ch22.doc.pdf

CHAPTER 22 ACCOUNTING CHANGES AND ERROR ANALYSIS CHAPTER LEARNING OBJECTIVES 1.

Identify the two types of accounting changes.

2.

Describe the accounting for changes in accounting policies.

3.

Understand how to account for retrospective accounting changes.

4.

Understand how to account for impracticable changes.

5.

Describe the accounting for changes in estimates.

6.

Describe the accounting for correction of errors.

7.

Identify economic motives for changing accounting policies.

8.

Analyze the effect of errors.

TRUE-FALSE—Conceptual 1.

A change in accounting policy is a change that occurs as the result of new information or additional experience.

2.

Errors in financial statements result from mathematical mistakes or oversight or misuse of facts that existed when preparing the financial statements.

3.

Adoption of a new policy in recognition of events that have occurred for the first time or that were previously immaterial is treated as an accounting change.

4.

Retrospective application refers to the application of a different accounting policy to recast previously issued financial statements—as if the new policy had always been used.

5.

When a company changes an accounting policy, it should report the change by reporting the cumulative effect of the change in the current year’s income statement.

6.

One of the disclosure requirements for a change in accounting policy is to show the cumulative effect of the change on retained earnings as of the beginning of the earliest period presented.

7.

An indirect effect of an accounting change is any change to current or future cash flows of a company that result from making a change in accounting policy that is applied retrospectively.

8.

The IASB is silent on the application of the direct effects of a change in accounting policy.

22 - 2

Test Bank for Intermediate Accounting, IFRS Edition, 2e

9.

The new IFRS on financial instruments will be subject to the proper accounting for changes in accounting policy.

10.

The requirements for disclosure are the same whether a change is voluntary or is mandated by the issuance of a new IFRS.

11.

Under U.S. GAAP, the impracticality exception applies both to changes in accounting policies and to the correction of errors.

12.

Retrospective application is considered impracticable if a company cannot determine the prior period effects using every reasonable effort to do so.

13.

Companies report changes in accounting estimates retrospectively.

14.

When it is impossible to determine whether a change in policy or change in estimate has occurred, the change is considered a change in estimate.

15.

Companies account for a change in depreciation methods as a change in accounting policy.

16.

Accounting errors include changes in estimates that occur because a company acquires more experience, or as it obtains additional information.

17.

Companies record corrections of errors from prior periods as an adjustment to the beginning balance of retained earnings in the current period.

18.

If an IASB standard creates a new policy, expresses preference for, or rejects a specific accounting policy, the change is considered clearly acceptable.

19.

Statement of financial position errors affect only the presentation of an asset or liability account.

20.

Counterbalancing errors are those that will be offset and that take longer than two periods to correct themselves.

21.

For counterbalancing errors, restatement of comparative financial statements is necessary even if a correcting entry is not required.

22.

Companies must make correcting entries for non-counterbalancing errors, even if they have closed the prior year’s books.

23.

An income statement classification error has no effect on the statement of financial position and no effect on net income.

24.

The accounting for change in estimates differs between U.S.GAAP and IFRS.

25.

Non-counterbalancing errors are those that longer than two periods to correct themselves.

Accounting Changes and Error Analysis

True-False Answers—Conceptual Item 1. 2. 3. 4. 5. 6. 7.

Ans. F T F T F T T

Item 8. 9. 10. 11. 12. 13. 14.

Ans. F T F F T F T

Item 15. 16. 17. 18. 19. 20. 21.

Ans. F F T T F F T

Item 22. 23. 24. 25.

Ans. T T F T

22 - 3

22 - 4

Test Bank for Intermediate Accounting, IFRS Edition, 2e

MULTIPLE CHOICE—Conceptual 26.

Accounting changes are often made and the monetary impact is reflected in the financial statements of a company even though, in theory, this may be a violation of the accounting concept of a. materiality. b. consistency. c. prudence. d. objectivity.

27.

Which of the following is not classified as an accounting change by IASB? a. Change in the accounting policy b. Change in accounting estimate c. Errors in the financial statements d. All of these are classified as an accounting change

28

Which of the following is the best explanation for why IASB has classified accounting changes into different categories? a. IASB established categories based on the materiality of the changes involved. b. IASB classifies changes in the categories because each category involves different method of recognizing changes in the financial statements. c. IASB established categories based on the fact that some treatment are consider GAAP and some are not. d. IASB established the categories based on a survey of managers and their need to provide a favorable profit picture.

29.

IASB requires companies to use which method for reporting changes in accounting policies? a. cumulative effect approach b. retrospective approach c. prospective approach d. averaging approach

30.

Which of the following is not treated as a change in accounting policy? a. A change from average cost to FIFO for inventory valuation b. A change to a different method of depreciation for plant assets c. A change from full-cost to successful efforts in the extractive industry d. A change from cost-recovery to percentage-of-completion

31.

Which of the following is not a retrospective-type accounting change? a. Cost-recovery method to the percentage-of-completion method for long-term contracts b. Cost-recovery method to the FIFO method for inventory valuation c. Sum-of-the-years'-digits method to the straight-line method d. "Full cost" method to another method in the extractive industry

32.

Which of the following is accounted for as a change in accounting policy? a. A change in the estimated useful life of plant assets. b. A change from the cash basis of accounting to the accrual basis of accounting. c. A change from expensing immaterial expenditures to deferring and amortizing them as they become material. d. A change in inventory valuation from average cost to FIFO.

Accounting Changes and Error Analysis

22 - 5

33.

A company changes from straight-line to an accelerated method of calculating depreciation, which will be similar to the method used for tax purposes. The entry to record this change should include a a. credit to Accumulated Depreciation. b. debit to Retained Earnings in the amount of the difference on prior years. c. debit to Deferred Tax Asset. d. credit to Deferred Tax Liability.

34.

Which of the following disclosures is required for a change from sum-of-the-years-digits to straight-line? a. The cumulative effect on prior years, net of tax, in the current retained earnings statement b. Restatement of prior years’ income statements c. Recalculation of current and future years’ depreciation d. All of these answer choices are required.

35.

Which of the following would be a reason where IASB would permit companies to change accounting policy? a. The change would allow the company to present a more favorable profit picture. b. The change would result in the financial statements providing more reliable and relevant information about a company`s financial position, financial performance, and cash flows. c. The change is made by the internal auditor. d. The change will be long-term.

36.

If a particular transaction is not specifically addressed by IFRS, where should an accountant turn to find a hierarchy of guidance to be considered in the selection of an accounting policy? a. accounting standards from other countries b. IAS 8 c. the company’s board of directors d. the company’s external auditors

37.

A company changes from percentage-of-completion to cost-recovery, which is the method used for tax purposes. The entry to record this change should include a a. debit to Construction in Process. b. debit to Loss on Long-term Contracts in the amount of the difference on prior years, net of tax. c. debit to Retained Earnings in the amount of the difference on prior years, net of tax. d. credit to Deferred Tax Liability.

38.

Which of the following disclosures is not required for a change from average cost to FIFO? a. Basic and diluted earnings per share for the current period and each prior period presented b. The nature of the change in accounting policy c. The amount of the adjustment relating to periods before those presented d. All of these answer choices are required.

22 - 6

Test Bank for Intermediate Accounting, IFRS Edition, 2e

39.

Stone Company changed its method of pricing inventories from average cost to FIFO. What type of accounting change does this represent? a. A change in accounting estimate for which the financial statements for prior periods included for comparative purposes should be presented as previously reported. b. A change in accounting policy for which the financial statements for prior periods included for comparative purposes should be presented as previously reported. c. A change in accounting estimate for which the financial statements for prior periods included for comparative purposes should be restated. d. A change in accounting policy for which the financial statements for prior periods included for comparative purposes should be restated.

40.

Which type of accounting change should always be accounted for in current and future periods? a. Change in accounting policy b. Change in reporting entity c. Change in accounting estimate d. Correction of an error

41.

Which of the following is (are) the proper time period(s) to record the effects of a change in accounting estimate? a. Current period and prospectively b. Current period and retrospectively c. Retrospectively only d. Current period only

42.

When a company decides to switch from the double-declining balance method to the straight-line method, this change should be handled as a a. change in accounting policy. b. change in accounting estimate. c. prior period adjustment. d. correction of an error.

43.

The estimated life of a building that has been depreciated 30 years of an originally estimated life of 50 years has been revised to a remaining life of 10 years. Based on this information, the accountant should a. continue to depreciate the building over the original 50-year life. b. depreciate the remaining book value over the remaining life of the asset. c. adjust accumulated depreciation to its appropriate balance, through net income, based on a 40-year life, and then depreciate the adjusted book value as though the estimated life had always been 40 years. d. adjust accumulated depreciation to its appropriate balance through retained earnings, based on a 40-year life, and then depreciate the adjusted book value as though the estimated life had always been 40 years.

44.

Which of the following statements is correct? a. Changes in accounting policy are always handled in the current or prospective period. b. Prior statements should be restated for changes in accounting estimates. c. A change from expensing certain costs to capitalizing these costs due to a change in the period benefited, should be handled as a change in accounting estimate. d. Correction of an error related to a prior period should be considered as an adjustment to current year net income.

Accounting Changes and Error Analysis

22 - 7

45.

Why does IASB prohibit retrospective treatment of changes in accounting estimates? a. The IASB view changes in estimates as normal recurring corrections and adjustments, which are the natural result of the accounting process. b. The IASB does not allow the retrospective treatment for any type of presentation. c. The IASB prohibits retrospective treatment of changes in accounting estimates because IFRS requires it. d. IASB does not prohibit retrospective treatment of changes in accounting estimates, but is silent on this issue

46.

All of the following statements are true regarding IASB’s guideline that companies must demonstrate change in accounting policy as preferable or as an improvement, except a. Diversity in situations and characteristics of the items encountered in practice require the use of professional judgment. b. Changes in accounting policy are appropriate only when a company demonstrates that the newly adopted generally accepted accounting policy is more relevant and reliable than the existing one. c. Changes in accounting policy are appropriate only when a company demonstrates an improved income tax effect alone. d. All of these statements are true.

47.

Each of the following errors will overstate 2016 net income except a. Equipment purchased in 2015 was expensed. b. Wages payable were not recorded at 12/31/16. c. Equipment purchased in 2016 was expensed. d. 2016 ending inventory was overstated

48.

Yee Construction Co. had followed the practice of expensing all materials assigned to a construction job without recognizing any residual inventory. On December 31, 2016, it was determined that residual inventory should be valued at ¥56,000. Of this amount, ¥23,000 arose during the current year. Based on this information, all of the following statements are true regarding the effect on the financial statements to be prepared at the end of 2016 except a. ¥23,000 should be reported in the 2016 statements as a reduction of materials cost. b. ¥33,000 should be reported as an adjustment to the beginning balance of retained earnings in the 2016 financial statements. c. This change should be handled as a correction of an error. d. This change should be handled as a change in accounting estimate.

49.

An example of a correction of an error in previously issued financial statements is a change a. from the FIFO method of inventory valuation to the average cost method. b. in the service life of plant assets, based on changes in the economic environment. c. from the cash basis of accounting to the accrual basis of accounting. d. in the tax assessment related to a prior period.

50.

The IASB has declared, as part of its conceptual framework, that it will assess the merits of proposed standards a. from a position of neutrality. b. from a position of materiality. c. based on the possible impact on behavior. d. based on lobbyist arguments.

22 - 8

Test Bank for Intermediate Accounting, IFRS Edition, 2e

51.

Which of the following is true regarding whether IFRS specifically addresses the accounting and reporting for effects of changes in accounting policies? Direct effects Indirect effects a. YES YES b. NO NO c. NO YES d. YES NO

52.

Under IFRS, when a company prepares financial statements on a new basis, how many years of comparative data are reported? a. One b. Two c. Three d. Five

53.

Counterbalancing errors do not include a. errors that correct themselves in two years. b. errors that correct themselves in three years. c. an understatement of purchases. d. an overstatement of unearned revenue.

54.

A company using a perpetual inventory system neglected to record a purchase of merchandise on account at year end. This merchandise was omitted from the year-end physical count. How will these errors affect assets, liabilities, and equity at year end and net income for the year? Assets No effect No effect Understate Understate

a. b. c. d. 55.

Liabilities Understate Overstate Understate No effect

Equity Overstate Understate No effect Understate

Net Income Overstate. Understate. No effect. Understate.

If, at the end of a period, a company erroneously excluded some goods from its ending inventory and also erroneously did not record the purchase of these goods in its accounting records, these errors would cause a. the ending inventory and retained earnings to be understated. b. the ending inventory, cost of goods sold, and retained earnings to be understated. c. no effect on net income, working capital, and retained earnings. d. cost of goods sold and net income to be understated.

Multiple Choice Answers—Conceptual Item

26. 27. 28. 29. 30.

Ans.

b c b b b

Item

31. 32. 33. 34. 35.

Ans.

c d a c b

Item

36. 37. 38. 39. 40.

Ans.

b c d d c

Item

41. 42. 43. 44. 45.

Ans.

a b b c a

Item

46. 47. 48. 49. 50.

Ans.

c c d c a

Item

51. 52. 53. 54. 55.

Ans.

d b b c c

Item

Ans.

Accounting Changes and Error Analysis

22 - 9

MULTIPLE CHOICE—Computational 56.

On January 1, 2013, Neal Corporation acquired equipment at a cost of $540,000. Neal adopted the sum-of-the-years’-digits method of depreciation for this equipment and had been recording depreciation over an estimated life of eight years, with no residual value. At the beginning of 2016, a decision was made to change to the straight-line method of depreciation for this equipment. The depreciation expense for 2016 would be a. $28,125. b. $45,000. c. $67,500. d. $108,000.

57.

On January 1, 2013, Knapp Corporation acquired machinery at a cost of $250,000. Knapp adopted the double-declining balance method of depreciation for this machinery and had been recording depreciation over an estimated useful life of ten years, with no residual value. At the beginning of 2016, a decision was made to change to the straight-line method of depreciation for the machinery. The depreciation expense for 2016 would be a. $12,800. b. $18,286. c. $25,000. d. $35,714.

58.

On January 1, 2013, Piper Co., purchased a machine (its only depreciable asset) for $300,000. The machine has a five-year life, and no salvage value. Sum-of-the-years'digits depreciation has been used for financial statement reporting and the elective straight-line method for income tax reporting. Effective January 1, 2016, for financial statement reporting, Piper decided to change to the straight-line method for depreciation of the machine. Assume that Piper can justify the change. Piper's income before depreciation, before income taxes, and before the cumulative effect of the accounting change (if any), for the year ended December 31, 2016, is $250,000. The income tax rate for 2016, as well as for the years 2013-2015, is 30%. What amount should Piper report as net income for the year ended December 31, 2016? a. $60,000 b. $91,000 c. $154,000 d. $175,000

Use the following information for questions 59 and 60. Ventura Corporation purchased machinery on January 1, 2014 for $630,000. The company used the sum-of-the-years’-digits method and no salvage value to depreciate the asset for the first two years of its estimated six-year life. In 2016, Ventura changed to the straight-line depreciation method for this asset. The following facts pertain: 2014 2015 Straight-line $105,000 $105,000 Sum-of-the-years’-digits 180,000 150,000

22 - 10 Test Bank for Intermediate Accounting, IFRS Edition, 2e 59.

Ventura is subject to a 40% tax rate. The cumulative effect of this accounting change on beginning retained earnings is a. $135,000. b. $120,000. c. $72,000. d. $0.

60.

The amount that Ventura should report for depreciation expense on its 2016 income statement is a. $120,000. b. $105,000. c. $75,000. d. none of the above.

61.

During 2016, a construction company changed from the cost-recovery method to the percentage-of-completion method for accounting purposes but not for tax purposes. Gross profit figures under both methods for the past three years appear below: 2014 2015 2016

Cost-Recovery $ 475,000 625,000 700,000 $1,800,000

Percentage-of-Completion $ 800,000 950,000 1,050,000 $2,800,000

Assuming an income tax rate of 40% for all years, the effect of this accounting change on prior periods should be reported by a credit of a. $600,000 on the 2016 income statement. b. $390,000 on the 2016 income statement. c. $600,000 on the 2016 retained earnings statement. d. $390,000 on the 2016 retained earnings statement. Use the following information for questions 62 and 63. On January 1, 2013, Nobel Corporation acquired machinery at a cost of $600,000. Nobel adopted the straight-line method of depreciation for this machine and had been recording depreciation over an estimated life of ten years, with no residual value. At the beginning of 2016, a decision was made to change to the double-declining balance method of depreciation for this machine. 62.

Assuming a 30% tax rate, the cumulative effect of this accounting change on beginning retained earnings, is a. $67,200. b. $0. c. $78,960. d. $112,800.

63.

The amount that Nobel should record as depreciation expense for 2016 is a. $60,000. b. $84,000. c. $120,000. d. none of the above.

Accounting Changes and Error Analysis

22 - 11

64.

On December 31, 2016 Dean Company changed its method of accounting for inventory from the average cost method to the FIFO method. This change caused the 2016 beginning inventory to increase by $420,000. The cumulative effect of this accounting change to be reported for the year ended 12/31/16, assuming a 40% tax rate, is a. $420,000. b. $252,000. c. $168,000. d. $0.

65.

Sun Construction Company decided at the beginning of 2016 to change from the costrecovery method to the percentage-of-completion method for financial reporting purposes. The company will continue to use the cost-recovery method for tax purposes. For years prior to 2016, pretax income under the two methods was as follows: percentage-ofcompletion £120,000, and cost-recovery £80,000. The tax rate is 35%. Sun’s 2016 journal entry to record the change in accounting policy will include: a. a debit to Retained Earnings for £40,000. b. a credit to Construction in Process for £40,000. c. a debit to Deferred Tax Asset for £14,000. d. a credit to Deferred Tax Liability for £14,000

66.

Jacob, Inc., changed from the average cost to the FIFO cost flow assumption in 2016. The increase in the prior year`s income before taxes is €1,100,000. The tax rate is 35%. Jacob’s 2016 journal entry to record the change in accounting policy will include. a. a debit to Retained Earnings for €1,100,000. b. a credit to Retained Earnings for €1,100,000. c. a debit to Inventory for €715,000. d. a credit to Deferred Tax Liability for €385,000

67.

Detmer Construction Company decided at the beginning of 2016 to change from the costrecovery method to the percentage-of-completion method for financial reporting purposes. The company will continue to use the cost-recovery method for tax purposes. For years prior to 2016, pretax income under the two methods was as follows: percentage-ofcompletion £144,000, and cost-recovery £114,000. The tax rate is 35%. Detmer has a profit-sharing plan, which pays all employees a bonus at year-end based on 1.5% of pretax income. What is the amount of the indirect effect of Detmer’s change in accounting policy that will be reported in the 2016 income statement, assuming that the profit-sharing contract explicitly requires adjustment for changes in income numbers? a. £2,160 b. £1,710 c. £ 450 d. £ 954

68.

Heinz Company began operations on January 1, 2015, and uses the FIFO method in costing its raw material inventory. Management is contemplating a change to the average cost method and is interested in determining what effect such a change will have on net income. Accordingly, the following information has been developed: Final Inventory FIFO Average cost Net Income (computed under the FIFO method)

2015 $640,000 560,000 980,000

2016 $ 712,000 636,000 1,080,000

22 - 12 Test Bank for Intermediate Accounting, IFRS Edition, 2e Based on the above information, a change to the average cost method in 2016 would result in net income for 2016 of a. $1,120,000. b. $1,080,000. c. $1,004,000. d. $1,000,000. 69.

Lanier Company began operations on January 1, 2015, and uses the FIFO method in costing its raw material inventory. Management is contemplating a change to the average cost method and is interested in determining what effect such a change will have on net income. Accordingly, the following information has been developed: Final Inventory 2015 2016 FIFO $320,000 $360,000 Average cost 240,000 300,000 Net Income (computed under the FIFO method) 500,000 600,000 Based upon the above information, a change to the average cost method in 2016 would result in net income for 2016 of a. $540,000. b. $600,000. c. $620,000. d. $660,000.

70.

Equipment was purchased at the beginning of 2013 for $204,000. At the time of its purchase, the equipment was estimated to have a useful life of six years and a residual value of $24,000. The equipment was depreciated using the straight-line method of depreciation through 2015. At the beginning of 2016, the estimate of useful life was revised to a total life of eight years and the expected residual value was changed to $15,000. The amount to be recorded for depreciation for 2016, reflecting these changes in estimates, is a. $12,375. b. $19,800. c. $22,800. d. $23,625.

Use the following information for questions 71 and 72. Swift Company purchased a machine on January 1, 2013, for $300,000. At the date of acquisition, the machine had an estimated useful life of six years with no residual value. The machine is being depreciated on a straight-line basis. On January 1, 2016, Swift determined, as a result of additional information, that the machine had an estimated useful life of eight years from the date of acquisition with no residual value. An accounting change was made in 2016 to reflect this additional information. 71.

Assume that the direct effects of this change are limited to the effect on depreciation and the related tax provision, and that the income tax rate was 30% in 2013, 2014, 2015, and 2016. What should be reported in Swift's income statement for the year ended December 31, 2016, as the cumulative effect on prior years of changing the estimated useful life of the machine? a. $0 b. $20,000 c. $30,000 d. $105,000

Accounting Changes and Error Analysis

22 - 13

72.

What is the amount of depreciation expense on this machine that should be charged in Swift's income statement for the year ended December 31, 2016? a. $30,000 b. $37,500 c. $60,000 d. $75,000

73.

Brittany Company purchased a computer system for £94,250 on January 1, 2014. It was depreciated on a straight-line basis based on a 7-year life and an £19,000 residual value. On January 1, 2016, Brittany revised these estimates to a total useful life of 4 years and a residual value of £10,000. Brittany’s entry to record 2016 depreciation expense will include a debit to Depreciation Expense for: a. £75,250 b. £72,750 c. £19,000 d. £31,375

Use the following information for questions 74 and 75. In January 2015, Marcus Ltd. has installation costs of £9,000 on new machinery that were charged to Repair Expense. Other costs of this machinery of £30,000 were correctly recorded and have been depreciated using the straight-line method with an estimated life of 10 years and no residual value. At December 31, 2016, Marcus decides that the machinery has remaining useful life of 15 years, starting with January 1, 2016 74.

If the book have not been closed for 2016 and depreciation expense has not yet been recorded for 2016, the entry that Marcus makes in 2016 to correct for the error of expensing installation costs on the machinery acquired in January, 2015, will include: a. a debit to Retained Earnings for £9,000 b. a credit to Retained Earnings for £9,000. c. a debit to Retained Earnings for £8,100. d. a credit to Retained Earnings for £8,100.

75.

If the book have not been closed for 2016 and depreciation expense has not yet been recorded for 2016, the entry that Marcus makes in 2016 to record depreciation on the machinery acquired in January, 2015, will include: a. a debit to Depreciation Expense for £2,600 b. a credit to Accumulated Depreciation for £900. c. a debit to Depreciation Expense for £3,900 d. a credit to Accumulated Depreciation for £2,340

76.

In 2016, Krasny Corporation discovered that equipment purchased on January 1,2014, for €52,500 was expensed at that time. The equipment should have been depreciated over 5 years, with no residual value. The effective tax rate is 30%. Krasny’s 2016 journal entry to correct the error would include a. a credit to Equipment for €52,500 b. a debit to Retained Earnings for €52,500. c. a credit to Retained Earnings for €22,050. d. a credit to Deferred Tax Liability for €15,750.

22 - 14 Test Bank for Intermediate Accounting, IFRS Edition, 2e Use the following information for questions 77 and 78. Armstrong Inc. is a calendar-year corporation. Its financial statements for the years ended 12/31/15 and 12/31/16 contained the following errors: Ending inventory Depreciation expense

2015 $15,000 overstatement 6,000 understatement

2016 $24,000 understatement 12,000 overstatement

77.

Assume that the 2015 errors were not corrected and that no errors occurred in 2014. By what amount will 2015 income before income taxes be overstated or understated? a. $21,000 overstatement b. $9,000 overstatement c. $21,000 understatement d. $9,000 understatement

78.

Assume that no correcting entries were made at 12/31/15, or 12/31/16. Ignoring income taxes, by how much will retained earnings at 12/31/16 be overstated or understated? a. $24,000 overstatement b. $21,000 overstatement c. $30,000 understatement d. $9,000 understatement

Use the following information for questions 79 through 81. Langley Company's December 31 year-end financial statements contained the following errors: Dec. 31, 2014 Dec. 31, 2015 Ending inventory $7,500 understated $11,000 overstated Depreciation expense 2,000 understated An insurance premium of $18,000 was prepaid in 2014 covering the years 2014, 2015, and 2016. The prepayment was recorded with a debit to insurance expense. In addition, on December 31, 2015, fully depreciated machinery was sold for $9,500 cash, but the sale was not recorded until 2016. There were no other errors during 2015 or 2016 and no corrections have been made for any of the errors. Ignore income tax considerations. 79.

What is the total net effect of the errors on Langley's 2015 net income? a. Net income understated by $14,500. b. Net income overstated by $7,500. c. Net income overstated by $13,000. d. Net income overstated by $15,000.

80.

What is the total net effect of the errors on the amount of Langley's working capital at December 31, 2015? a. Working capital overstated by $5,000 b. Working capital overstated by $1,500 c. Working capital understated by $4,500 d. Working capital understated by $12,000

Accounting Changes and Error Analysis

22 - 15

81.

What is the total effect of the errors on the balance of Langley's retained earnings at December 31, 2015? a. Retained earnings understated by $10,000 b. Retained earnings understated by $4,500 c. Retained earnings understated by $2,500 d. Retained earnings overstated by $3,500

82.

Accrued salaries payable of $51,000 were not recorded at December 31, 2015. Office supplies on hand of $24,000 at December 31, 2016 were erroneously treated as expense instead of supplies inventory. Neither of these errors was discovered nor corrected. The effect of these two errors would cause a. 2016 net income to be understated $75,000 and December 31, 2016 retained earnings to be understated $24,000. b. 2015 net income and December 31, 2015 retained earnings to be understated $51,000 each. c. 2015 net income to be overstated $27,000 and 2016 net income to be understated $24,000. d. 2016 net income and December 31, 2016 retained earnings to be understated $24,000 each.

Use the following information for questions 83 through 85. Bishop Co. began operations on January 1, 2015. Financial statements for 2015 and 2016 contained the following errors: Dec. 31, 2015 Dec. 31, 2016 Ending inventory $132,000 too high $156,000 too low Depreciation expense 84,000 too high — Insurance expense 60,000 too low 60,000 too high Prepaid insurance 60,000 too high — In addition, on December 31, 2016 fully depreciated equipment was sold for $28,800, but the sale was not recorded until 2017. No corrections have been made for any of the errors. Ignore income tax considerations. 83.

The total effect of the errors on Bishop's 2016 net income is a. understated by $376,800. b. understated by $244,800. c. overstated by $115,200. d. overstated by $199,200.

84.

The total effect of the errors on the balance of Bishop's retained earnings at December 31, 2016 is understated by a. $328,800. b. $268,800. c. $184,800. d. $136,800.

85.

The total effect of the errors on the amount of Bishop's working capital at December 31, 2016 is understated by a. $400,800. b. $316,800. c. $184,800. d. $124,800.

22 - 16 Test Bank for Intermediate Accounting, IFRS Edition, 2e Use the following information for questions 86 and 87. Link Co. purchased machinery that cost $810,000 on January 4, 2014. The entire cost was recorded as an expense. The machinery has a nine-year life and a $54,000 residual value. The error was discovered on December 20, 2016. Ignore income tax considerations. 86.

Link's income statement for the year ended December 31, 2016, should show the cumulative effect of this error in the amount of a. $726,000. b. $642,000. c. $558,000. d. $0.

87.

Before the correction was made, and before the books were closed on December 31, 2016, retained earnings was understated by a. $810,000. b. $726,000. c. $642,000. d. $558,000.

Use the following information for questions 88 and 89. Ernst Company purchased equipment that cost $750,000 on January 1, 2015. The entire cost was recorded as an expense. The equipment had a nine-year life and a $30,000 residual value. Ernst uses the straight-line method to account for depreciation expense. The error was discovered on December 10, 2017. Ernst is subject to a 40% tax rate. 88.

Ernst’s net income for the year ended December 31, 2015, was understated by a. $402,000. b. $450,000. c. $670,000. d. $750,000.

89.

Before the correction was made and before the books were closed on December 31, 2017, retained earnings was understated by a. $332,000. b. $336,000. c. $354,000. d. $450,000.

Multiple Choice Answers—Computational Item

56. 57. 58. 59. 60.

Ans.

b b c d c

Item

61. 62. 63. 64. 65.

Ans.

d b c b d

Item

66. 67. 68. 69. 70.

Ans.

d c c a b

Item

71. 72. 73. 74. 75.

Ans.

a a d d d

Item

76. 77. 78. 79. 80.

Ans.

c a c d c

Item

81. 82. 83. 84. 85.

Ans.

c a a b c

Item

86. 87. 88. 89.

Ans.

d c a c

Accounting Changes and Error Analysis

22 - 17

MULTIPLE CHOICE—CPA Adapted 90.

Which of the following should be reported as a prior period adjustment? Change in Change from Estimated Lives Unaccepted Policy of Depreciable Assets to Accepted Policy a. Yes Yes b. No Yes c. Yes No d. No No

91.

On December 31, 2016, Grantham, Inc. appropriately changed its inventory valuation method to FIFO cost from average cost for financial statement and income tax purposes. The change will result in a $1,500,000 increase in the beginning inventory at January 1, 2016. Assume a 30% income tax rate. The cumulative effect of this accounting change on beginning retained earnings is a. $0. b. $450,000. c. $1,050,000. d. $1,500,000.

92.

On January 1, 2016, Frost Corp. changed its inventory method to FIFO from average cost for both financial and income tax reporting purposes. The change resulted in an $800,000 increase in the January 1, 2016 inventory. Assume that the income tax rate for all years is 30%. The cumulative effect of the accounting change should be reported by Frost in its 2016 a. retained earnings statement as a $560,000 addition to the beginning balance. b. income statement as a $560,000 cumulative effect of accounting change. c. retained earnings statement as an $800,000 addition to the beginning balance. d. income statement as an $800,000 cumulative effect of accounting change.

93.

On January 1, 2013, Lake Co. purchased a machine for $792,000 and depreciated it by the straight-line method using an estimated useful life of eight years with no residual value. On January 1, 2016, Lake determined that the machine had a useful life of six years from the date of acquisition and will have a residual value of $72,000. An accounting change was made in 2016 to reflect these additional data. The accumulated depreciation for this machine should have a balance at December 31, 2016 of a. $438,000. b. $462,000. c. $480,000. d. $528,000.

94.

On January 1, 2013, Hess Co. purchased a patent for $595,000. The patent is being amortized over its remaining legal life of 15 years expiring on January 1, 2028. During 2016, Hess determined that the economic benefits of the patent would not last longer than ten years from the date of acquisition. What amount should be reported in the statement of financial position for the patent, net of accumulated amortization, at December 31, 2016? a. $357,000 b. $408,000 c. $420,000 d. $436,375

22 - 18 Test Bank for Intermediate Accounting, IFRS Edition, 2e 95.

During 2015, a textbook written by Mercer Co. personnel was sold to Roark Publishing, Inc., for royalties of 10% on sales. Royalties are receivable semiannually on March 31, for sales in July through December of the prior year, and on September 30, for sales in January through June of the same year. 

Royalty income of $108,000 was accrued at 12/31/15 for the period July-December 2015.  Royalty income of $120,000 was received on 3/31/16, and $156,000 on 9/30/16.  Mercer learned from Roark that sales subject to royalty were estimated at $1,620,000 for the last half of 2016. In its income statement for 2016, Mercer should report royalty income at a. $276,000. b. $288,000. c. $318,000. d. $330,000. 96.

On January 1, 2015, Janik Corp. acquired a machine at a cost of $500,000. It is to be depreciated on the straight-line method over a five-year period with no residual value. Because of a bookkeeping error, no depreciation was recognized in Janik's 2015 financial statements. The oversight was discovered during the preparation of Janik's 2016 financial statements. Depreciation expense on this machine for 2016 should be a. $0. b. $100,000. c. $125,000. d. $200,000.

97.

On December 31, 2016, special insurance costs, incurred but unpaid, were not recorded. If these insurance costs were related to work in process, what is the effect of the omission on accrued liabilities and retained earnings in the December 31, 2016 statement of financial position? a. b. c. d.

98.

Accrued Liabilities No effect No effect Understated Understated

Retained Earnings No effect Overstated No effect Overstated

Black, Inc. is a calendar-year corporation whose financial statements for 2015 and 2016 included errors as follows: Year 2015 2016

Ending Inventory $162,000 overstated 54,000 understated

Depreciation Expense $135,000 overstated 45,000 understated

Assume that purchases were recorded correctly and that no correcting entries were made at December 31, 2015, or at December 31, 2016. Ignoring income taxes, by how much should Black's retained earnings be retroactively adjusted at January 1, 2017? a. $144,000 increase b. $36,000 increase c. $18,000 decrease d. $9,000 increase

Accounting Changes and Error Analysis

22 - 19

Multiple Choice Answers—CPA Adapted Item

90. 91.

Ans.

b c

Item

92. 93.

Ans.

Item

a a

94. 95.

Ans.

b d

Item

Ans.

96. 97.

b c

Item

Ans.

98.

a

DERIVATIONS — Computational No. Answer

Derivation

56.

b

[(8 + 7 + 6) ÷ 36] × $540,000 = $ 315,000 (AD) ($540,000 - $ 315,000) ÷ 5 = $ 45,000.

57.

b

{$250,000 – [($250,000 × .2) + ($200,000 × .2) + ($160,000 × .2)]} ÷ 7 = $18,286.

58.

c

[(5/15 + 4/15 + 3/15) × $300,000] = $240,000 (AD) ($300,000 – $240,000) = $60,000 (BV) [$250,000 – ($60,000 ÷ 2)] × (1 – .3) = $154,000.

59.

d

$0, No cumulative effect; handle prospectively.

60.

c

[$630,000 – ($180,000 + $150,000)] ÷ 4 = $75,000.

61.

d

[($800,000 + $950,000) – ($475,000 + $625,000)] × (1 – .40) = $390,000.

62.

b

$0, No cumulative effect; handle prospectively.

63.

c

[{($600,000 – [($600,000 ÷ 10) × 3]} ÷ 7] × 2 = $120,000.

64.

b

$420,000 × (1 – .40) = $252,000.

65.

d

[(£120,000 – £80,000) × .35] = £14,000 cr

66.

d

€1,100,000 × .35 = €385,000

67.

c

(£144,000 – £114,000) × .015 = £450

68.

c

$1,080,000 – ($712,000 – $636,000) = $1,004,000.

69.

a

$600,000 – ($360,000 – $300,000) = $540,000.

70.

b

$204,000 – {[($204,000 – $24,000) ÷ 6] × 3} = $114,000 ($114,000 – $15,000) ÷ (8 – 3) = $19,800.

71.

a

$0, no cumulative effect, handle prospectively (change in estimate).

72.

a

($300,000 ÷ 6) × 3 = $150,000 $150,000 ÷ 5 = $30,000.

73.

d

[(£94,250 – £19,000) ÷ 7] × 2 = £21,500 [(£94,250 – £21,500) – £10,000] ÷ (4 – 2) = £31,375

22 - 20 Test Bank for Intermediate Accounting, IFRS Edition, 2e

DERIVATIONS — Computational (cont.) No. Answer

Derivation

74.

d

[£9,000 – (£9,000 ÷ 10)] = £8,100 cr

75.

d

£39,000 – (£39,000 ÷ 10)] = £35,100 £35,100 ÷ 15 = £2,340

76.

c

[€52,500 – (€52,500 × 2/5)] = €31,500 [€31,500 × (1 – .30)] = €22,050

77.

a

$15,000 + $6,000 = $21,000 overstatement.

78.

c

$24,000 + $6,000 = $30,000 understatement.

79.

d

$7,500 (o) + $11,000 (o) + $6,000 (o) – $9,500 (u) = $15,000 (o).

80.

c

$11,000 (o) – $6,000 (u) – $9,500 (u) = $4,500 (u).

81.

c

$2,000 (o) + $11,000 (o) – $6,000 (u) – $9,500 (u) = $2,500 (u).

82.

a

2016 NI = $51,000 (u) + $24,000 (u) = $75,000 (u). 2016 RE = $24,000 (u) [The 2010 $51,000 (o) is offset by 2011 $51,000 (u)].

83.

a

$132,000 (u) + $156,000 (u) + $60,000 (u) + $28,800 (u) = $376,800 (u).

84.

b

$156,000 (u) + $84,000 (u) – $60,000 (o) + $60,000 (u) + $28,800 (u) = $268,800 (u).

85.

c

$156,000 (u) + $28,800 (u) = $184,800 (u).

86.

d

CE = $0, correction of error.

87.

c

$810,000 – 

88.

a

($750,000 – [($750,000 – $30,000) ÷ 9]) × (1 – .40) = $402,000.

89.

c

$750,000 – [($750,000 – $30,000) ÷ 9 × 2] = $590,000. $590,000 × (1 – .40) = $354,000.

 $810,000  $54,000    2  = $642,000 9   

DERIVATIONS — CPA Adapted No. Answer

Derivation

90.

b

Conceptual.

91.

c

$1,500,000 × (1 – .3) = $1,050,000.

92.

a

$800,000 × (1 – .3) = $560,000.

93.

a

$792,000 × 3/8 = $297,000 $297,000 + [($792,000 – $297,000 – $72,000) × 1/3] = $438,000.

Accounting Changes and Error Analysis

22 - 21

DERIVATIONS — CPA Adapted (cont.) No. Answer

Derivation

94.

b

$595,000 × 3/15 = $119,000 $595,000 – $119,000 – [($595,000 – $119,000) × 1/7] = $408,000.

95.

d

($120,000 – $108,000) + $156,000 + ($1,620,000 × .10) = $330,000.

96.

b

$500,000 ÷ 5 = $100,000.

97.

c

Conceptual.

98.

a

$54,000 (u) + $135,000 (u) – $45,000 (o) = $144,000 (u).

EXERCISES Ex. 22-99—Matching accounting changes to situations. The three types of accounting changes, including error correction, are: Code a. Change in accounting policy. b. Change in accounting estimate. c. Error correction. Instructions Following are a series of situations. You are to enter a code letter to the left to indicate the type of change. ______ 1.

Change due to understatement of inventory.

______ 2.

Change due to charging a new asset directly to an expense account.

______ 3.

Change from expensing to capitalizing certain costs, due to a change in periods benefited.

______ 4.

Change from FIFO to average-cost inventory procedures.

______ 5.

Change due to failure to recognize an accrued (uncollected) revenue.

______ 6.

Change in amortization period for an intangible asset.

______ 7.

Change in expected recovery of an account receivable.

______ 8.

Change in the loss rate on warranty costs.

______ 9.

Change due to failure to recognize and accrue income.

______ 10.

Change in residual value of a depreciable plant asset.

______ 11.

Change from an unacceptable to an acceptable accounting policy.

______ 12.

Change in both estimate and acceptable accounting policies.

______ 13.

Change due to failure to recognize a prepaid asset.

22 - 22 Test Bank for Intermediate Accounting, IFRS Edition, 2e Ex. 22-99 (cont.) ______ 14.

Change from straight-line to sum-of-the-years'-digits method of depreciation.

______ 15.

Change in life of a depreciable plant asset.

______ 16.

Change from one acceptable policy to another acceptable policy.

Solution 22-99 1. c 2. c 3. b

4. a 5. c 6. b

7. b 8. b 9. c

10. b 11. c 12. b

13. c 14. b 15. b

16. a

Ex. 22-100—How changes or corrections are recognized. For each of the following items, indicate the type of accounting change and how each is recognized in the accounting records in the current year. (a)

Change from straight-line method of depreciation to sum-of-the-years'-digits

(b)

Change from the cash basis to accrual basis of accounting

(c)

Change from cost-recovery to percentage-of-completion method on construction contracts.

(d)

Change due to failure to record depreciation in a previous period

(e)

Change in the realizability of certain receivables

(f)

Change from average cost to FIFO method for inventory valuation purposes

Solution 22-100 (a)

Change in accounting estimate; currently and prospectively.

(b)

Correction of an error; restatement of financial statements of all prior periods presented; adjustment of beginning retained earnings of the current period.

(c)

Change in accounting policy; retrospective restatement of all affected prior financial statements; adjustment of beginning retained earnings of the current period.

(d)

Correction of an error; restatement of financial statements of the period affected; prior period adjustment; adjustment of beginning retained earnings of the first period after the error.

(e)

Change in accounting estimate; currently and prospectively.

(f)

Change in accounting policy; retrospective restatement of all affected prior financial statements; adjustment of beginning retained earnings of the current period.

Accounting Changes and Error Analysis

22 - 23

Ex. 22-101—Matching disclosures to situations. In the blank to the left of each question, fill in the letter from the following list which best describes the presentation of the item on the financial statements of Helton Corporation for 2016. a. b. c. d.

Change in estimate Prior period adjustment (not due to change in principle) Retrospective type accounting change with note disclosure None of the above

_____

1.

In 2016, the company changed its method of recognizing income from the costrecovery method to the percentage-of-completion method.

_____

2.

At the end of 2016, an audit revealed that the corporation's allowance for doubtful accounts was too large and should be reduced to 2%. When the audit was made in 2015, the allowance seemed appropriate.

_____

3.

Depreciation on a truck, acquired in 2013, was understated because the useful life had been overestimated. The understatement had been made in order to show higher net income in 2014 and 2015.

_____

4.

The company switched from an average-cost to a FIFO inventory valuation method during the current year.

_____

5.

In the current year, the company decides to change from expensing certain costs to capitalizing these costs, due to a change in the period benefited.

_____

6.

During 2016, a long-term bond with a carrying value of $3,600,000 was retired at a cost of $4,100,000.

_____

7.

After negotiations with the taxing authority, income taxes for 2014 were established at $42,900. They were originally estimated to be $28,600.

_____

8.

In 2016, the company incurred interest expense of $29,000 on a 20-year bond issue.

_____

9.

In computing the depreciation in 2014 for equipment, an error was made which overstated income in that year $75,000. The error was discovered in 2016.

_____ 10.

In 2016, the company changed its method of depreciating plant assets from the double-declining balance method to the straight-line method.

Solution 22-101 1. 2.

c a

3. 4.

b c

5. 6.

a d

7. 8.

a d

9. 10.

b a

22 - 24 Test Bank for Intermediate Accounting, IFRS Edition, 2e Ex. 22-102—Change in accounting policy. In 2016, Fischer Corporation changed its method of inventory pricing from average cost to FIFO. Net income computed on an average cost as compared to a FIFO basis for the four years involved is: (Ignore income taxes.) AVERAGE FIFO 2013 $78,200 $83,700 2014 84,500 88,100 2015 87,000 91,400 2016 92,500 94,700 Instructions (a) Indicate the net income that would be shown on comparative financial statements issued at 12/31/16 for each of the four years, assuming that the company changed to the FIFO method in 2016. (b)

Assuming that the company switched from the FIFO to the average cost method, what would be the net income reported on comparative financial statements issued at 12/31/16 for 2013, 2014, 2015 and 2016?

Solution 22-102 (a)

2013, $83,700; 2014, $88,100; 2015, $91,400; 2016, $94,700, (Retrospective restatement).

(b)

2013, $78,200; 2014, $84,500; 2015, $87,000; 2016, $92,500, (Retrospective restatement).

Ex. 22-103—Change in estimate and correction of errors. Discuss the accounting procedures for and illustrate the following: (a) Change in estimate (b) Correction of an error Solution 22-103 (a)

Accounting estimates will change as new events occur, as more experience is acquired, or new information is obtained. Examples of changes in estimate are: (a) collectability of receivables, (b) inventory obsolescence, (c) estimated lives or residual values, and (d) warranty costs. Changes in estimates are handled prospectively; that is, in current and future periods. No restatement of previous financial statements is made.

(b)

Examples of accounting errors are: (a) a change from an accounting policy that is not generally accepted to an accounting policy that is acceptable, (b) mathematical mistakes, (c) changes in estimates that occur because the estimates are not made in good faith, (d) an oversight, (e) a misuse of facts, and (f) misclassification of an expense as an asset or vice versa. Corrections of errors are recorded in the year discovered, are treated as prior period adjustments, and the beginning balance of retained earnings is adjusted. Prior financial statements are restated.

Accounting Changes and Error Analysis

22 - 25

Ex. 22-104—Changes in depreciation methods, estimates. On January 1, 2011, Powell Company purchased a building and machinery that have the following useful lives, residual value, and costs. Building, 25-year estimated useful life, $4,000,000 cost, $400,000 residual value Machinery, 10-year estimated useful life, $500,000 cost, no residual value The building has been depreciated under the straight-line method through 2015. In 2016, the company decided to switch to the double-declining balance method of depreciation for the building. Powell also decided to change the total useful life of the machinery to 8 years, with a residual value of $25,000 at the end of that time. The machinery is depreciated using the straightline method. Instructions (a) Prepare the journal entry necessary to record the depreciation expense on the building in 2016. (b) Compute depreciation expense on the machinery for 2016.

Solution 22-104 Computation of 2016 depreciation expense on the building: Cost of building Less: Accumulated depreciation [($4,000,000 – $400,000) ÷ 25] × 5 years Book value, 1/1/16

$4,000,000 720,000 $3,280,000

2016 Depreciation expense: $3,280,000 × 10% = $328,000 Depreciation Expense..................................................................... Accumulated Depreciation—Building...................................... Computation of 2016 depreciation expense on machinery: Cost of machinery Less: Accumulated depreciation [($500,000 – $0) ÷ 10] × 5 years Book value, 1/1/16

328,000 328,000 $500,000 250,000 $250,000

2016 Depreciation expense: ($250,000 – $25,000) ÷ (8 – 5) = $225,000 ÷ 3 = $75,000

Ex. 22-105—Non-counterbalancing error. Quigley Co. bought a machine on January 1, 2014 for $875,000. It had a $75,000 estimated residual value and a ten-year life. An expense account was debited on the purchase date. Quigley uses straight-line depreciation. This was discovered in 2016. Instructions Prepare the entry or entries related to the machine for 2016.

22 - 26 Test Bank for Intermediate Accounting, IFRS Edition, 2e Solution 22-105 Machinery............................................................................................. Retained Earnings..................................................................... Accumulated Depreciation-Machinery (2 × $80,000).................

875,000

Depreciation Expense........................................................................... Accumulated Depreciation-Machinery.......................................

80,000

715,000 160,000 80,000

Ex. 22-106—Effects of errors. Show how the following independent errors will affect net income on the Income Statement and the stockholders' equity section of the Statement of Financial Position (SFP) using the symbol + (plus) for overstated, – (minus) for understated, and 0 (zero) for no effect. 2015 2016 Income Income Statement SFP Statement SFP 1. Ending inventory in 2015 overstated. 2. Failed to accrue 2015 interest revenue. 3. A capital expenditure for factory equipment (useful life, 5 years) was erroneously charged to maintenance expense in 2015.

4. Failed to count office supplies on hand at 12/31/15. Cash expenditures have been charged to an office supplies expense account during the year 2015. 5. Failed to accrue 2015 wages. 6. Ending inventory in 2015 understated. 7. Overstated 2015 depreciation expense; 2014 expense correct.

22 - 27

Accounting Changes and Error Analysis Solution 22-106 2015 Income Statement 1. Ending inventory in 2015 overstated. 2. Failed to accrue 2015 interest revenue. 3. A capital expenditure for factory equipment (useful life, 5 years) was erroneously charged to maintenance expense in 2015. 4. Failed to count office supplies on hand at 12/31/15. Cash expenditures have been charged to Supplies Expense during the year 2015. 5. Failed to accrue 2015 wages. 6. Ending inventory in 2015 understated. 7. Overstated 2015 depreciation expense; 2016 expense correct.

SFP

2016 Income Statement

SFP

+

+

–

0

–

–

+

0

–

–

+

–

–

–

+

0

+

+

–

0

–

–

+

0

–

–

0

–

Ex. 22-107—Effects of errors. Joseph Co. began operations on January 1, 2015. Financial statements for 2015 and 2016 contained the following errors: Dec. 31, 2015 Dec. 31, 2016 Ending inventory $90,000 too high $114,000 too high Depreciation expense 48,000 too low — Accumulated depreciation 48,000 too low 48,000 too low Insurance expense 42,000 too high 42,000 too low Prepaid insurance 36,000 too low In addition, on December 26, 2016 fully depreciated equipment was sold for $58,000, but the sale was not recorded until 2017. No corrections have been made for any of the errors. Instructions Ignoring income taxes, show your calculation of the total effect of the errors on 2016 net income.

22 - 28 Test Bank for Intermediate Accounting, IFRS Edition, 2e Solution 22-107 2015 ending inventory 2016 ending inventory Insurance expense Unrecorded gain Overstatement of 2016 income

$ (90,000) 114,000 42,000 (58,000) $ 8,000

Note: The error in depreciation expense has no effect on 2016 income. The error in prepaid insurance is related to the error in insurance expense.

PROBLEMS Pr. 22-108—Accounting for changes and error corrections. Dyke Company's net incomes for the past three years are presented below: 2016 2015 2014 $480,000 $450,000 $360,000 During the 2016 year-end audit, the following items come to your attention: 1. Dyke bought a truck on January 1, 2013 for $196,000 with a $16,000 estimated residual value and a six-year life. The company debited an expense account and credited cash on the purchase date for the entire cost of the asset. (Straight-line method) 2. During 2016, Dyke changed from the straight-line method of depreciating its cement plant to the double-declining balance method. The following computations present depreciation on both bases: 2016 2015 2014 Straight-line 36,000 36,000 36,000 Double-declining 46,080 57,600 72,000 The net income for 2016 was computed using the double-declining balance method, on the January 1, 2016 book value, over the useful life remaining at that time. The depreciation recorded in 2016 was $72,000. 3. Dyke, in reviewing its provision for uncollectibles during 2016, has determined that 1% is the appropriate amount of bad debt expense to be charged to operations. The company had used 1/2 of 1% as its rate in 2015 and 2016 when the expense had been $18,000 and $12,000, respectively. The company recorded bad debt expense under the new rate for 2016. The company would have recorded $6,000 less of bad debt expense on December 31, 2016 under the old rate. Instructions (a) Prepare in general journal form the entry necessary to correct the books for the transaction in part 1 of this problem, assuming that the books have not been closed for the current year. (b)

Compute the net income to be reported each year 2014 through 2016.

Accounting Changes and Error Analysis

22 - 29

Pr. 22-108 (cont.) (c)

Assume that the beginning retained earnings balance (unadjusted) for 2014 was $1,260,000. At what adjusted amount should this beginning retained earnings balance for 2014 be stated, assuming that comparative financial statements were prepared?

(d)

Assume that the beginning retained earnings balance (unadjusted) for 2016 is $1,800,000 and that non-comparative financial statements are prepared. At what adjusted amount should this beginning retained earnings balance be stated?

Solution 22-108 (a)

Equipment.................................................................................... Depreciation Expense.................................................................. Accumulated Depreciation-Equipment (4 years, 09-12).... Retained Earnings............................................................

(b)

2014: $360,000 – $30,000 = $330,000. 2015: $450,000 – $30,000 = $420,000. 2016: $480,000 – $30,000 = $450,000.

(c)

Retained earnings (unadjusted) Correction of 2013 error ($196,000 – $30,000) Retained earnings (adjusted)

$1,260,000 166,000 $1,426,000

(d)

Retained earnings (unadjusted) Correction of error ($196,000 – $90,000) Retained earnings (adjusted)

$1,800,000 106,000 $1,906,000

196,000 30,000 120,000 106,000

Pr. 22-109—Correction of errors. Vance Company reported net incomes for a three-year period as follows: 2014, $186,000; 2015, $189,000; 2016, $180,000. In reviewing the accounts in 2017 after the books for the prior year have been closed, you find that the following errors have been made in summarizing activities: 2014 2015 2016 Overstatement of ending inventory $42,000 $51,000 $24,000 Understatement of accrued advertising expense 6,600 12,000 7,200 Instructions (a) Determine corrected net incomes for 2014, 2015, and 2016. (b)

Give the entry to bring the books of the company up to date in 2017, assuming that the books have been closed for 2016.

22 - 30 Test Bank for Intermediate Accounting, IFRS Edition, 2e Solution 22-109 (a)

2014 Net income (unadjusted) $186,000 Overstatement of ending inventory—2014 (42,000) Overstatement of ending inventory—2015 Overstatement of ending inventory—2016 Understatement of accrued advertising expense—2014 (6,600) Understatement of accrued advertising expense—2015 Understatement of accrued advertising expense—2016 Net income (corrected) $137,400

(b) Retained Earnings......................................................................... Advertising Expense............................................................ Inventory..............................................................................

2015 2016 $189,000 $180,000 42,000 (51,000) 51,000 (24,000) 6,600 (12,000) 12,000 (7,200) $174,600 $211,800 31,200 7,200 24,000

Pr. 22-110—Error corrections and adjustments. The controller for Haley Corporation is concerned about certain business transactions that the company experienced during 2016. The controller, after discussing these matters with various individuals, has come to you for advice. The transactions at issue are presented below. 1. The company has decided to switch from the direct write-off method in accounting for bad debt expense to the percentage-of-sales approach. Assume that Haley Corporation has recognized bad debt expense as the receivables have actually become uncollectible in the following way: 2015 2016 From 2015 sales 31,800 12,000 From 2016 sales 45,000 The controller estimates that an additional $65,400 will be charged off in 2017: $11,400 applicable to 2015 sales and $54,000 to 2016 sales. 2. Inventory has been shipped on consignment. These transactions have been recorded as ordinary sales and billed as such on account. At December 31, 2016, inventory billed and in the hands of consignees amounted to $400,000. The percentage markup on selling price is 20%. Assume that consigned inventory is sold the following year. The company uses the perpetual inventory system. Instructions (a) Assume that Haley Corporation reported net income of $1,000,000 for 2016. Present a schedule showing the corrected net income after reviewing the above transactions. (b)

Prepare the journal entries necessary at December 31, 2016, assuming that the books have been closed.

Accounting Changes and Error Analysis

22 - 31

Solution 22-110 (a)

Reported net income 1. Additional charge for bad debts 2015 debts written off in 2016 2016 debts to be written off in 2017

$1,000,000 $ 12,000 (54,000)

2. Consignment—(20% × $400,000)

(80,000)

Corrected net income (b)

(42,000)

$878,000

1. Retained Earnings.................................................................. Allowance for Doubtful Accounts.................................

65,400

2. Inventory on Consignment...................................................... Retained Earnings.................................................................. Accounts Receivable...................................................

320,000 80,000

65,400

400,000