Fall 2010 Class 13

Fall 2010 Class 13 - Chapter 21: Accounting Changes Chapter...

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Unformatted text preview: Chapter 21: Accounting Changes Chapter 21: Accounting Changes and Error Analysis Questions We Need to Answer 1. What are the major types of accounting changes? 1. 2. What are the major types of accounting errors? 3. How to account for accounting changes? 4. How to analyze and correct accounting errors? Skills We Will Learn Skills • Apply retroactive and prospective application method for Apply accounting changes. accounting • Understand the disclosure requirements for accounting changes Understand and correction of accounting errors. • Prepare journal entries to correct accounting errors. Prepare Types of Accounting Changes Types of Accounting Changes 1. Change in An Accounting Policy – 1. Change in An Accounting Estimate – 1. Change in the choice of specific principle or Change method used in the application of a specific principle principle Change occurs in circumstances on which a Change previous estimate was based or as the result of new information, more experience or subsequent developments developments Correction of an error in prior period financial statements – Errors resulting from mathematical mistakes, Errors mistakes in applying accounting principles, fraud, or oversight or misrepresentation of facts or Changes in Accounting Policy Changes in Accounting Policy • Handbook Section 1506.09: A change in an Handbook accounting policy is permitted only when the change change – Is required by a primary source of GAAP Is (Mandatory change), or – Results in portraying the effects of the Results transactions or events on the financial position, financial performance or cash flows in a reliable and more relevant presentation in the financial and statements (Voluntary change) statements Changes in Accounting Policy Changes in Accounting Policy • Does not result from adoption of a: – New policy that recognizes events that have occurred for the first time or that were previously immaterial previously – Different policy necessitated by events or transactions clearly different in substance from those previously occurring those Changes in Accounting Estimates Changes in Accounting Estimates • Examples of items requiring estimates Examples include: include: – – – – – – – Uncollectible receivables Inventory obsolescence Useful lives and residual values of depreciable Useful assets assets Periods benefited by deferred costs Liabilities for warranty costs and income taxes Pension Liability / Expenses Residual value of leased assets Correction of an Error in Correction of an Error in Prior Period Financial Statements • Examples of accounting errors include: – Change from non-GAAP to GAAP Change non-GAAP • e.g. change from cash basis of accounting to e.g. accrual basis accrual – Mathematical mistakes • e.g. incorrect totaling of inventory count sheets – Oversight • e.g. failure to defer expenses or revenues – Misappropriation of assets • e.g. discovery of inventory theft Alternative Methods to Account for Alternative Methods to Account for Changes • Three approaches have been suggested for Three reporting changes in the accounts reporting – – – Retroactively Currently Prospectively Retroactive Treatment Retroactive • Requires calculating the cumulative effect of Requires calculating the change on the financial statements of the period as if the new method or estimate had always been used always • Results in restating all affected prior years’ Results financial statements on a basis consistent financial with the newly adopted policy with Current Treatment Current • New method or estimate’s cumulative effect New on the financial statements of the beginning of the period is calculated is • Adjustment is reported in current year’s Adjustment income statement income • No restatement of previous years’ financial statements statements • Not suggested by Canadian GAAP Prospective Treatment Prospective • Previously reported results remain; no no change is made change • Opening balances are not adjusted and no attempt is made to correct or change past periods periods • New policy or estimate is adopted for current New and future periods only and applied to and balances existing at the date of the change balances Accounting Changes and Accounting Changes and Related Accounting Methods Type of Accounting Change Accounting Method Applied Adoption of primary source of Adoption GAAP (Mandatory Change in Accounting Policy) Accounting Apply method approved in Apply transitional provisions section of provisions the primary source; if none, then retroactively. retroactively Other than a change made on Other adoption of a primary source (Voluntary Change in Accounting Policy) Accounting Apply retroactively. Apply retroactively. Changes in accounting Changes estimates estimates Apply prospectively. prospectively. Errors Apply retroactively. Apply retroactively. Types of Error (1) Types of Error (1) • Balance Sheet Errors – Affect only the presentation of an asset, liability or shareholders’ Affect equity account equity • e.g. classifying short-term receivable as longterm – Reclassify when error is discovered & balance sheet for error year Reclassify is restated is • Income Statement Errors – Affect only the presentation of nominal accounts in the income Affect statement statement • Involve improper classification of revenues or Involve expenses expenses – No effect on balance sheet or net income – Reclassification entry required if discovered in the year it is made – If comparatives, restate error year Types of Error (2) Types of Error (2) • Balance Sheet and Income Statement Errors – Involve both balance sheet and income Involve statement statement • e.g. accrued wages payable was overlooked at e.g. year end year – Counterbalancing (self-correcting over two periods) periods) – Noncounterbalancing (takes more than two periods to self-correct) periods Error Analysis Error Analysis Approach to analysis: (1) Develop a clear picture of what is in the Develop is accounts now (before correcting) accounts (2) Develop a clear picture of what should be in the Develop should accounts now (after correcting or if done correctly from the start) correctly (3) Debit or credit accounts to bring (1) to (2) Error Correction Error Correction • Entries to correct differ – If books are closed (all past revenues and If expenses have been transferred to retained earnings), or earnings – If books are still open (amounts of revenue and If expense are still in their respective accounts) expense • The rule: need to correct them where they are! Error Analysis & Correction­Examples Error Analysis & Correction­Examples Example: The firm pay wages on 15th of each month. On December 31, 2004, accrued wages On accrued of $1,500 were not recognized. of Right Wrong Dec 31, 04 Dr. Exp. $1500 Cr. Payable $1500 Cr. Dec 31, 04 No entry. Jan. 15, 05 Dr. Exp. $ X Payabl $1500 Payabl Cr. Cash $X+1500 Jan. 15, 05 Jan. Dr. Exp. $X+1500 Cr. Cash $x+1500 Cr. Error Analysis & Correction­Examples Error Analysis & Correction­Examples Scenario 1 Error Error Occured Occured Scenario 2 Scenario 3 2004 Book 2004 Closed Closed Scenario 4 2005 Book Closed Error Error CounterCounterbalanced Error Analysis & Correction­Examples Error Analysis & Correction­Examples Scenario 1: Assume the error was found at Scenario 3:00pm on December 31, 2004. The book on had not been closed, and the error has not yet counterbalanced. The correcting entry yet would be: would Wages Expenses Wages payable 1,500 1,500 Error Analysis & Correction­Examples Error Analysis & Correction­Examples • Scenario 2: The error was found in January 2, 2005. Scenario January The book of 2004 had been closed, and the error was not yet counterbalanced. The correcting entry would not be: Retain earning (beginning balance) Retain Wages payable 1500 1500 If consider the tax effects, the entries would be: Retained Earnings-beginning balance Retained Future Tax Asset / Liability (1,500*40%) Future Wages payable 900 900 600 600 1,500 Error Analysis & Correction­Examples Error Analysis & Correction­Examples • Scenario 3: The error was found in January 16, 2005. Scenario January At that time, the firm has prepared journal entries to record January’s salary and included the $1,500 salary into current salary expenses. The book for 2005 has not been closed, and the error was counterbalanced. counterbalanced. • The correcting entry would be: The Retained Earnings-beginning balance Future Tax Asset / Liability (1,500*40%) Future Wages Expense 900 900 600 600 1,500 Error Analysis & Correction­Examples Error Analysis & Correction­Examples • Scenario 4: The error was found at 3:00pm, Dec 31, Scenario 2005. The book has been closed, and the error was 2005. counterbalanced. counterbalanced. No entry is necessary, because the error is already No because counterbalanced. (It increased the beginning balance of Retained Earnings of 2005, but also increased the salary expenses of 2005. The overstated beginning balance of R/E had been offset by the end of 2005.) balance One More Counterbalancing Error One More Counterbalancing Error • Example: The accountant recorded a purchase of Example: merchandise for $9,000 in 2005 that applied to 2006. The physical inventory for 2005 was correctly stated. The company uses the periodic inventory method. The error was found on December 31, 2006. Assume the books have not been closed for 2006. • The correcting entry would be: The Purchases $9,000 Purchases Retained Earning-Beginning Balance $5,400 Future Tax Asset / Liability (9,000*40%) $3,600 Non­counterbalancing Error Non­counterbalancing Error Example: Assume a company has inappropriately Example: been using the direct write-off method when the allowance method should have been applied. The following bad debt expense has been recognized as the debts have actually become uncollectible: as 2005 2006 From 2005 Sales $550 $690 From 2006 Sales $700 Total $550 $1390 Total The company estimates that total bad debt The associated with 2005 sales should be $1540, and $1540 and bad debt for 2006 sales should be $1800. $1800 Non­counterbalancing Example Non­counterbalancing Example • Right entries: Right – In 2005 & 2006: In 2006 Dr. Bad Debt Exp. $1,540 ($1800) ($1800 Cr. Allowance for Doubtful Accounts $1,540 ($1800) Cr. ($1800 • Difference: Bad debt exp. in 2005 has been understated for Bad $990= $1,540 -$550 $1,540 Bad debt exp. In 2006 has been understated for Bad $410= $1,800 - $( $690+ $700) $410 $1,800 $690 $700 Non­counterbalancing Example Non­counterbalancing Example • The correcting entries in 2006: The 2006 Bad Debt Expense $410 Retain Earnings $594 Future Tax Asset (990*40%) $396 Future Allowance for Doubtful Accounts $1,400 About Final Exam About Final Exam • Date, Time, and Location: – December 12 (Saturday), 19:00-22:00, B9201 December B9201 • Contents: – Cumulative – Coverage reduced for before-midterm Chapters Coverage (approximately 10%-15%) (approximately – Chapter 17-22 will account for 85%-90%. • Structure: – 16 Multiple-choice questions (40%) – 4 problems (60%) Final Exam Review (1) Final Exam Review (1) • Chapter 13 – Explain the accounting for warranties & Explain contingent liabilities contingent • Chapter 14 – Bond discount and premium amortization • Chapter 15 – Accounting for reacquisition and retirement of Accounting shares. shares. – Dividend preferences. Final Exam Review (2) Final Exam Review (2) • Chapter 16 – Accounting for issuance, conversion and Accounting retirement of convertible securities. retirement – Accounting for compensatory and employee Accounting option plans option Final Exam Review (3) Final Exam Review (3) • Chapter 17, EPS – – – – • Calculate basic EPS in a simple capital structure. Calculate diluted EPS using the if-converted method. Calculate diluted EPS using the treasury stock method. Calculate diluted EPS using the reverse treasury stock Calculate method. method. Chapter 18, Income Tax – – – Prepare analyses and related journal entries to record Prepare income tax expense when there are multiple temporary differences. differences. Explain the effect of various tax rates and tax rate Explain changes on future income tax accounts changes Entries for tax carryback and carryforward benefits Final Exam Review (4) Final Exam Review (4) • Chapter 19, Pension – Identify types of pension plans and their Identify characteristics. characteristics. – Complete a work sheet to support the Complete employer’s pension expense entries. employer’s • • Explain the pension accounting treatment of Explain past service costs. past Explain the pension accounting treatment of Explain actuarial gains and losses, including corridor amortization. amortization. Final Exam Review (5) Final Exam Review (5) • Chapter 20, Leases – – – – – – The accounting criteria and procedures for capitalizing The leases by the lessee and the lessor. leases Accounting for an operating lease for both the lessor and Accounting the lessee. the The lessor’s accounting for direct financing leases. The lessor’s accounting for sales-type leases. The effect of residual values, guaranteed and The unguaranteed, on lease accounting. unguaranteed, The effect of bargain purchase options on lease The accounting. accounting. Final Exam Review (6) Final Exam Review (6) • Chapter 22, Cash Flows Statement – Cash and cash equivalents. – The direct and indirect methods of The calculating net cash flow from operating activities. activities. – Prepare a statement of cash flows. Final Exam Review (7) Final Exam Review (7) • Chapter 21, Accounting Changes – Types of accounting changes. – GAAP requirements for each type of GAAP change. change. – Correcting entries for accounting errors. ...
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