chapter22 - MATERIALITY!!!! Accounting Changes and Error...

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Unformatted text preview: MATERIALITY!!!! Accounting Changes and Error Analysis Chapter Ch t Everything ever must be material to matter. Consequently, remember that for this whole class, we assume the items we discuss are material to the Company. 22 22-1 Bob Anderson- UCSB 22-2 Bob Anderson- UCSB 20:37 Accounting Changes - APBO No. 20 Classifications: a. Change in Accounting Principle -- GAAP to GAAP change NEW literature: FASB Statement No.154. b. Change in Accounting Estimate -- Example = useful lives of fixed assets c. Change in Reporting Entity -- Example = changing specific subsidiaries in consolidated financial statements. Change in Principle Change from one GAAP to another GAAP A change is NOT considered to result when a new principle is adopt in recognition of events that have occurred for the first time or p y immaterial. that were were previously immaterial. Change from non GAAP to GAAP is not an accounting changes but rather considered a Correction of an Error 22-3 Bob Anderson- UCSB 22-4 Bob Anderson- UCSB Change in Principle Enterprise must demonstrate that the new GAAP is preferable to the existing one. Three POSSIBLE Approaches for Reporting Changes: Retroactive (adjust prior years) Currently (adjust current year) Prospective (adjust current and future years) WHICH DO WE USE? For years and years, we used the "Cumulative effect" method, but that recently changed. GAAP requires the retrospective approach, which is WHAT YOU LEARNED IN 136A!!!!! Report each year presented as if the new principle had always been in place For the very first year presented, make sure to adjust the presented balance sheet accounts (including retained earnings) for the cumulative effect up to that point! 22-5 Bob Anderson- UCSB 22-6 Bob Anderson- UCSB 20:37 Bob Exercise 22-1 22Gerald Industries changed from the double-declining balance to the doublestraightstraight-line method in 2005. For tax purposes, assume that the amount of tax depreciation is higher than the double-declining doublebalance depreciation for each of the 3 years. The appropriate information related to this change is a s follows: Year DDB SL Difference 2003 2004 2005 $250,000 $225,000 $ $202,500 $125,000 $125,000 $ $125,000 $125,000 $100,000 $ $77,500 FACTS Tax rate 2003 2004 BEG 2005 DIFF 2005 34% DDB 250,000 225,000 475,000 202,500 1,152,500 SL 125,000 125,000 250,000 125,000 625,000 Difference 125,000 100,000 225,000 77,500 527,500 Tax effect 42,500 34,000 76,500 26,350 179,350 Tax effected 82,500 66,000 148,500 51,150 348,150 ENTRY TO RECORD CUMULATIVE EFFECT TO 2005 BEGINNING RETAINED EARNINGS Accumulated dep. 225,000 RETAINED EARNINGS 148,500 Deferred tax liability 76,500 ENTRY TO RECORD 2005 DEPRECIATION EXPENSE Depreciation expense 125,000 Accumulated depreciation Net income for 2004 was reported at $270,000; net income for 2005 was reported at $300,000, excluding any adjustment for the cumulative effect of a change in depreciation methods. The straightstraight-line method of depreciation was employed in computing net income for 2005. Assume a tax rate of 34%. Prepare the journal entry to record the change in accounting principle. 22-7 Bob Anderson- UCSB 125,000 22-8 Bob Anderson- UCSB CHANGE IN PRINCIPLE, REQUIRED DISCLOSURES: The Nature of and reason for the change Method of applying the change (i.e retrospective) (i.e Description of items that changed and by how much The effect on the following items: Income from continuing op's Net income Any other significant measure, including per share The cumulative effect on retained earnings. 22-9 Bob Anderson- UCSB Change in Estimate Changes are handled Prospectively, since estimates are an inherent part of accounting. Example -Change in estimate of salvage value or useful life. 22-10 Bob Anderson- UCSB 20:37 Exercise 22-11 22Peter purchased equipment for $510,000 which was estimated to have a useful life of 10 years with a salvage value of $10,000 at the end of that time. Depreciation has been entered for 7 years on a straight -line basis. In 2005, it is determined that the y g total estimated life should be 15 years with a salvage value of $5,000 at the end of that time. Exercise 22-11 22(a) Journal entry to correct prior years? No Entry Necessary 22-11 Bob Anderson- UCSB 22-12 Bob Anderson- UCSB Exercise 22-11 22(b) Journal entry to record depreciation in 2005? Original cost $510,000 Accum. Accum. depreciation ($510,000($510,000-10,000)/10x7 (350,000) Book value 160,000 Salvage value (5,000) Depreciable basis p 155,000 , Remaining life (15-7) (158 years Depreciation expense $ 19,375 ENTRY: Depreciation expense Accumulated depreciation Change in Reporting Entity Requires restating the financial statements of all prior periods presented (Retroactively). Footnotes should describe the nature of the change and the reason for it. $19,375 $19,375 22-13 Bob Anderson- UCSB 22-14 Bob Anderson- UCSB 20:37 Correction of an Error APBO No. 20 requires: (a) treated as prior period adjustments, (b) recorded in the year in which the error was discovered, and (c) reported in the F/S's as an adjustment to the ( ) p j beginning balance of Retained Earnings If comparative statements are presented, the prior statements affected should be restated to correct the error. 22-15 Bob Anderson- UCSB Errors Can result from: Mathematical mistakes, improper estimates, misapplication of accounting principles, etc. Once discovered, the accountant must determine: (a) What type of error is involved? (b) What entries are needed to correct the error? (c) How are the F/S's to be restated? Does the error affect B/S, I/S, or both? 22-16 Bob Anderson- UCSB ERRORS & RESTATEMENTS In 1997, there were 116 restatements. In 2002 there were 330 and 323 in 2003!!!!!!! Prevalence clearly growing! Many argue that this is a one-time issue of fixing oneold problems. I disagree. The Public Company Accounting g p y g Oversight Board (PCAOB) is closely reviewing public companies and have an OBVIOUS goal: Identify restatements Top two causes: #1 reserves and contingencies, #2 Revenue recognition say hello chapter 18 to the recognition REAL WORLD!!! 22-17 Bob Anderson- UCSB ERROR EXAMPLE Company Eye Dunnonada, Inc. was not properly reporting revenue from a pool of notes receivable they owned. This had been going on since 1972. Their effective tax rate is 35%. Their analysis is: Tax rate Prior to 2002 2002 2003 2004 22-18 35% Overstated/ (Understated) Pretax effect of errors Tax effect Tax effected 100,000 35,000 65,000 10,000 3,500 6,500 (5,000) (1,750) (3,250) (5,000) (1,750) (3,250) Bob Anderson- UCSB 20:37 ERROR EXAMPLE What are the journal entries for 2004, 2003 and 2002, respectively to properly fix the error? (assume that the basis in the note pool is the location of the problem on the balance sheet and interest income is the location of the problem on the income statement) Based on recording the proper adjustments and including thi i i l di this impact in the tax provision, proper net t i th t i i t income in 2004, 2003 and 2002 is $275,000, $200,000 and $280,000, respectively. Present the 3 year statement of retained earnings assuming that the retained earnings at the beginning of 2002 (prior to any restatements) was $1,275,000. ERROR EXAMPLE SOLUTION Tax rate Prior to 2002 2002 2003 2004 35% Overstated/ (Understated) Pretax effect of errors Tax effect Tax effected 100,000 35,000 65,000 10,000 3,500 6,500 (5,000) (1,750) (3,250) (5,000) (1,750) (3,250) 2002 ENTRY TO FIX BEGINNING RETAINED EARNINGS Beginning retained earnings 65,000 Notes receivable 100,000 Deferred taxes 35,000 35 000 2002 ENTRY TO RECORD PROPERLY* Interest income 10,000 Notes receivable 2003 ENTRY TO RECORD PROPERLY* Notes receivable Interest income 2004 ENTRY TO RECORD PROPERLY* Notes receivable Interest income 10,000 5,000 5,000 5,000 5,000 22-19 Bob Anderson- UCSB 22-20 * NOTE that as the "fix" occurs in the income statement before the income tax provision, these entries do not need to be tax effected- the tax provision will take this into account automatically. Bob Anderson- UCSB ERROR EXAMPLE- RETAINED EARNINGS EXAMPLEPRESENTATION Idunnonada, Inc. Statements of Retained Earnings Retained earnings as of January 1, 2002, as previously reported Correction of an error, see note X, net of $35,000 tax effect Retained earnings as of January 1, 2002, as RESTATED Net income 2002 Retained eanrings at December 31, 2002 Net income 2003 Retained earnings at December 31, 2003 Net income 2004 Retained earnings at December 31, 2004 22-21 Bob Anderson- UCSB Problem 23-6, pg. 1261 10. Insurance expense Prepaid insurance Retained earnings Amortization expense Retained earnings Trademark 5,000 7,500 12,500 1,250 1,250 2,500 11. 1,275,000 22 (65,000) 1,210,000 1 210 000 280,000 1,490,000 200,000 1,690,000 275,000 1,965,000 22-22 Bob Anderson- UCSB 20:37 ...
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This note was uploaded on 08/06/2008 for the course ECON 136C taught by Professor Anderson during the Summer '08 term at UCSB.

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