Chapter 22 Accounting Changes and Error Analysis

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Chapter 22 Accounting Changes and Error Analysis

QUESTIONS

1. In recent years, the Wall Street Journal has indicated that many companies have changed their accounting principles. What are the major reasons why companies change accounting methods?
2.
State how each of the following items is reflected in the financial statements. (a) Change from FIFO to LIFO method for inventory valuation purposes. (b) Charge for failure to record depreciation in a previous period. (c) Litigation won in current year, related to prior period. (d) Change in the realizability of certain receivables. (e) Write-off of receivables. (f) Change from the percentage-of-completion to the completed-contract method for reporting net income.
3.
Discuss briefly the three approaches that have been suggested for reporting changes in accounting principles.
4.
Identify and describe the approach the FASB requires for reporting changes in accounting principles.
5.
What is the indirect effect of a change in accounting principle? Briefly describe the reporting of the indirect effects of a change in accounting principle.
6.
Define a change in estimate and provide an illustration. When is a change in accounting estimate effected by a change in accounting principle?
7.
Lenexa State Bank has followed the practice of capitalizing certain marketing costs and amortizing these costs over their expected life. In the current year, the bank determined that the future benefits from these costs were doubtful. Consequently, the bank adopted the policy of expensing these costs as incurred. How should the bank report this accounting change in the comparative financial statements?
8.
Indicate how the following items are recorded in the accounting records in the current year of Coronet Co. (a) Impairment of goodwill. (b) A change in depreciating plant assets from accelerated to the straight-line method. (c) Large write-off of inventories because of obsolescence. (d) Change from the cash basis to accrual basis of accounting. (e) Change from LIFO to FIFO method for inventory valuation purposes. (f) Change in the estimate of service lives for plant assets.
9.
Whittier Construction Co. had followed the practice of expensing all materials assigned to a construction job without recognizing any salvage inventory. On December 31, 2012, it was determined that salvage inventory should be valued at $52,000. Of this amount, $29,000 arose during the current year. How does this information affect the financial statements to be prepared at the end of 2012?
10.
Parsons Inc. wishes to change from the completed-contract to the percentage-of-completion method for financial reporting purposes. The auditor indicates that a change would be permitted only if it is to a preferable method. What difficulties develop in assessing preferability?
11.
Discuss how a change to the LIFO method of inventory valuation is handled when it is impracticable to determine previous LIFO inventory amounts.
12.
How should consolidated financial statements be reported this year when statements of individual companies were presented last year?
13.
Simms Corp. controlled four domestic subsidiaries and one foreign subsidiary. Prior to the current year, Simms Corp. had excluded the foreign subsidiary from consolidation. During the current year, the foreign subsidiary was included in the financial statements. How should this change in accounting entity be reflected in the financial statements?
14.
Distinguish between counterbalancing and noncounterbalancing errors. Give an example of each.
15.
Discuss and illustrate how a correction of an error in previously issued financial statements should be handled.
16.
Prior to 2012, Heberling Inc. excluded manufacturing overhead costs from work in process and finished goods inventory. These costs have been expensed as incurred. In 2012, the company decided to change its accounting methods for manufacturing inventories to full costing by including these costs as product costs. Assuming that these costs are material, how should this change be reflected in the financial statements for 2011 and 2012?
17.
Elliott Corp. failed to record accrued salaries for 2011, $2,000; 2012, $2,100; and 2013, $3,900. What is the amount of the overstatement or understatement of Retained Earnings at December 31, 2014?
18.
In January 2012, installation costs of $6,000 on new machinery were charged to Maintenance and Repairs Expense. Other costs of this machinery of $30,000 were correctly recorded and have been depreciated using the straightline method with an estimated life of 10 years and no salvage value. At December 31, 2013, it is decided that the machinery has a remaining useful life of 20 years, starting with January 1, 2013. What entry(ies) should be made in 2013 to correctly record transactions related to machinery, assuming the machinery has no salvage value? The books have not been closed for 2013 and depreciation expense has not yet been recorded for 2013.
19.
On January 2, 2012, $100,000 of 11%, 10-year bonds were issued for $97,000. The $3,000 discount was charged to Interest Expense. The bookkeeper, Mark Landis, records interest only on the interest payment dates of January 1 and July 1. What is the effect on reported net income for 2012 of this error, assuming straight-line amortization of the discount? What entry is necessary to correct for this error, assuming that the books are not closed for 2012?
20.
An entry to record Purchases and related Accounts Payable of $13,000 for merchandise purchased on December 23, 2013, was recorded in January 2014. This merchandise was not included in inventory at December 31, 2013. What effect does this error have on reported net income for 2013? What entry should be made to correct for this error, assuming that the books are not closed for 2013?
21.
Equipment was purchased on January 2, 2012, for $24,000, but no portion of the cost has been charged to depreciation. The corporation wishes to use the straight-line method for these assets, which have been estimated to have a life of 10 years and no salvage value. What effect does this error have on net income in 2012? What entry is necessary to correct for this error, assuming that the books are not closed for 2012? BRI E F EXERCI S E S
BE22-1
Wertz Construction Company decided at the beginning of 2012 to change from the completedcontract method to the percentage-of-completion method for financial reporting purposes. The company will continue to use the completed-contract method for tax purposes. For years prior to 2012, pretax income under the two methods was as follows: percentage-of-completion $120,000, and completedcontract $80,000. The tax rate is 35%. Prepare Wertz’s 2012 journal entry to record the change in accounting principle.
BE22-2
Refer to the accounting change by Wertz Construction Company in
BE22-1. Wertz has a profitsharing plan, which pays all employees a bonus at year-end based on 1% of pretax income. Compute the indirect effect of Wertz’s change in accounting principle that will be reported in the 2012 income statement, assuming that the profit-sharing contract explicitly requires adjustment for changes in income numbers.

BE22-3
Shannon, Inc., changed from the LIFO cost flow assumption to the FIFO cost flow assumption in 2012. The increase in the prior year’s income before taxes is $1,200,000. The tax rate is 40%. Prepare Shannon’s 2012 journal entry to record the change in accounting principle.
BE22-4
Tedesco Company changed depreciation methods in 2012 from double-declining-balance to straight-line. Depreciation prior to 2012 under double-declining-balance was $90,000, whereas straight-line depreciation prior to 2012 would have been $50,000. Tedesco’s depreciable assets had a cost of $250,000 with a $40,000 salvage value, and an 8-year remaining useful life at the beginning of 2012. Prepare the 2012 journal entries, if any, related to Tedesco’s depreciable assets.
BE22-5
Sesame Company purchased a computer system for $74,000 on January 1, 2011. It was depreciated based on a 7-year life and an $18,000 salvage value. On January 1, 2013, Sesame revised these estimates to a total useful life of 4 years and a salvage value of $10,000. Prepare Sesame’s entry to record 2013 depreciation expense.
BE22-6
In 2012, Bailey Corporation discovered that equipment purchased on January 1, 2010, for $50,000 was expensed at that time. The equipment should have been depreciated over 5 years, with no salvage value. The effective tax rate is 30%. Prepare Bailey’s 2012 journal entry to correct the error.
BE22-7
At January 1, 2012, Beidler Company reported retained earnings of $2,000,000. In 2012, Beidler discovered that 2011 depreciation expense was understated by $400,000. In 2012, net income was $900,000 and dividends declared were $250,000. The tax rate is 40%. Prepare a 2012 retained earnings statement for Beidler Company.
BE22-8
Indicate the effect—Understate, Overstate, No Effect—that each of the following errors has on 2012 net income and 2013 net income. 2012 2013 (a) Equipment purchased in 2010 was expensed. (b) Wages payable were not recorded at 12/31/12. (c) Equipment purchased in 2012 was expensed. (d) 2012 ending inventory was overstated. (e) Patent amortization was not recorded in 2013.
BE22-9
Roundtree Manufacturing Co. is preparing its year-end financial statements and is considering the accounting for the following items. 1. The vice president of sales had indicated that one product line has lost its customer appeal and will be phased out over the next 3 years. Therefore, a decision has been made to lower the estimated lives on related production equipment from the remaining 5 years to 3 years. 2. The Hightone Building was converted from a sales office to offices for the Accounting Department at the beginning of this year. Therefore, the expense related to this building will now appear as an administrative expense rather than a selling expense on the current year’s income statement. 3. Estimating the lives of new products in the Leisure Products Division has become very difficult because of the highly competitive conditions in this market. Therefore, the practice of deferring and amortizing preproduction costs has been abandoned in favor of expensing such costs as they are incurred. Identify and explain whether each of the above items is a change in principle, a change in estimate, or an error.
BE22-10
Palmer Co. is evaluating the appropriate accounting for the following items. 1. Management has decided to switch from the FIFO inventory valuation method to the LIFO inventory valuation method for all inventories. 2. When the year-end physical inventory adjustment was made for the current year, the controller discovered that the prior year’s physical inventory sheets for an entire warehouse were mislaid and excluded from last year’s count. 3. Palmer’s Custom Division manufactures large-scale, custom-designed machinery on a contract basis. Management decided to switch from the completed-contract method to the percentageof- completion method of accounting for long-term contracts. Identify and explain whether each of the above items is a change in accounting principle, a change in estimate, or an error. *B E22-11 Simmons Corporation owns stock of Armstrong, Inc. Prior to 2012, the investment was accounted for using the equity method. In early 2012, Simmons sold part of its investment in Armstrong, and began using the fair value method. In 2012, Armstrong earned net income of $80,000 and paid dividends of $95,000. Prepare Simmons’s entries related to Armstrong’s net income and dividends, assuming Simmons now owns 10% of Armstrong’s stock. *B E22-12 Oliver Corporation has owned stock of Conrad Corporation since 2009. At December 31, 2012, its balances related to this investment were: Equity Investments $185,000 Fair Value Adjustment (AFS) 34,000 Dr. Unrealized Holding Gain or Loss—Equity 34,000 Cr. On January 1, 2013, Oliver purchased additional stock of Conrad Company for $475,000 and now has significant influence over Conrad. If the equity method had been used in 2009–2012, Oliver’s share of income would have been $33,000 greater than dividends received. Prepare Oliver’s journal entries to record the purchase of the investment and the change to the equity method. EXERCI S E S
E22-1 (Change in Principle—Long-Term Contracts)
Cherokee Construction Company began operations in 2011 and changed from the completed-contract to the percentage-of-completion method of accounting for long-term construction contracts during 2012. For tax purposes, the company employs the completedcontract method and will continue this approach in the future. (Hint: Adjust all tax consequences through the Deferred Tax Liability account.) The appropriate information related to this change is as follows. Pretax Income from Percentage-of-Completion Completed-Contract Difference 2011 $780,000 $610,000 $170,000 2012 700,000 480,000 220,000
Instructions
(a) Assuming that the tax rate is 35%, what is the amount of net income that would be reported in 2012? (b) What entry(ies) are necessary to adjust the accounting records for the change in accounting principle?
E22-2 (Change in Principle—Inventory Methods)
Whitman Company began operations on January 1, 2010, and uses the average cost method of pricing inventory. Management is contemplating a change in inventory methods for 2013. The following information is available for the years 2010–2012. Net Income Computed Using Average Cost Method FIFO Method LIFO Method 2010 $16,000 $19,000 $12,000 2011 18,000 21,000 14,000 2012 20,000 25,000 17,000
Instructions
(Ignore all tax effects.) (a) Prepare the journal entry necessary to record a change from the average cost method to the FIFO method in 2013. 3 3 3 7 10 10 (b) Determine net income to be reported for 2010, 2011, and 2012, after giving effect to the change in accounting principle. (c) Assume Whitman Company used the LIFO method instead of the average cost method during the years 2010–2012. In 2013, Whitman changed to the FIFO method. Prepare the journal entry necessary to record the change in principle.
E22-3 (Accounting Change)
Ramirez Co. decides at the beginning of 2012 to adopt the FIFO method of inventory valuation. Ramirez had used the LIFO method for financial reporting since its inception on January 1, 2010, and had maintained records adequate to apply the FIFO method retrospectively. Ramirez concluded that FIFO is the preferable inventory method because it reflects the current cost of inventory on the balance sheet. The table presents the effects of the change in accounting principle on inventory and cost of goods sold. Inventory Determined by Cost of Goods Sold Determined by Date LIFO Method FIFO Method LIFO Method FIFO Method January 1, 2010 $ 0 $ 0 $ 0 $ 0 December 31, 2010 100 80 800 820 December 31, 2011 200 240 1,000 940 December 31, 2012 320 390 1,130 1,100 Retained earnings reported under LIFO are as follows. Retained Earnings Balance December 31, 2010 $2,200 December 31, 2011 4,200 December 31, 2012 6,070 Other information: 1. For each year presented, sales are $4,000 and operating expenses are $1,000. 2. Ramirez provides two years of financial statements. Earnings per share information is not required.
Instructions
(a) Prepare income statements under LIFO and FIFO for 2010, 2011, and 2012. (b) Prepare income statements reflecting the retrospective application of the accounting change from the LIFO method to the FIFO method for 2012 and 2011. (c) Prepare the note to the financial statements describing the change in method of inventory valuation. In the note, indicate the income statement line items for 2012 and 2011 that were affected by the change in accounting principle. (d) Prepare comparative retained earnings statements for 2011 and 2012 under FIFO.
E22-4 (Accounting Change)
Linden Company started operations on January 1, 2008, and has used the FIFO method of inventory valuation since its inception. In 2014, it decides to switch to the average cost method. You are provided with the following information. Net Income Retained Earnings (Ending Balance) Under FIFO Under Average Cost Under FIFO 2008 $100,000 $ 92,000 $100,000 2009 70,000 65,000 160,000 2010 90,000 80,000 235,000 2011 120,000 130,000 340,000 2012 300,000 293,000 590,000 2013 305,000 310,000 780,000
Instructions
(a) What is the beginning retained earnings balance at January 1, 2010, if Linden prepares comparative financial statements starting in 2010? (b) What is the beginning retained earnings balance at January 1, 2013, if Linden prepares comparative financial statements starting in 2013? (c) What is the beginning retained earnings balance at January 1, 2014, if Linden prepares single-period financial statements for 2014? (d) What is the net income reported by Linden in the 2013 income statement if it prepares comparative financial statements starting with 2011?
E22-5 (Accounting Change)
Presented on page 1410 are income statements prepared on a LIFO and FIFO basis for Carlton Company, which started operations on January 1, 2011. The company presently uses the LIFO method of pricing its inventory and has decided to switch to the FIFO method in 2012. The FIFO 3 income statement is computed in accordance with GAAP requirements. Carlton’s profit-sharing agreement with its employees indicates that the company will pay employees 5% of income before profit sharing. Income taxes are ignored. LIFO Basis FIFO Basis 2012 2011 2012 2011 Sales $3,000 $3,000 $3,000 $3,000 Cost of goods sold 1,130 1,000 1,100 940 Operating expenses 1,000 1,000 1,000 1,000 Income before profi t sharing 870 1,000 900 1,060 Profi t sharing expense 44 50 45 53 Net income $ 826 $ 950 $ 855 $1,007
Instructions
Answer the following questions. (a) If comparative income statements are prepared, what net income should Carlton report in 2011 and 2012? (b) Explain why, under the FIFO basis, Carlton reports $50 in 2011 and $48 in 2012 for its profit-sharing expense. (c) Assume that Carlton has a beginning balance of retained earnings at January 1, 2012, of $8,000 using the LIFO method. The company declared and paid dividends of $2,500 in 2012. Prepare the retained earnings statement for 2012, assuming that Carlton has switched to the FIFO method.
E22-6 (Accounting Changes—Depreciation)
Robillard Inc. acquired the following assets in January of 2009. Equipment, estimated service life, 5 years; salvage value, $15,000 $465,000 Building, estimated service life, 30 years; no salvage value $780,000 The equipment has been depreciated using the sum-of-the-years’-digits method for the first 3 years for financial reporting purposes. In 2012, the company decided to change the method of computing depreciation to the straight-line method for the equipment, but no change was made in the estimated service life or salvage value. It was also decided to change the total estimated service life of the building from 30 years to 40 years, with no change in the estimated salvage value. The building is depreciated on the straight-line method.
Instructions
(a) Prepare the journal entry to record depreciation expense for the equipment in 2012. (b) Prepare the journal entry to record depreciation expense for the building in 2012. (Round to nearest dollar.)
E22-7 (Change in Estimate and Error; Financial Statements)
Presented below are the comparative income statements for Pannebecker Inc. for the years 2011 and 2012. 2012 2011 Sales $340,000 $270,000 Cost of sales 200,000 142,000 Gross profi t 140,000 128,000 Expenses 88,000 50,000 Net income $ 52,000 $ 78,000 Retained earnings (Jan. 1) $125,000 $ 72,000 Net income 52,000 78,000 Dividends (30,000) (25,000) Retained earnings (Dec. 31) $147,000 $125,000 The following additional information is provided. 1. In 2012, Pannebecker Inc. decided to switch its depreciation method from sum-of-the-years’-digits to the straight-line method. The assets were purchased at the beginning of 2011 for $90,000 with an estimated useful life of 4 years and no salvage value. (The 2012 income statement contains depreciation expense of $27,000 on the assets purchased at the beginning of 2011.) 2. In 2012, the company discovered that the ending inventory for 2011 was overstated by $20,000; ending inventory for 2012 is correctly stated.
Instructions
Prepare the revised retained earnings statement for 2011 and 2012, assuming comparative statements. (Ignore income taxes.) 5 5 7
E22-8 (Accounting for Accounting Changes and Errors)
Listed below are various types of accounting changes and errors. ______ 1. Change from FIFO to average cost inventory method. ______ 2. Change due to overstatement of inventory. ______ 3. Change from sum-of-the-years’-digits to straight-line method of depreciation. ______ 4. Change from presenting unconsolidated to consolidated fi nancial statements. ______ 5. Change from LIFO to FIFO inventory method. ______ 6. Change in the rate used to compute warranty costs. ______ 7. Change from an unacceptable accounting principle to an acceptable accounting principle. ______ 8. Change in a patent’s amortization period. ______ 9. Change from completed-contract to percentage-of-completion method on construction contracts. ______ 10. Change in a plant asset’s salvage value.
Instructions
For each change or error, indicate how it would be accounted for using the following code letters: (a) Accounted for prospectively. (b) Accounted for retrospectively. (c) Neither of the above.
E22-9 (Error and Change in Estimate—Depreciation)
Tarkington Co. purchased a machine on January 1, 2009, for $440,000. At that time it was estimated that the machine would have a 10-year life and no salvage value. On December 31, 2012, the firm’s accountant found that the entry for depreciation expense had been omitted in 2010. In addition, management has informed the accountant that the company plans to switch to straight-line depreciation, starting with the year 2012. At present, the company uses the sum-of-theyears’- digits method for depreciating equipment.
Instructions
Prepare the general journal entries that should be made at December 31, 2012, to record these events. (Ignore tax effects.)
E22-10 (Depreciation Changes)
On January 1, 2008, McElroy Company purchased a building and equipment that have the following useful lives, salvage values, and costs. Building, 40-year estimated useful life, $50,000 salvage value, $1,200,000 cost Equipment, 12-year estimated useful life, $10,000 salvage value, $130,000 cost The building has been depreciated under the double-declining-balance method through 2011. In 2012, the company decided to switch to the straight-line method of depreciation. McElroy also decided to change the total useful life of the equipment to 9 years, with a salvage value of $5,000 at the end of that time. The equipment is depreciated using the straight-line method.
Instructions
(a) Prepare the journal entry(ies) necessary to record the depreciation expense on the building in 2012. (b) Compute depreciation expense on the equipment for 2012.
E22-11 (Change in Estimate—Depreciation)
Thurber Co. purchased equipment for $710,000 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 2013, it is determined that the total estimated life should be 15 years with a salvage value of $4,000 at the end of that time.
Instructions
(a) Prepare the entry (if any) to correct the prior years’ depreciation. (b) Prepare the entry to record depreciation for 2013.
E22-12 (Change in Estimate—Depreciation)
Frederick Industries changed from the double-decliningbalance to the straight-line method in 2012 on all its plant assets. There was no change in the assets’ salvage values or useful lives. Plant assets, acquired on January 2, 2011, had an original cost of $2,400,000, with a $100,000 salvage value and an 8-year estimated useful life. Income before depreciation expense was $370,000 in 2009 and $300,000 in 2012.
Instructions
(a) Prepare the journal entry(ies) to record the change in depreciation method in 2012. (b) Starting with income before depreciation expense, prepare the remaining portion of the income statement for 2011 and 2012.
E22-13 (Change in Principle—Long-Term Contracts)
Bryant Construction Company began operations in 2011 and changed from the completed-contract to the percentage-of-completion method of accounting for long-term construction contracts during 2012. For tax purposes, the company employs the completedcontract method and will continue this approach in the future. The appropriate information related to this change is as follows. Pretax Income from Percentage-of-Completion Completed-Contract Difference 2011 $980,000 $730,000 $250,000 2012 900,000 480,000 420,000
Instructions
(a) Assuming that the tax rate is 40%, what is the amount of net income that would be reported in 2012? (b) What entry(ies) are necessary to adjust the accounting records for the change in accounting principle?
E22-14 (Various Changes in Principle—Inventory Methods)
Below is the net income of Benchley Instrument Co., a private corporation, computed under the three inventory methods using a periodic system. FIFO Average Cost LIFO 2010 $26,000 $23,000 $20,000 2011 30,000 25,000 21,000 2012 29,000 27,000 24,000 2013 34,000 30,000 26,000
Instructions
(Ignore tax considerations.) (a) Assume that in 2013 Benchley decided to change from the FIFO method to the average cost method of pricing inventories. Prepare the journal entry necessary for the change that took place during 2013, and show net income reported for 2010, 2011, 2012, and 2013. (b) Assume that in 2013 Benchley, which had been using the LIFO method since incorporation in 2010, changed to the FIFO method of pricing inventories. Prepare the journal entry necessary to record the change in 2013 and show net income reported for 2010, 2011, 2012, and 2013.
E22-15 (Error Correction Entries)
The first audit of the books of Fenimore Company was made for the year ended December 31, 2012. In examining the books, the auditor found that certain items had been overlooked or incorrectly handled in the last 3 years. These items are: 1. At the beginning of 2010, the company purchased a machine for $510,000 (salvage value of $51,000) that had a useful life of 5 years. The bookkeeper used straight-line depreciation, but failed to deduct the salvage value in computing the depreciation base for the 3 years. 2. At the end of 2011, the company failed to accrue sales salaries of $45,000. 3. A tax lawsuit that involved the year 2010 was settled late in 2012. It was determined that the company owed an additional $85,000 in taxes related to 2010. The company did not record a liability in 2010 or 2011 because the possibility of loss was considered remote, and debited the $85,000 to a loss account in 2012 and credited Cash for the same amount. 4. Fenimore Company purchased a copyright from another company early in 2010 for $50,000. Fenimore has not amortized the copyright because management believes that its value had not diminished. The copyright has a useful life at purchase of 20 years. 5. In 2012, the company wrote off $87,000 of inventory considered to be obsolete; this loss was charged directly to Retained Earnings and credited to Inventory.
Instructions
Prepare the journal entries necessary in 2012 to correct the books, assuming that the books have not been closed. Disregard effects of corrections on income tax.
E22-16 (Error Analysis and Correcting Entry)
You have been engaged to review the financial statements of Longfellow Corporation. In the course of your examination, you conclude that the bookkeeper hired during the current year is not doing a good job. You notice a number of irregularities as follows. 1. Year-end wages payable of $3,400 were not recorded because the bookkeeper thought that “they were immaterial.” 2. Accrued vacation pay for the year of $31,100 was not recorded because the bookkeeper “never heard that you had to do it.” 3. Insurance for a 12-month period purchased on November 1 of this year was charged to insurance expense in the amount of $3,300 because “the amount of the check is about the same every year.” 3 3 7 7 4. Reported sales revenue for the year is $1,908,000. This includes all sales taxes collected for the year. The sales tax rate is 6%. Because the sales tax is forwarded to the state’s Department of Revenue, the Sales Tax Expense account is debited. The bookkeeper thought that “the sales tax is a selling expense.” At the end of the current year, the balance in the Sales Tax Expense account is $103,400.
Instructions
Prepare the necessary correcting entries, assuming that Longfellow uses a calendar-year basis.
E22-17 (Error Analysis and Correcting Entry)
The reported net incomes for the first 2 years of Sinclair Products, Inc., were as follows: 2012, $147,000; 2013, $185,000. Early in 2014, the following errors were discovered. 1. Depreciation of equipment for 2012 was overstated $19,000. 2. Depreciation of equipment for 2013 was understated $38,500. 3. December 31, 2012, inventory was understated $50,000. 4. December 31, 2013, inventory was overstated $14,200.
Instructions
Prepare the correcting entry necessary when these errors are discovered. Assume that the books for 2013 are closed. (Ignore income tax considerations.)
E22-18 (Error Analysis)
Emerson Tool Company’s December 31 year-end financial statements contained the following errors. December 31, 2011 December 31, 2012 Ending inventory $9,600 understated $7,100 overstated Depreciation expense $2,300 understated — An insurance premium of $60,000 was prepaid in 2011 covering the years 2011, 2012, and 2013. The entire amount was charged to expense in 2011. In addition, on December 31, 2012, fully depreciated machinery was sold for $15,000 cash, but the entry was not recorded until 2013. There were no other errors during 2011 or 2012, and no corrections have been made for any of the errors. (Ignore income tax considerations.)
Instructions
(a) Compute the total effect of the errors on 2012 net income. (b) Compute the total effect of the errors on the amount of Emerson’s working capital at December 31, 2012. (c) Compute the total effect of the errors on the balance of Emerson’s retained earnings at December 31, 2012.
E22-19 (Error Analysis and Correcting Entries)
A partial trial balance of Dickinson Corporation is as follows on December 31, 2012. Dr. Cr. Supplies $ 2,500 Salaries and Wages Payable $ 1,500 Interest Receivable 5,100 Prepaid Insurance 90,000 Unearned Rent –0– Interest Payable 15,000 Additional adjusting data: 1. A physical count of supplies on hand on December 31, 2012, totaled $1,100. 2. Through oversight, the Salaries and Wages Payable account was not changed during 2012. Accrued salaries and wages on December 31, 2012, amounted to $4,400. 3. The Interest Receivable account was also left unchanged during 2012. Accrued interest on investments amounts to $4,350 on December 31, 2012. 4. The unexpired portions of the insurance policies totaled $65,000 as of December 31, 2012. 5. $24,000 was received on January 1, 2012, for the rent of a building for both 2012 and 2013. The entire amount was credited to Rent Revenue. 6. Depreciation for the year was erroneously recorded as $5,000 rather than the correct figure of $50,000. 7. A further review of depreciation calculations of prior years revealed that depreciation of $7,200 was not recorded. It was decided that this oversight should be corrected by a prior period adjustment.
Instructions
(a) Assuming that the books have not been closed, what are the adjusting entries necessary at December 31, 2012? (Ignore income tax considerations.) (b) Assuming that the books have been closed, what are the adjusting entries necessary at December 31, 2012? (Ignore income tax considerations.)
E22-20 (Error Analysis)
The before-tax income for Fitzgerald Co. for 2012 was $101,000 and $77,400 for 2013. However, the accountant noted that the following errors had been made. 1. Sales for 2012 included amounts of $38,200 which had been received in cash during 2012, but for which the related products were delivered in 2013. Title did not pass to the purchaser until 2013. 2. The inventory on December 31, 2012, was understated by $8,640. 3. The bookkeeper in recording interest expense for both 2012 and 2013 on bonds payable made the following entry on an annual basis. Interest Expense 15,000 Cash 15,000 The bonds have a face value of $250,000 and pay a stated interest rate of 6%. They were issued at a discount of $10,000 on January 1, 2012, to yield an effective-interest rate of 7%. (Assume that the effective-interest method should be used.) 4. Ordinary repairs to equipment had been erroneously charged to the Equipment account during 2012 and 2013. Repairs in the amount of $8,000 in 2012 and $9,400 in 2013 were so charged. The company applies a rate of 10% to the balance in the Equipment account at the end of the year in its determination of depreciation charges.
Instructions
Prepare a schedule showing the determination of corrected income before taxes for 2012 and 2013.
E22-21 (Error Analysis)
When the records of Archibald Corporation were reviewed at the close of 2013, the errors listed below were discovered. For each item, indicate by a check mark in the appropriate column whether the error resulted in an overstatement, an understatement, or had no effect on net income for the years 2012 and 2013. 2012 2013 Over- Under- No Over- Under- No Item statement statement Effect statement statement Effect 1. Failure to refl ect supplies on hand on balance sheet at end of 2012. 2. Failure to record the correct amount of ending 2012 inventory. The amount was understated because of an error in calculation. 3. Failure to record merchandise purchased in 2012. Merchandise was also omitted from ending inventory in 2012 but was not yet sold. 4. Failure to record accrued interest on notes payable in 2012; that amount was recorded when paid in 2013. 5. Failure to record amortization of patent in 2013. 7 9 7 9 *E 22-22 (Change from Fair Value to Equity) On January 1, 2012, Sandburg Co. purchased 25,000 shares (a 10% interest) in Yevette Corp. for $1,400,000. At the time, the book value and the fair value of Yevette’s net identifiable assets were $13,000,000. On July 1, 2013, Sandburg paid $3,040,000 for 50,000 additional shares of Yevette common stock, which represented a 20% investment in Yevette. The fair value of Yevette’s identifiable assets net of liabilities was equal to their carrying amount of $14,200,000. As a result of this transaction, Sandburg owns 30% of Yevette and can exercise significant influence over Yevette’s operating and financial policies. Any excess of the cost over the fair value of the identifiable net assets is attributed to goodwill. Yevette reported the following net income and declared and paid the following dividends. Net Income Dividend per Share Year ended 12/31/12 $900,000 None Six months ended 6/30/13 500,000 None Six months ended 12/31/13 815,000 $1.40
Instructions
Determine the ending balance that Sandburg Co. should report as its investment in Yevette Corp. at the end of 2013. *E 22-23 (Change from Equity to Fair Value) Gamble Corp. was a 30% owner of Sabrina Company, holding 210,000 shares of Sabrina’s common stock on December 31, 2012. The investment account had the following entries. Investment in Sabrina 1/1/11 Cost $3,180,000 12/6/11 Dividend received $150,000 12/31/11 Share of income 390,000 12/5/12 Dividend received 200,000 12/31/12 Share of income 510,000 On January 2, 2013, Gamble sold 126,000 shares of Sabrina for $3,440,000, thereby losing its significant influence. During the year 2013, Sabrina experienced the following results of operations and paid the following dividends to Gamble. Sabrina Dividends Paid Income (Loss) to Gamble 2013 $350,000 $50,400 At December 31, 2013, the fair value of Sabrina shares held by Gamble is $1,570,000. This is the first reporting date since the January 2 sale of Sabrina shares.
Instructions
(a) What effect does the January 2, 2013, transaction have upon Gamble’s accounting treatment for its investment in Sabrina? (b) Compute the carrying amount in Sabrina as of December 31, 2013. (c) Prepare the adjusting entry on December 31, 2013, applying the fair value method to Gamble’s longterm investment in Sabrina Company’s securities. See the book’s companion website, www.wiley.com/college/kieso, for a set of B Exercises. PROBLEMS
P22-1 (Change in Estimate and Error Correction)
Holtzman Company is in the process of preparing its financial statements for 2012. Assume that no entries for depreciation have been recorded in 2012. The following information related to depreciation of fixed assets is provided to you. 1. Holtzman purchased equipment on January 2, 2009, for $85,000. At that time, the equipment had an estimated useful life of 10 years with a $5,000 salvage value. The equipment is depreciated on a straight-line basis. On January 2, 2012, as a result of additional information, the company determined that the equipment has a remaining useful life of 4 years with a $3,000 salvage value. 2. During 2012, Holtzman changed from the double-declining-balance method for its building to the straight-line method. The building originally cost $300,000. It had a useful life of 10 years and a salvage value of $30,000. The following computations present depreciation on both bases for 2010 and 2011. 2011 2010 Straight-line $27,000 $27,000 Declining-balance 48,000 60,000 3. Holtzman purchased a machine on July 1, 2010, at a cost of $120,000. The machine has a salvage value of $16,000 and a useful life of 8 years. Holtzman’s bookkeeper recorded straight-line depreciation in 2010 and 2011 but failed to consider the salvage value.
Instructions
(a) Prepare the journal entries to record depreciation expense for 2012 and correct any errors made to date related to the information provided. (b) Show comparative net income for 2011 and 2012. Income before depreciation expense was $300,000 in 2012, and was $310,000 in 2011. (Ignore taxes.)
P22-2 (Comprehensive Accounting Change and Error Analysis Problem)
Botticelli Inc. was organized in late 2010 to manufacture and sell hosiery. At the end of its fourth year of operation, the company has been fairly successful, as indicated by the following reported net incomes. 2010 $140,000a 2012 $205,000 2011 160,000b 2013 276,000 aIncludes a $10,000 increase because of change in bad debt experience rate. bIncludes extraordinary gain of $30,000. The company has decided to expand operations and has applied for a sizable bank loan. The bank officer has indicated that the records should be audited and presented in comparative statements to facilitate analysis by the bank. Botticelli Inc. therefore hired the auditing firm of Check & Doublecheck Co. and has provided the following additional information. 1. In early 2011, Botticelli Inc. changed its estimate from 2% to 1% on the amount of bad debt expense to be charged to operations. Bad debt expense for 2010, if a 1% rate had been used, would have been $10,000. The company therefore restated its net income for 2010. 2. In 2013, the auditor discovered that the company had changed its method of inventory pricing from LIFO to FIFO. The effect on the income statements for the previous years is as follows. 2010 2011 2012 2013 Net income unadjusted—LIFO basis $140,000 $160,000 $205,000 $276,000 Net income unadjusted—FIFO basis 155,000 165,000 215,000 260,000 $ 15,000 $ 5,000 $ 10,000 $ (16,000) 3. In 2013, the auditor discovered that: (a) The company incorrectly overstated the ending inventory by $14,000 in 2012. (b) A dispute developed in 2011 with the Internal Revenue Service over the deductibility of entertainment expenses. In 2010, the company was not permitted these deductions, but a tax settlement was reached in 2013 that allowed these expenses. As a result of the court’s finding, tax expenses in 2013 were reduced by $60,000.
Instructions
(a) Indicate how each of these changes or corrections should be handled in the accounting records. (Ignore income tax considerations.) (b) Present comparative income statements for the years 2010 to 2013, starting with income before extraordinary items. (Ignore income tax considerations.)
P22-3 (Error Corrections and Accounting Changes)
Penn Company is in the process of adjusting and correcting its books at the end of 2012. In reviewing its records, the following information is compiled. 1. Penn has failed to accrue sales commissions payable at the end of each of the last 2 years, as follows. December 31, 2011 $3,500 December 31, 2012 $2,500 2. In reviewing the December 31, 2011, inventory, Penn discovered errors in its inventory-taking procedures that have caused inventories for the last 3 years to be incorrect, as follows. December 31, 2010 Understated $16,000 December 31, 2011 Understated $19,000 December 31, 2012 Overstated $ 6,700 Penn has already made an entry that established the incorrect December 31, 2012, inventory amount. 3 5 7 3 5 7 3. At December 31, 2012, Penn decided to change the depreciation method on its office equipment from double-declining-balance to straight-line. The equipment had an original cost of $100,000 when purchased on January 1, 2010. It has a 10-year useful life and no salvage value. Depreciation expense recorded prior to 2012 under the double-declining-balance method was $36,000. Penn has already recorded 2012 depreciation expense of $12,800 using the double-declining-balance method. 4. Before 2012, Penn accounted for its income from long-term construction contracts on the completedcontract basis. Early in 2012, Penn changed to the percentage-of-completion basis for accounting purposes. It continues to use the completed-contract method for tax purposes. Income for 2012 has been recorded using the percentage-of-completion method. The following information is available. Pretax Income Percentage-of-Completion Completed-Contract Prior to 2012 $150,000 $105,000 2012 60,000 20,000
Instructions
Prepare the journal entries necessary at December 31, 2012, to record the above corrections and changes. The books are still open for 2012. The income tax rate is 40%. Penn has not yet recorded its 2012 income tax expense and payable amounts so current-year tax effects may be ignored. Prior-year tax effects must be considered in item 4.
P22-4 (Accounting Changes)
Aston Corporation performs year-end planning in November of each year before its calendar year ends in December. The preliminary estimated net income is $3 million. The CFO, Rita Warren, meets with the company president, J. B. Aston, to review the projected numbers. She presents the following projected information. ASTON CORPORATION PROJECTED INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 2012 Sales $29,000,000 Cost of goods sold $14,000,000 Depreciation 2,600,000 Operating expenses 6,400,000 23,000,000 Income before income tax 6,000,000 Income tax 3,000,000 Net income $ 3,000,000 ASTON CORPORATION SELECTED BALANCE SHEET INFORMATION AT DECEMBER 31, 2012 Estimated cash balance $ 5,000,000 Available-for-sale securities (at cost) 10,000,000 Fair value adjustment (1/1/12) 200,000 Estimated market value at December 31, 2012: Security Cost Estimated Market A $ 2,000,000 $ 2,200,000 B 4,000,000 3,900,000 C 3,000,000 3,000,000 D 1,000,000 1,800,000 Total $10,000,000 $10,900,000 Other information at December 31, 2012: Equipment $ 3,000,000 Accumulated depreciation (5-year SL) 1,200,000 New robotic equipment (purchased 1/1/12) 5,000,000 Accumulated depreciation (5-year DDB) 2,000,000 The corporation has never used robotic equipment before, and Warren assumed an accelerated method because of the rapidly changing technology in robotic equipment. The company normally uses straightline depreciation for production equipment. Aston explains to Warren that it is important for the corporation to show a $7,000,000 income before taxes because Aston receives a $1,000,000 bonus if the income before taxes and bonus reaches $7,000,000. Aston also does not want the company to pay more than $3,000,000 in income taxes to the government.
Instructions
(a) What can Warren do within GAAP to accommodate the president’s wishes to achieve $7,000,000 in income before taxes and bonus? Present the revised income statement based on your decision. (b) Are the actions ethical? Who are the stakeholders in this decision, and what effect do Warren’s actions have on their interests?
P22-5 (Change in Principle—Inventory—Periodic)
The management of Utrillo Instrument Company had concluded, with the concurrence of its independent auditors, that results of operations would be more fairly presented if Utrillo changed its method of pricing inventory from last-in, first-out (LIFO) to average cost in 2012. Given below is the 5-year summary of income under LIFO and a schedule of what the inventories would be if stated on the average cost method. UTRILLO INSTRUMENT COMPANY STATEMENT OF INCOME AND RETAINED EARNINGS FOR THE YEARS ENDED MAY 31 2008 2009 2010 2011 2012 Sales—net $13,964 $15,506 $16,673 $18,221 $18,898 Cost of goods sold Beginning inventory 1,000 1,100 1,000 1,115 1,237 Purchases 13,000 13,900 15,000 15,900 17,100 Ending inventory (1,100) (1,000) (1,115) (1,237) (1,369) Total 12,900 14,000 14,885 15,778 16,968 Gross profi t 1,064 1,506 1,788 2,443 1,930 Administrative expenses 700 763 832 907 989 Income before taxes 364 743 956 1,536 941 Income taxes (50%) 182 372 478 768 471 Net income 182 371 478 768 470 Retained earnings—beginning 1,206 1,388 1,759 2,237 3,005 Retained earnings—ending $ 1,388 $ 1,759 $ 2,237 $ 3,005 $ 3,475 Earnings per share $1.82 $3.71 $4.78 $7.68 $4.70 SCHEDULE OF INVENTORY BALANCES USING AVERAGE COST METHOD FOR THE YEARS ENDED MAY 31 2007 2008 2009 2010 2011 2012 $1,010 $1,124 $1,101 $1,270 $1,500 $1,720
Instructions
Prepare comparative statements for the 5 years, assuming that Utrillo changed its method of inventory pricing to average cost. Indicate the effects on net income and earnings per share for the years involved. Utrillo Instruments started business in 2007. (All amounts except EPS are rounded up to the nearest dollar.)
P22-6 (Accounting Change and Error Analysis)
On December 31, 2012, before the books were closed, the management and accountants of Madrasa Inc. made the following determinations about three depreciable assets. 1. Depreciable asset A was purchased January 2, 2009. It originally cost $540,000 and, for depreciation purposes, the straight-line method was originally chosen. The asset was originally expected to be useful for 10 years and have a zero salvage value. In 2012, the decision was made to change the depreciation method from straight-line to sum-of-the-years’ digits, and the estimates relating to useful life and salvage value remained unchanged. 2. Depreciable asset B was purchased January 3, 2008. It originally cost $180,000 and, for depreciation purposes, the straight-line method was chosen. The asset was originally expected to be useful for 15 3 5 7 9 years and have a zero salvage value. In 2012, the decision was made to shorten the total life of this asset to 9 years and to estimate the salvage value at $3,000. 3. Depreciable asset C was purchased January 5, 2008. The asset’s original cost was $160,000, and this amount was entirely expensed in 2008. This particular asset has a 10-year useful life and no salvage value. The straight-line method was chosen for depreciation purposes. Additional data: 1. Income in 2012 before depreciation expense amounted to $400,000. 2. Depreciation expense on assets other than A, B, and C totaled $55,000 in 2012. 3. Income in 2011 was reported at $370,000. 4. Ignore all income tax effects. 5. 100,000 shares of common stock were outstanding in 2011 and 2012.
Instructions
(a) Prepare all necessary entries in 2012 to record these determinations. (b) Prepare comparative retained earnings statements for Madrasa Inc. for 2011 and 2012. The company had retained earnings of $200,000 at December 31, 2010.
P22-7 (Error Corrections)
You have been assigned to examine the financial statements of Zarle Company for the year ended December 31, 2012. You discover the following situations. 1. Depreciation of $3,200 for 2012 on delivery vehicles was not recorded. 2. The physical inventory count on December 31, 2011, improperly excluded merchandise costing $19,000 that had been temporarily stored in a public warehouse. Zarle uses a periodic inventory system. 3. A collection of $5,600 on account from a customer received on December 31, 2012, was not recorded until January 2, 2013. 4. In 2012, the company sold for $3,700 fully depreciated equipment that originally cost $25,000. The company credited the proceeds from the sale to the Equipment account. 5. During November 2012, a competitor company filed a patent-infringement suit against Zarle claiming damages of $220,000. The company’s legal counsel has indicated that an unfavorable verdict is probable and a reasonable estimate of the court’s award to the competitor is $125,000. The company has not reflected or disclosed this situation in the financial statements. 6. Zarle has a portfolio of trading securities. No entry has been made to adjust to market. Information on cost and market value is as follows. Cost Market December 31, 2011 $95,000 $95,000 December 31, 2012 $84,000 $82,000 7. At December 31, 2012, an analysis of payroll information shows accrued salaries of $12,200. The accrued salaries account had a balance of $16,000 at December 31, 2012, which was unchanged from its balance at December 31, 2011. 8. A large piece of equipment was purchased on January 3, 2012, for $40,000 and was charged to Maintenance and Repairs Expense. The equipment is estimated to have a service life of 8 years and no residual value. Zarle normally uses the straight-line depreciation method for this type of equipment. 9. A $12,000 insurance premium paid on July 1, 2011, for a policy that expires on June 30, 2014, was charged to insurance expense. 10. A trademark was acquired at the beginning of 2011 for $50,000. No amortization has been recorded since its acquisition. The maximum allowable amortization period is 10 years.
Instructions
Assume the trial balance has been prepared but the books have not been closed for 2012. Assuming all amounts are material, prepare journal entries showing the adjustments that are required. (Ignore income tax considerations.)
P22-8 (Comprehensive Error Analysis)
On March 5, 2013, you were hired by Hemingway Inc., a closely held company, as a staff member of its newly created internal auditing department. While reviewing the company’s records for 2011 and 2012, you discover that no adjustments have yet been made for the items listed below. Items 1. Interest income of $14,100 was not accrued at the end of 2011. It was recorded when received in February 2012. 2. A computer costing $4,000 was expensed when purchased on July 1, 2011. It is expected to have a 4-year life with no salvage value. The company typically uses straight-line depreciation for all fixed assets. 3. Research and development costs of $33,000 were incurred early in 2011. They were capitalized and were to be amortized over a 3-year period. Amortization of $11,000 was recorded for 2011 and $11,000 for 2012. 4. On January 2, 2011, Hemingway leased a building for 5 years at a monthly rental of $8,000. On that date, the company paid the following amounts, which were expensed when paid. Security deposit $20,000 First month’s rent 8,000 Last month’s rent 8,000 $36,000 5. The company received $36,000 from a customer at the beginning of 2011 for services that it is to perform evenly over a 3-year period beginning in 2011. None of the amount received was reported as unearned revenue at the end of 2011. 6. Merchandise inventory costing $18,200 was in the warehouse at December 31, 2011, but was incorrectly omitted from the physical count at that date. The company uses the periodic inventory method.
Instructions
Indicate the effect of any errors on the net income figure reported on the income statement for the year ending December 31, 2011, and the retained earnings figure reported on the balance sheet at December 31, 2012. Assume all amounts are material, and ignore income tax effects. Using the following format, enter the appropriate dollar amounts in the appropriate columns. Consider each item independent of the other items. It is not necessary to total the columns on the grid. Net Income for 2011 Retained Earnings at 12/31/12 Item Understand Overstated Understated Overstated (CIA adapted)
P22-9 (Error Analysis)
Lowell Corporation has used the accrual basis of accounting for several years. A review of the records, however, indicates that some expenses and revenues have been handled on a cash basis because of errors made by an inexperienced bookkeeper. Income statements prepared by the bookkeeper reported $29,000 net income for 2011 and $37,000 net income for 2012. Further examination of the records reveals that the following items were handled improperly. 1. Rent was received from a tenant in December 2011. The amount, $1,000, was recorded as revenue at that time even though the rental pertained to 2012. 2. Wages payable on December 31 have been consistently omitted from the records of that date and have been entered as expenses when paid in the following year. The amounts of the accruals recorded in this manner were: December 31, 2010 $1,100 December 31, 2011 1,200 December 31, 2012 940 3. Invoices for office supplies purchased have been charged to expense accounts when received. Inventories of supplies on hand at the end of each year have been ignored, and no entry has been made for them. December 31, 2010 $1,300 December 31, 2011 940 December 31, 2012 1,420
Instructions
Prepare a schedule that will show the corrected net income for the years 2011 and 2012. All items listed should be labeled clearly. (Ignore income tax considerations.)
P22-10 (Error Analysis and Correcting Entries)
You have been asked by a client to review the records of Roberts Company, a small manufacturer of precision tools and machines. Your client is interested in buying 7 9 7 9 the business, and arrangements have been made for you to review the accounting records. Your examination reveals the following information. 1. Roberts Company commenced business on April 1, 2010, and has been reporting on a fiscal year ending March 31. The company has never been audited, but the annual statements prepared by the bookkeeper reflect the following income before closing and before deducting income taxes. Year Ended Income March 31 Before Taxes 2011 $ 71,600 2012 111,400 2013 103,580 2. A relatively small number of machines have been shipped on consignment. These transactions have been recorded as ordinary sales and billed as such. On March 31 of each year, machines billed and in the hands of consignees amounted to: 2011 $6,500 2012 none 2013 5,590 Sales price was determined by adding 25% to cost. Assume that the consigned machines are sold the following year. 3. On March 30, 2012, two machines were shipped to a customer on a C.O.D. basis. The sale was not entered until April 5, 2012, when cash was received for $6,100. The machines were not included in the inventory at March 31, 2012. (Title passed on March 30, 2012.) 4. All machines are sold subject to a 5-year warranty. It is estimated that the expense ultimately to be incurred in connection with the warranty will amount to 12 of 1% of sales. The company has charged an expense account for warranty costs incurred. Sales per books and warranty costs were as follows. Warranty Expense Year Ended for Sales Made in March 31 Sales 2011 2012 2013 Total 2011 $ 940,000 $760 $ 760 2012 1,010,000 360 $1,310 1,670 2013 1,795,000 320 1,620 $1,910 3,850 5. Bad debts have been recorded on a direct write-off basis. Experience of similar enterprises indicates that losses will approximate 14 of 1% of sales. Bad debts written off were: Bad Debts Incurred on Sales Made in 2011 2012 2013 Total 2011 $750 $ 750 2012 800 $ 520 1,320 2013 350 1,800 $1,700 3,850 6. The bank deducts 6% on all contracts financed. Of this amount, 12% is placed in a reserve to the credit of Roberts Company that is refunded to Roberts as finance contracts are paid in full. The reserve established by the bank has not been reflected in the books of Roberts. The excess of credits over debits (net increase) to the reserve account with Roberts on the books of the bank for each fiscal year were as follows. 2011 $ 3,000 2012 3,900 2013 5,100 $12,000 7. Commissions on sales have been entered when paid. Commissions payable on March 31 of each year were as follows. 2011 $1,400 2012 900 2013 1,120 8. A review of the corporate minutes reveals the manager is entitled to a bonus of 1% of the income before deducting income taxes and the bonus. The bonuses have never been recorded or paid.
Instructions
(a) Present a schedule showing the revised income before income taxes for each of the years ended March 31, 2011, 2012, and 2013. Make computations to the nearest whole dollar. (b) Prepare the journal entry or entries you would give the bookkeeper to correct the books. Assume the books have not yet been closed for the fiscal year ended March 31, 2013. Disregard correction of income taxes. (AICPA adapted) *
P22-11 (Fair Value to Equity Method with Goodwill)
On January 1, 2012, Millay Inc. paid $700,000 for 10,000 shares of Genso Company’s voting common stock, which was a 10% interest in Genso. At that date, the net assets of Genso totaled $6,000,000. The fair values of all of Genso’s identifiable assets and liabilities were equal to their book values. Millay does not have the ability to exercise significant influence over the operating and financial policies of Genso. Millay received dividends of $1.50 per share from Genso on October 1, 2012. Genso reported net income of $550,000 for the year ended December 31, 2012. On July 1, 2013, Millay paid $2,325,000 for 30,000 additional shares of Genso Company’s voting common stock which represents a 30% investment in Genso. The fair values of all of Genso’s identifiable assets net of liabilities were equal to their book values of $6,550,000. As a result of this transaction, Millay has the ability to exercise significant influence over the operating and financial policies of Genso. Millay received dividends of $2.00 per share from Genso on April 1, 2013, and $2.50 per share on October 1, 2013. Genso reported net income of $650,000 for the year ended December 31, 2013, and $350,000 for the 6 months ended December 31, 2013.
Instructions
(a) Prepare a schedule showing the income or loss before income taxes for the year ended December 31, 2012, that Millay should report from its investment in Genso in its income statement issued in March 2013. (b) During March 2014, Millay issues comparative financial statements for 2012 and 2013. Prepare schedules showing the income or loss before income taxes for the years ended December 31, 2012 and 2013, that Millay should report from its investment in Genso. (AICPA adapted) *
P22-12 (Change from Fair Value to Equity Method)
On January 3, 2011, Martin Company p urchased for $500,000 cash a 10% interest in Renner Corp. On that date, the net assets of Renner had a book value of $3,700,000. The excess of cost over the underlying equity in net assets is attributable to undervalued depreciable assets having a remaining life of 10 years from the date of Martin’s purchase. The fair value of Martin’s investment in Renner securities is as follows: December 31, 2011, $560,000, and December 31, 2012, $515,000. On January 2, 2013, Martin purchased an additional 30% of Renner’s stock for $1,545,000 cash when the book value of Renner’s net assets was $4,150,000. The excess was attributable to depreciable assets having a remaining life of 8 years. During 2011, 2012, and 2013, the following occurred. Renner Dividends Paid by Net Income Renner to Martin 2011 $350,000 $15,000 2012 450,000 20,000 2013 550,000 70,000
Instructions
On the books of Martin Company, prepare all journal entries in 2011, 2012, and 2013 that relate to its investment in Renner Corp., reflecting the data above and a change from the fair value method to the equity method. 10 10 CONCEPTS FOR ANALYS I S
CA22-1 (Analysis of Various Accounting Changes and Errors)
Joblonsky Inc. has recently hired a new independent auditor, Karen Ogleby, who says she wants “to get everything straightened out.” Consequently, she has proposed the accounting changes shown below and on the next page in connection with Joblonsky Inc.’s 2012 financial statements. 1. At December 31, 2011, the client had a receivable of $820,000 from Hendricks Inc. on its balance sheet. Hendricks Inc. has gone bankrupt, and no recovery is expected. The client proposes to write off the receivable as a prior period item. 2. The client proposes the following changes in depreciation policies. (a ) For office furniture and fixtures, it proposes to change from a 10-year useful life to an 8-year life. If this change had been made in prior years, retained earnings at December 31, 2011, would have been $250,000 less. The effect of the change on 2012 income alone is a reduction of $60,000. (b ) F or its equipment in the leasing division, the client proposes to adopt the sum-of-the-years’-digits depreciation method. The client had never used SYD before. The first year the client operated a leasing division was 2012. If straight-line depreciation were used, 2012 income would be $110,000 greater. 3. In preparing its 2011 statements, one of the client’s bookkeepers overstated ending inventory by $235,000 because of a mathematical error. The client proposes to treat this item as a prior period adjustment. 4. In the past, the client has spread preproduction costs in its furniture division over 5 years. Because its latest furniture is of the “fad” type, it appears that the largest volume of sales will occur during the first 2 years after introduction. Consequently, the client proposes to amortize preproduction costs on a per-unit basis, which will result in expensing most of such costs during the first 2 years after the furniture’s introduction. If the new accounting method had been used prior to 2012, retained earnings at December 31, 2011, would have been $375,000 less. 5. For the nursery division, the client proposes to switch from FIFO to LIFO inventories because it believes that LIFO will provide a better matching of current costs with revenues. The effect of making this change on 2012 earnings will be an increase of $320,000. The client says that the effect of the change on December 31, 2011, retained earnings cannot be determined. 6. To achieve a better matching of revenues and expenses in its building construction division, the client proposes to switch from the completed-contract method of accounting to the percentage-of-completion method. Had the percentage-of-completion method been employed in all prior years, retained earnings at December 31, 2011, would have been $1,075,000 greater.
Instructions
(a) For each of the changes described above, decide whether: (1) The change involves an accounting principle, accounting estimate, or correction of an error. (2) Restatement of opening retained earnings is required. (b) What would be the proper adjustment to the December 31, 2011, retained earnings?
CA22-2 (Analysis of Various Accounting Changes and Errors)
Various types of accounting changes can affect the financial statements of a business enterprise differently. Assume that the following list describes changes that have a material effect on the financial statements for the current year of your business enterprise. 1. A change from the completed-contract method to the percentage-of-completion method of accounting for long-term construction-type contracts. 2. A change in the estimated useful life of previously recorded fixed assets as a result of newly acquired information. 3. A change from deferring and amortizing preproduction costs to recording such costs as an expense when incurred because future benefits of the costs have become doubtful. The new accounting method was adopted in recognition of the change in estimated future benefits. 4. A change from including the employer share of FICA taxes with payroll tax expenses to including it with “Retirement benefits” on the income statement. 5. Correction of a mathematical error in inventory pricing made in a prior period. 6. A change from presentation of statements of individual companies to presentation of consolidated statements. 7. A change in the method of accounting for leases for tax purposes to conform with the financial accounting method. As a result, both deferred and current taxes payable changed substantially. 8. A change from the FIFO method of inventory pricing to the LIFO method of inventory pricing.
Instructions
Identify the type of change that is described in each item above and indicate whether the prior year’s financial statements should be retrospectively applied or restated when presented in comparative form with the current year’s financial statements.
CA22-3 (Analysis of Three Accounting Changes and Errors)
Listed below and on the next page are three independent, unrelated sets of facts relating to accounting changes. Situation 1 Sanford Company is in the process of having its first audit. The company has used the cash basis of accounting for revenue recognition. Sanford president, B. J. Jimenez, is willing to change to the accrual method of revenue recognition. Situation 2 Hopkins Co. decides in January 2013 to change from FIFO to weighted-average pricing for its inventories. Situation 3 Marshall Co. determined that the depreciable lives of its fixed assets are too long at present to fairly match the cost of the fixed assets with the revenue produced. The company decided at the beginning of the current year to reduce the depreciable lives of all of its existing fixed assets by 5 years.
Instructions
For each of the situations described, provide the information indicated below. (a) Type of accounting change. (b) Manner of reporting the change under current generally accepted accounting principles including a discussion, where applicable, of how amounts are computed. (c) Effect of the change on the balance sheet and income statement.
CA22-4 (Analysis of Various Accounting Changes and Errors)
Katherine Irving, controller of Lotan Corp., is aware of a pronouncement on accounting changes. After reading the pronouncement, she is confused about what action should be taken on the following items related to Lotan Corp. for the year 2012. 1. In 2012, Lotan decided to change its policy on accounting for certain marketing costs. Previously, the company had chosen to defer and amortize all marketing costs over at least 5 years because Lotan believed that a return on these expenditures did not occur immediately. Recently, however, the time differential has considerably shortened, and Lotan is now expensing the marketing costs as incurred. 2. In 2012, the company examined its entire policy relating to the depreciation of plant equipment. Plant equipment had normally been depreciated over a 15-year period, but recent experience has indicated that the company was incorrect in its estimates and that the assets should be depreciated over a 20-year period. 3. One division of Lotan Corp., Hawthorne Co., has consistently shown an increasing net income from period to period. On closer examination of its operating statement, it is noted that bad debt expense and inventory obsolescence charges are much lower than in other divisions. In discussing this with the controller of this division, it has been learned that the controller has increased his net income each period by knowingly making low estimates related to the write-off of receivables and inventory. 4. In 2012, the company purchased new machinery that should increase production dramatically. The company has decided to depreciate this machinery on an accelerated basis, even though other machinery is depreciated on a straight-line basis. 5. All equipment sold by Lotan is subject to a 3-year warranty. It has been estimated that the expense ultimately to be incurred on these machines is 1% of sales. In 2012, because of a production breakthrough, it is now estimated that 1/2 of 1% of sales is sufficient. In 2010 and 2011, warranty expense was computed as $64,000 and $70,000, respectively. The company now believes that these warranty costs should be reduced by 50%. 6. In 2012, the company decided to change its method of inventory pricing from average cost to the FIFO method. The effect of this change on prior years is to increase 2010 income by $65,000 and increase 2011 income by $20,000.
Instructions
Katherine Irving has come to you, as her CPA, for advice about the situations above. Prepare a report, indicating the appropriate accounting treatment that should be given each of these situations.
CA22-5 (Change in Principle, Estimate)
As a certified public accountant, you have been contacted by Joe Davison, CEO of Sports-Pro Athletics, Inc., a manufacturer of a variety of athletic equipment. He has asked you how to account for the following changes. 1. Sports-Pro appropriately changed its depreciation method for its production machinery from the double-declining-balance method to the production method effective January 1, 2012. 2. Effective January 1, 2012, Sports-Pro appropriately changed the salvage values used in computing depreciation for its office equipment. 3. On December 31, 2012, Sports-Pro appropriately changed the specific subsidiaries constituting the group of companies for which consolidated financial statements are presented.
Instructions
Write a 1–1.5 page letter to Joe Davison explaining how each of the above changes should be presented in the December 31, 2012, financial statements.
CA22-6 (Change in Estimate)
Mike Crane is an audit senior of a large public accounting firm who has just been assigned to the Frost Corporation’s annual audit engagement. Frost has been a client of Crane’s firm for many years. Frost is a fast-growing business in the commercial construction industry. In reviewing the fixed asset ledger, Crane discovered a series of unusual accounting changes, in which the useful lives of assets, depreciated using the straight-line method, were substantially lowered near the midpoint of the original estimate. For example, the useful life of one dump truck was changed from 10 to 6 years during its fifth year of service. Upon further investigation, Mike was told by Kevin James, Frost’s accounting manager, “I don’t really see your problem. After all, it’s perfectly legal to change an accounting estimate. Besides, our CEO likes to see big earnings!”
Instructions
Answer the following questions. (a) What are the ethical issues concerning Frost’s practice of changing the useful lives of fixed assets? (b) Who could be harmed by Frost’s unusual accounting changes? (c) What should Crane do in this situation? Using Your Judgment 1425
FINANCIAL REPORTING

Financial Reporting Problem

The Procter & Gamble Company (P&G)
The financial statements of P&G are provided in Appendix 5B or can be accessed at the book’s companion website, www.wiley.com/college/kieso.
Instructions
Refer to P&G’s financial statements and the accompanying notes to answer the following questions. (a) Were there changes in accounting principles reported by P&G during the three years covered by its income statements (2007–2009)? If so, describe the nature of the change and the year of change. (b) What types of estimates did P&G discuss in 2009?
Comparative Analysis Case
The Coca-Cola Company and PepsiCo, Inc.
Instructions
Go to the book’s companion website and use information found there to answer the following questions related to The Coca-Cola Company and PepsiCo Inc. (a) Identify the changes in accounting principles reported by Coca-Cola during the 3 years covered by its income statements (2007–2009). Describe the nature of the change and the year of change. (b) Identify the changes in accounting principles reported by PepsiCo during the 3 years covered by its income statements (2007–2009). Describe the nature of the change and the year of change. (c) For each change in accounting principle by Coca-Cola and PepsiCo, identify, if possible, the cumulative effect of each change on prior years and the effect on operating results in the year of change.
Accounting, Analysis, and Principles
In preparation for significant international operations, ABC Co. has adopted a plan to gradually shift to the same accounting methods as used by its international competitors. Part of this plan USING YOUR JUDGMENT includes a switch from LIFO inventory accounting to FIFO (recall that IFRS does not allow LIFO). ABC decides to make the switch to FIFO at January 1, 2012. The following data pertains to ABC’s 2012 financial statements. ABC CO. BALANCE SHEET AT DECEMBER 31, 2011 2011 2010 2011 2010 Cash $ 365 $ 200 Common stock $ 500 $ 500 Inventory 500 480 Retained earnings 685 540 Property, plant, and equipment 400 400 Accumulated depreciation (80) (40) Total assets $1,185 $1,040 Total equity $1,185 $1,040 ABC CO. INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 2011 2011 Sales $ 500 Cost of goods sold (300) Depreciation expense (40) Compensation expense (15) Net income $ 145 Summary of Significant Accounting Policies Inventory: The company accounts for inventory by the LIFO method. The current cost of the company’s inventory, which approximates FIFO, was $60 and $50 higher at the end of fi scal 2011 and 2010, respectively, than those reported in the balance sheet.
Accounting
Prepare ABC’s December 31, 2012, balance sheet and an income statement for the year ended December 31, 2012. In columns beside 2012’s numbers, include 2011’s numbers as they would appear in the 2012 financial statements for comparative purposes.
Analysis
Compute ABC’s inventory turnover for 2011 and 2012 under both LIFO and FIFO. Assume averages are equal to year-end balances where necessary. What causes the differences in this ratio between LIFO and FIFO?
Principles
Briefly explain, in terms of the principles discussed in Chapter 2, why GAAP requires that companies that change accounting methods recast prior year’s financial statement data. Sales $550 Inventory purchases 350 12/31/12 inventory (using FIFO) 580 Compensation expense 17 All sales and purchases were with cash. All of 2012’s compensation expense was paid with cash. (Ignore taxes.) ABC’s property, plant, and equipment cost $400 and has an estimated useful life of 10 years with no salvage value. ABC Co. reported the following for fiscal 2011 (in millions of dollars):
BRIDGE TO THE PROFESSION

Professional Research: FASB  Codification
As part of the year-end accounting process and review of operating policies, Cullen Co. is considering a change in the accounting for its equipment from the straight-line method to an accelerated method. Your supervisor wonders how the company will report this change in principle. He read in a newspaper article that the FASB has issued a standard in this area and has changed GAAP for a “change in estimate that is effected by a change in accounting principle.” (Thus, the accounting may be different from that he learned in intermediate accounting.) Your supervisor wants you to research the authoritative guidance on a change in accounting principle related to depreciation methods.
Instructions
If your school has a subscription to the FASB Codification, go to http://aaahq.org/ascLogin.cfm to log in and prepare responses to the following. Provide Codification references for your responses. (a) What are the accounting and reporting guidelines for a change in accounting principle related to depreciation methods? (b) What are the conditions that justify a change in depreciation method, as contemplated by Cullen Co.? (c) What guidance does the SEC provide concerning the impact that recently issued accounting standards will have on the fi nancial statements in a future period?
Professional Simulation
In this simulation, you are asked questions about changes in accounting principle. Prepare responses to all parts. Using Your Judgment 1427 Garner Company began operations on January 1, 2010, and uses the average cost method of pricing inventory. Management is contemplating a change in inventory methods for 2013. The following information is available for the years 2010–2012. Assuming Garner had the accounting change described in (b) above, Garner’s income in 2013 was $30,000. Compute basic and diluted earnings per share for Garner Company for 2013. Show how income and EPS will be reported for 2013 and 2012. Directions Situation Journal Entries Financial Statements Resources Directions Situation Journal Entries Financial Statements Resources Directions Situation Journal Entries Financial Statements Resources Net Income Computed Using Average Cost Method FIFO Method $15,000 18,000 20,000 $20,000 24,000 27,000 LIFO Method $12,000 14,000 17,000 2010 2011 2012 On January 1, 2012, Garner issued 10-year, $200,000 face value, 6% bonds, at par. Each $1,000 bond is convertible into 30 shares of Garner common stock. The company has had 10,000 common shares outstanding throughout its life. None of the bonds have been exercised as of the end of 2013. (Ignore tax effects.) Changes in Accounting Principle Time Remaining 1 hour 20 minutes 1 2 3 45 A B C + KWW_Professional_Simulation Unsplit Split Horiz Split Vertical Spreadsheet Calculator Exit (a) Prepare the journal entry necessary to record a change from the average cost method to the FIFO method in 2013. (b) Assume Garner Company used the LIFO method instead of the average cost method during the years 2010–2012. In 2013, Garner changed to the FIFO method. Prepare the journal entry necessary to record the change in accounting principle.
ACCOUNTING CHANGES AND ERRORS The IFRS addressing accounting and reporting for changes in accounting principles, 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 (“Presentation of Financial Statements”). As indicated in the chapter, the FASB has issued guidance on changes in accounting principles, changes in estimates, and corrections of errors, which essentially converges GAAP to IAS 8. RELEVANT FACTS One area in which GAAP and IFRS differ is the reporting of error corrections in previously issued fi nancial statements. While both sets of standards require restatement, GAAP is an absolute standard—that is, there is no exception to this rule. The accounting for changes in estimates is similar between GAAP and IFRS. Under GAAP and IFRS, if determining the effect of a change in accounting policy is considered impracticable, then a company should report the effect of the change in the period in which it believes it practicable to do so, which may be the current period. Under IFRS, the impracticality exception applies both to changes in accounting principles and to the correction of errors. Under GAAP, this exception applies only to changes in accounting principle. IFRS (IAS 8) does not specifi cally address the accounting and reporting for indirect effects of changes in accounting principles. As indicated in the chapter, GAAP has detailed guidance on the accounting and reporting of indirect effects.
ABOUT THE NUMBERS Direct and Indirect Effects of Changes Are there other effects that a company should report when it makes a change in accounting policy? For example, what happens when a company like Lancer (see pages 1374–1378) has a bonus plan based on net income and the prior year’s net income changes when FIFO is retrospectively applied? Should Lancer also change the reported amount of bonus expense? Or, what happens if we had not ignored income taxes in the Lancer example? Should Lancer adjust net income, given that taxes will be different under average cost and FIFO in prior periods? The answers depend on whether the effects are direct or indirect. Direct Effects Similar to GAAP, IFRS indicates that companies should retrospectively apply the direct effects of a change in accounting policy. An example of a direct effect is an adjustment to an inventory balance as a result of a change in the inventory valuation method. For example, referring to Lancer Company on pages 1374–1378, Lancer should change the inventory amounts in prior periods to indicate the change to the FIFO method of inventory valuation. Another inventory-related example would be an impairment adjustment resulting from applying the lower-of-cost-or-net realizable value test to the adjusted inventory balance. Related changes, such as deferred income tax effects of the impairment adjustment, are also considered direct effects. This entry was illustrated in the Denson example on page 1371, in which the change to percentage-of-completion accounting resulted in recording a deferred tax liability. Insights Indirect Effects In addition to direct effects, companies can have indirect effects related to a change in accounting policy. An indirect effect is any change to current or future cash flows of a company that results from making a change in accounting policy that is applied retrospectively. An example of an indirect effect is a change in profit-sharing or royalty payment that is based on a reported amount such as revenue or net income. The IASB is silent on what to do in this situation. GAAP (likely because its standard in this area was issued after IAS 8) requires that indirect effects do not change prior period amounts. For example, let’s assume that Lancer Company has an employee profit-sharing plan based on net income and it changed from the weighted-average inventory method to FIFO in 2012. Lancer reports higher income in 2011 and 2012 if it used the FIFO method. In addition, let’s assume that the profit-sharing plan requires that Lancer pay the incremental amount due based on the FIFO income amounts. In this situation, Lancer reports this additional expense in the current period; it would not change prior periods for this expense. If the company prepares comparative financial statements, it follows that it does not recast the prior periods for this additional expense. If the terms of the profit-sharing plan indicate that no payment is necessary in the current period due to this change, then the company need not recognize additional profit-sharing expense in the current period. Neither does it change amounts reported for prior periods. When a company recognizes the indirect effects of a change in accounting policy, it includes in the financial statements a description of the indirect effects. In doing so, it discloses the amounts recognized in the current period and related per share information.
Impracticability It is not always possible for companies to determine how they would have reported prior periods’ financial information under retrospective application of an accounting policy change. Retrospective application is considered impracticable if a company cannot determine the prior period effects using every reasonable effort to do so. Companies should not use retrospective application if one of the following conditions exists: 1. The company cannot determine the effects of the retrospective application. 2. Retrospective application requires assumptions about management’s intent in a prior period. 3. Retrospective application requires signifi cant estimates for a prior period, and the company cannot objectively verify the necessary information to develop these estimates. If any of the above conditions exists, it is deemed impracticable to apply the retrospective approach. In this case, the company prospectively applies the new accounting policy as of the earliest date it is practicable to do so. For example, assume that Williams Company changed its accounting policy for depreciable assets so as to more fully apply component depreciation under revaluation accounting. Unfortunately, the company does not have detailed accounting records to establish a basis for the components of these assets. As a result, Williams determines it is not practicable to account for the change to full component depreciation using the retrospective application approach. It therefore applies the policy prospectively, starting at the beginning of the current year. Williams must disclose only the effect of the change on the results of operations in the period of change. Also, the company should explain the reasons for omitting the computations of the cumulative effect for prior years. Finally, it should disclose the justification for the change to component depreciation. IFRS

ON THE HORIZON For the most part, IFRS and GAAP are similar in the area of accounting changes and reporting the effects of errors. Thus, there is no active project in this area. A related development involves the presentation of comparative data. Under IFRS, when a company prepares financial statements on a new basis, two years of comparative data are reported. GAAP requires comparative information for a three-year period. Use of the shorter comparative data period must be addressed before U.S. companies can adopt IFRS.
IFRS SELF-TEST QUESTIONS 1. Which of the following is false? (a) GAAP and IFRS have the same absolute standard regarding the reporting of error corrections in previously issued fi nancial statements. (b) The accounting for changes in estimates is similar between GAAP and IFRS. (c) Under IFRS, the impracticality exception applies both to changes in accounting principles and to the correction of errors. (d) GAAP has detailed guidance on the accounting and reporting of indirect effects; IFRS does not. 2. Which of the following is not classifi ed as an accounting change by IFRS? (a) Change in accounting policy. (b) Change in accounting estimate. (c) Errors in fi nancial statements. (d) None of the above. 3. IFRS 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. 4. Under IFRS, the retrospective approach should not be used if: (a) retrospective application requires assumptions about management’s intent in a prior period. (b) the company does not have trained staff to perform the analysis. (c) the effects of the change have counterbalanced. (d) the effects of the change have not counterbalanced. 5. Which of the following is true regarding whether IFRS specifi cally 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
IFRS CONCEPTS AND APPLICATION
IFRS22-1
Where can authoritative IFRS related to accounting changes be found?
IFRS22-2
Briefl y describe some of the similarities and differences between GAAP and IFRS with respect to reporting accounting changes.
IFRS22-3
How might differences in presentation of comparative data under GAAP and IFRS affect adoption of IFRS by U.S. companies?
IFRS22-4
What is the indirect effect of a change in accounting policy? Briefl y describe the approach to reporting the indirect effects of a change in accounting policy under IFRS.
IFRS22-5
Discuss how a change in accounting policy is handled when it is impracticable to determine previous amounts.
IFRS22-6
Joblonsky Inc. has recently hired a new independent auditor, Karen Ogleby, who says she wants “to get everything straightened out.” Consequently, she has proposed the following accounting changes in connection with Joblonsky Inc.’s 2012 fi nancial statements. 1. At December 31, 2011, the client had a receivable of $820,000 from Hendricks Inc. on its statement of fi nancial position. Hendricks Inc. has gone bankrupt, and no recovery is expected. The client proposes to write off the receivable as a prior period item. 2. The client proposes the following changes in depreciation policies. (a) For offi ce furniture and fi xtures, it proposes to change from a 10-year useful life to an 8-year life. If this change had been made in prior years, retained earnings at December 31, 2011, would have been $250,000 less. The effect of the change on 2012 income alone is a reduction of $60,000. (b) For its equipment in the leasing division, the client proposes to adopt the sumof- the-years’-digits depreciation method. The client had never used SYD before. The fi rst year the client operated a leasing division was 2012. If straight-line depreciation were used, 2012 income would be $110,000 greater. 3. In preparing its 2011 statements, one of the client’s bookkeepers overstated ending inventory by $235,000 because of a mathematical error. The client proposes to treat this item as a prior period adjustment. 4. In the past, the client has spread preproduction costs in its furniture division over 5 years. Because its latest furniture is of the “fad” type, it appears that the largest volume of sales will occur during the fi rst 2 years after introduction. Consequently, the client proposes to amortize preproduction costs on a per-unit basis, which will result in expensing most of such costs during the fi rst 2 years after the furniture’s introduction. If the new accounting method had been used prior to 2012, retained earnings at December 31, 2011, would have been $375,000 less. 5. For the nursery division, the client proposes to switch from FIFO to average cost inventories because it believes that average cost will provide a better matching of current costs with revenues. The effect of making this change on 2012 earnings will be an increase of $320,000. The client says that the effect of the change on December 31, 2011, retained earnings cannot be determined. 6. To achieve a better matching of revenues and expenses in its building construction division, the client proposes to switch from the cost-recovery method of accounting to the percentage-of-completion method. Had the percentage-of-completion method been employed in all prior years, retained earnings at December 31, 2011, would have been $1,075,000 greater.
Instructions
(a) For each of the changes described above, decide whether: (1) The change involves an accounting policy, accounting estimate, or correction of an error. (2) Restatement of opening retained earnings is required. (b) What would be the proper adjustment to the December 31, 2011, retained earnings?
Professional Research

IFRS22-7
As part of the year-end accounting process and review of operating policies, Cullen Co. is considering a change in the accounting for its equipment from the straightline method to an accelerated method. Your supervisor wonders how the company will IFRS Insights 1431 report this change in accounting. It has been few years since he took intermediate accounting, and he cannot remember whether this change would be treated in a retrospective or prospective manner. Your supervisor wants you to research the authoritative guidance on a change in accounting policy related to depreciation methods.
Instructions
Access the IFRS authoritative literature at the IASB website (http://eifrs.iasb.org/). When you have accessed the documents, you can use the search tool in your Internet browser to respond to the following questions. (Provide paragraph citations.) (a) What are the accounting and reporting guidelines for a change in accounting policy related to depreciation methods? (b) What are the conditions that justify a change in depreciation method, as contemplated by Cullen Co.?
International Financial Reporting Problem:
Marks and Spencer plc
IFRS22-8
The fi nancial statements of Marks and Spencer plc (M&S) are available at the book’s companion website or can be accessed at http://corporate.marksandspencer. com/documents/publications/2010/Annual_Report_2010.
Instructions
Refer to M&S’s financial statements and the accompanying notes to answer the following questions. (a) Were there changes in accounting policies reported by M&S during the two years covered by its income statements (2009–2010)? If so, describe the nature of the change and the year of change. (b) What types of estimates did M&S discuss in 2010?
ANSWERS TO IFRS SELF-TEST QUESTIONS
1. a 2. c 3. b 4. a 5. d  




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