ACCOUNTI NG FOR D EFINED BENEFIT PENSION AND OTHER POSTRETI MENT P LANS, an amendment of FASB Statements No. 87, 88, 106, and 132(R). In September 2006, the FASB issued SFAS 158, Employers Account ing for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R). SFAS 158 r equires companies to recognize t he over-funded and under- funded status of defined benefit pension and other postretirement plans as assets o r liabilities on t heir balance sheets. In addition, changes in the funded status m ust be recognized through other comprehensive income in shareholders equity in the year in which the changes occur. We a dopted SFAS 158 on June 30, 2007. In accordance with the t ransition rules in SFAS 158, this standard is being adopted on a p rospective basis. The adoption of SFAS 158 resulted in an adjustment to our balance sheet, but had no impact on our net earnings or cash flow, nor did it impact any debt covenants. SFAS 158 had no impact on our measurement date, which continues to be as of our fiscal year end. Refer to Note 9 for a dditional information regarding our pension and postretirement plans. FASB INTERPRETAT IO N 48, U NCERTAI NTY IN INCOME TAXES ACCOUNT I NG FOR
In July 2006, the FASB issued FASB Interpretation (FIN) 48, Accounting for Uncertainty in Income Taxes. FIN 48 addresses t he accounting and d isclosure of uncertain tax positions. FIN 48 p rescribes a recognition threshold and measurement attribute for the financial statement recogni tion and measurement of a tax position taken or expected to be taken in a tax return. We will
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adopt FIN 48 on July 1, 2007. We estimate that the adoption of F IN 48 will result in a net decrease to beginning retained earnings of approximately $200 $250 million, primarily related to the accrual of additional interest and penalties on unrecognized tax benefits.
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F INANCIAL REPORT I NG PROBLEM (Continued) (b) Use of Estimates Preparation of financial statements in conformity with accounting princi- ples generally accepted in the United States of America (U.S. GAAP) requires management to make estimates a nd assumptions that affect the amounts reported in the Consolidated Financial Statements and accompanying disclosures. These estimates are based on managements best k nowledge of current events and actions the Company may u ndertake in the future. Estimates are used in accounting for, a mong other items, consumer and trade promotion accruals, pensions, post-employment benefits, stock options, valuation of acquired intangible assets, useful lives for depreciation and amortization, future cash flows associated with impairment t esting for goodwill and long-lived assets, deferred tax assets, potential income tax assessments and contingencies. Actual results may ultimately differ from estimates, although management does not believe such differences would materially affect the financial statements in any individual year.
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COMPARATIVE ANALYSIS CASE
THE COCA-COLA COMPANY VS. PEPSICO, INC. (a) and (c) for Coca-Cola Company: NOTE 1: SUMMARY OF SIGNIF ICANT ACCOUNT I NG POLICI ES Recent Accounting Standards and Pronouncements In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations. SFAS No. 141(R) amends the principles a nd requirements for how an acquirer recognizes and measures in i ts financial statements the identifiable assets acquired, the l iabilities assumed, any noncontrolling interest in the acquiree and t he goodwill acquired. SFAS No. 141(R) also establishes disclosure r equirements to enable the evaluation of the nature and financial effects of the business combination. SFAS No. 141(R) is effective for our Company on January 1, 2009, and the Company will apply p rospectively to all business combinations subsequent to the effective date. In December 2007, the FASB issued SFAS No. 160, Noncontrolling I nterests i n Consolidated Financial Statementsan amendment of Accounting Research Bulletin No. 51. SFAS No. 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the decon solidation of a subsidiary. SFAS No. 160 also establishes disclosure require ments that clearly identify and d istinguish between the controlling and noncontrolling interests and r equires the separate disclosure of income attributable to controlling and noncontrolling interests. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the impact that the adoption of SFAS No. 160 w ill have on our consolidated financial statements. In February 2007, FASB issued the SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilitiesincluding an amendment of F ASB Statement No. 115. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at f air value. Unrealized gains and losses on items for which the fair
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value option has been subsequent reporting Company on January have a material impact
elected will be recognized in earnings at each date. SFAS No. 159 was effective for our 1, 2008. The adoption of SFAS No. 159 did not on our consolidated f inancial statements.
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COMPARATIVE ANALYSIS CASE (Continued) In September 2006, the SEC staff published SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB No. 108 addresses quantifying the financial statement effects of misstatements, specifically, how the effects of prior year uncorrected errors must be considered in quantifying misstatements i n the current year financial statements. SAB No. 108 was effective for fiscal years ending after November 15, 2006. The adoption of SAB No. 108 by our Company in the fourth quarter of 2006 did not have a material i mpact on our consolidated financial statements. As previously discussed, Our Company adopted SFAS No. 158 related to defined benefit pension and other postretirement plans. Refer to Note 16. In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements . SFAS No. 157 defines fair value, establishes a f ramework for measuring fair value and expands disclosure requirements about fair value measurements . SFAS No. 157 was effective for our Company on January 1, 2008. However, in F ebruary 2008, the FASB released a FASB Staff Position (FSP FAS 157-2 E ffective Date of FASB Statement No. 157) which delayed the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The adoption of SFAS No. 157 for our financial assets and liabilities did not have a material impact upon adoption . We do not believe the adoption of SFAS No. 157 for our non-financial assets a nd l iabilities, effective January 1, 2009, will have a material impact on our consolidated financial statements. In July 2006, the FASB issued Interpretation No. 48 which clarifies t he accounting for uncertainty in income taxes recognized in an enterprises financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. Interpretation No. 48 prescribes a r ecognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. I nterpretation No. 48 also provides guidance on derecognition, classification , interest and penalties, accounting in interim periods, disclosure and transition . For our Company, Interpretation No. 48 was effective January 1, 2007. As
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a r esult of the adoption of Interpretation No. 48, we recorded an a pproximate $65 million increase in accrued income taxes in our consolidated balance sheet for unrecognized tax benefits, which was accounted for as a cumulative effect adjustment to the January 1, 2007 balance of reinvested earnings. Refer to Note 17.
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COMPARATIVE ANALYSIS CASE (Continued) In May 2005, the FASB issued SFAS No. 154, Accounting Changes a nd Error Corrections, a replacement of Accounting Principles Board (APB) Opinion No. 20 and FASB Statement No. 3. SFAS No. 154 requires retro spective application to prior periods financial statements of a voluntary change in accounting principle unless it is impracticable. APB Opinion No. 20, Accounting Changes, previously r equired that most voluntary changes in accounting principle be r ecognized by including in net income of the period of the change t he cumulative effect of changing to the new accounting principle. SFAS No. 154 became effective for our Company on January 1, 2006. T he adoption of SFAS No. 154 did not have a material impact on our consolidated financial statements. (b) and (c) for PepsiCo, Inc.: Reported one accounting change: Recent Accounting Pronouncements In September 2006, the SEC issued SAB 108 to address diversity in p ractice in quantifying financial statement misstatements. SAB 108 requires that we quantify misstatements based on their i mpact on each of our financial statements and related d isclosures. On December 30, 2006, we adopted SAB 108. Our adoption of SAB 108 did not impact our financial statements.
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P ROFESSIONAL RESEARCH: FINANC IAL ACCOUNT I NG AND R EPORT I NG
(a) According to FASB ASC 250-10-20 (Glossary), a change in accounting estimate that is inseparable f rom the effect of a related change in accounting principle is a change in estimate effected by a change in principle. A change in the method of depreciation, amortization, or depletion for long-lived, nonfinancial assets are examples of changes in estimate effected by a change in principle. Under FASB ASC 250-10-45-17, 19, a change in accounting estimate shall be accounted for i n the period of change if the change affects that period only or in the period of change and f uture periods if the change affects both. A change in accounting estimate shall not be accounted for by restating or retrospectively adjusting amounts reported in financial statements of prior periods or by reporting pro forma amounts for prior periods. (45-19) L ike other changes in accounting principle, a change in accounting estimate that is effected by a change in accounting principle may be made only if the new accounting p rinciple is justifiable on the basis that it is preferable. For example, an entity that concludes t hat the pattern of consumption of the expected benefits of an asset has changed, and determines that a new depr eciation method better reflects that pattern, may be justified in making a change in accounting estimate effected by a change in accounting p rinciple. (See paragraph 250-10-45-12.) (b) According to FASB ASC 250-10-45-18, distinguishing between a change in an accounting p rinciple and a change in an accounting estimate is sometimes difficult. In some cases, a change in accounting estimate is effected by a change in accounting principle. One example of this type of change is a change in method of depreciation, amortization, or depletion for long-lived, non financial assets (hereinafter referred to as depreciation method). The new depreciation method is adopted in partial or complete recognition of a change in the estimated future benefits inherent in the asset, the pattern of consumption of those benefits, or the information available to the entity about those benefits. The effect of the change in accounting principle, or the method of applying it, may be inseparable from the effect of t he change in accounting estimate. Changes of t hat type often are related to the continuing process of obtaining additional information and revising estimates and, therefore, shall be considered changes in estimates for purposes of applying this Subtopic. According to FASB ASC 250-10-S50-1-1Disclosure of the Impact that Recently Issued Accounting Standards Will Have on the Financial Statements of the Registrant w hen Adopted in a Future Period S50-1 See paragraph 250-10-S99-5, SAB Topic 11.M, for SEC Staff views regarding disclosure of the impact of recently issued accounting standards. SAB Topic 11.M, Disclosure of the Impact that Recently Issued Accounting Standards Will Have on the Financial Statements of the Registrant when Adopted in a Future Period S99-5 The following is the text of SAB Topic 11.M, Disclosure of the Impact that Recently Issued Accounting Standards Will Have on the Financial Statements of the Registrant when Adopted in a Future Period.
(c)
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F INANCIAL ACCOUNTI NG AND REPORT I NG (Continued)
Facts: An accounting standard has been issued that does not require adoption until some future date. A registrant is required to include financial statements in f illings with the Commission after the Issuance of the standard but before it is adopted by the registrant. 5 5Some registrants may want to disclose the potential effects of proposed accounting standards not yet issued, (e.g., exposure drafts). Such disclosures, which generally are not required because the final standard may differ from t he exposure draft, are not addressed by this SAB. See also FRR 26. Question 1: Does the staff believe that these filings should include disclosure of t he impact that the recently issued accounting standard will have on the f inancial position and results of operations of the registrant when such standard is adopted in a future period? I nterpretive Response: Yes. The commission addressed a similar issue with respect to Statement 52 and concluded that The Commission also believes that registrants that have not yet adopted Statement 52 should discuss the potential effects of adoption in registration statements and reports filed with the Commission. 6 The staff believes that this disclosure guidance applies to all accounting standards which have been issued but not yet adopted by the registrant unless the impact on its financial position and results of operations is not expected to be material. 7 M D&A 8 requires registrants to provide information w ith respect to liquidity, capital resources and results of operations and such other information that the registrant believes to be necessary to understand its f inancial condition and results of operations . In addition, MD&A requires disclosure of presently known material changes, trends and uncer tainties that have had or that the registrant reasonably expects will have a material impact on future sales, revenues or income from continuing operations. The staff believes that disclosure of impending accounting changes is necessary to inform t he reader about expected impacts on financial information to be reported in the f uture and, therefore, should be disclosed in accordance with the existing MD&A requirements. With respect to financial statement disclosure, GAAS 9 specifically address the need for the auditor to consider the adequacy of the disclosure of i mpending changes in accounting principles if (a) the financial statements have been prepared on the basis of accounting principles that were acceptable at the f inancial statement date but that will not be acceptable in the future and (b) the f inancial statements will be restated in the future as a result of the change. The staff believes t hat recently issued accounting standards may constitute material matters and, therefore , disclosure in the financial statements should also be considered in situations where the change to the new accounting standard will be accounted for in financial statements of future periods, prospectively or with a cumulative catch-up adjustment. 6FRR 6, Section 2. 7In those instances where a recently issued standard will impact the preparation of, but not materially affect, the financial statements, the registrant is encouraged to disclose that a standard has been issued and that its adoption w ill not have a material effect on its financial position or results of operations. 8Item 303 of Regulation S-K. 9See AU 9410.13-18. Question 2: Does the staff have a view on the types of disclosure that would be
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meaningful and appropriate when a new accounting standard has been issued but not yet adopted by the registrant?
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F INANCIAL ACCOUNTI NG AND REPORT I NG (Continued)
I nterpretive Response: The staff believes that the registrant should evaluate each new accounting standard to determine the appropriate disclosure and recognizes that the level of information available to the registrant will differ with respect to various standards and from one registrant to another. The objectives of the disclosure should be to (1) notify the reader of the disclosure documents t hat a standard has been issued which the registrant will be required to adopt in t he future and (2) assist the reader in assessing the significance of the impact t hat the standard will have on the financial statements of the registrant when adopted. The staff understands that the registrant will only be able to disclose i nformation that is known. The following disclosures should generally be considered by the registrant: A brief description of the new standard, the date that adoption is required and t he date that the registrant plans to adopt, if earlier. A discussion of the methods of adoption allowed by the standard and the method expected to be utilized by the registrant, if determined. A discussion of the impact that adoption of the standard is expected to have on t he f inancial statements of the registrant, unless not known or reasonably estimable. In that case, a statement to that effect may be made. Disclosure of the potential impact of other significant matters that the registrant believes might result from the adoption of the standard (such as technical violations of debt covenant agreements, planned or intended changes i n business practices, etc.) is encouraged.
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P ROFESSIONAL SIMULAT ION
Journal Entries (a) Inventory ......................................................... Retained Earnings ................................. 18,000* 18,000
*($20,000 + $24,000 + $27,000) ($15,000 + $18,000 + $20,000) (b) Inventory ......................................................... Retained Earnings ................................. 28,000* 28,000
*($20,000 + $24,000 + $27,000) ($12,000 + $14,000 + $17,000) Financial Statements Computation of EPS for 2011 Basic EPS Net income ................................................... Outstanding shares ................................... Basic EPS ..................................................... Diluted EPS Net income ................................................... Add: Interest savings ($200,000 X 6%).. Adjusted net income ................................. Adjusted net income ................................. Outstanding shares ................................... Shares upon conversion ........................... Diluted EPS .................................................
$30,000 10,000 $3.00 ($30,000 10,000)
$30,000 12,000 $42,000 $42,000 10,000 6,000* $2.63 ($42,000 16,000)
*$200,000 $1,000 = 200 bonds; 200 bonds X 30 = 6,000 shares
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P ROFESSIONAL SIMULAT ION (Continued) Computation of EPS for 2010 Basic EPS Net income ................................................ Outstanding shares ................................ Basic EPS .................................................. Diluted EPS Net income ................................................ Add: Interest savings ($200,000 X 6%) Adjusted net income .............................. Adjusted net income ............................... Outstanding shares ................................. Shares upon conversion ......................... Diluted EPS ...............................................
$27,000 10,000 $2.70 ($27,000 10,000)
$27,000 12,000 $39,000 $39,000 10,000 6,000 $2.44 ($39,000 16,000)
EPS Presentation 2011 Net income Basic EPS Diluted EPS $30,000 $ $ 3.00 2.63 2010 $27,000 $ $ 2.70 2.44
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