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Unformatted text preview: CHAPTER 22 Accounting Changes and Error Analysis ANSWERS TO QUESTIONS 1. The major reasons 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. 2. (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) Charge to expense. (f) Change in accounting principle; retrospective application to prior period financial statements. 3. The three approaches suggested for reporting changes in accounting principles are: (a) Currentlythe cumulative effect of the change is reported in the current years income 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 the 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. 4. 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. 5. The indirect effect of a change in accounting principle reflects any changes in current or future 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 instead are reported in the period in which the accounting change occurs (current period). 6. 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 inseparable...
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