Accounting Changes and Error Corrections Flashcards
What is a prior period adjustment? Under what conditions is a prior period adjustment appropriate?
A prior period adjustment is a change made to prior period F/S, reflected as a retroactive adjustment. A prior period adjustment is rarely recorded, unless net income from a previously reported year contains an error of some type. For example, if an expense has been incorrectly computed in an earlier year, a prior period adjustment would be used to correct that mistake.
An accountant is preparing an entity’s F/S for year 3 and discovers a mistake in the computation of NI for year 1. How is a prior period adjustment reported?
If the year 1 statements are to be reported, the incorrect number is actually changed to the correct figure.
If year 1 statements are not to be reported, the earliest R/E balance being reported is adjusted to corrected the error(less any tax effect)
On Dec 31 of year 3, a business wants to make a change in an accounting principle or an estimation.
When is this change assumed to be made?
All changes in an accounting principle or an estimation are assumed to occur on Jan 1 of the current year
When is a retrospective restatement of previous statements justified?
change in accounting principle
correction of a misstatement or the application of an inappropriate principle
change in what is viewed as the reporting entity
An entity reports a certain expense as $20,000 in year 1, $30,000 in year 2, and $40,000 in year 3. The entity changes the accounting principles being applied so that this figure should now be $50,000 per year. The entity is now only reporting comparative F/S for years 2 and 3.
How is this change shown?
in year 2 and year 3 statements the expense is shown as $50,000
and increase of $20,000 in year 2 and $10,000 in year 3
beginning R/E for year 2 must also be reduced by $30,000 to reflect the impact of the change on Year 1
An entity reports a certain expense as $10,000 in year 1, $20,000 in year 2, and $30,000 in year 3. On Dec 31, year 3, the business decides to change an accounting principle, so this expense would be $40,000 each year.
What expense is shown for these 3 years on comparative statements?
the expense shown would be $40,000 for all years since it is a retrospective change
An entity reports a certain expense as $10,000 in year 1, $20,000 in year 2, and $30,000 in year 3. On Dec 31, year 3, the business decides to change an accounting principle, so this expense would be $40,000 each year. Comparative F/S are being shown for just years 2 and 3.
How is the change in Year 1 - not shown in the F/S - from $10,000 to $40,000 reported?
if the retrospective change is made and one or more years are not reported, the change in income for those years is shown as an adjustment in the earliest R/E balance that is reported.
In this specific case year 2 beginning R/E would be reduced by $30,000 (net of taxes)
An entity is making a change in one of its accounting principles. In order to change all previous years, a reduction in net income (net of taxes) of $68,000 is needed.
If a j/e is required, how is this income reduction recorded?
a debit is made to R/E as of the beginning of the current year for $68,000
An entity reports a certain expense as $10,000 in year 1, $20,000 in year 2 both based on estimations. In year 3, it is determined that the correct amount for each year should have been $40,000. In year 3, comparative F/S are produced for years 1 through 3.
What expense should be shown for years 1 and 2?
Changes in estimates are not retrospectively adjusted for unless the estimate was made in bad faith (error correction would be needed)
the numbers originally stated will continue to be reported year 1, $10,000 and year 2 $20,000
Equipment is bought on Jan 1, year 1, for $100,000 with a $10,000 salvage value and an estimated life of 10 years. Straight-line depreciation is used. At the end of year 2, the entity realizes that the life of the equipment will only be 6 years with no salvage value.
On comparative statements for years 1 and 2, how much depreciation expense should be recognized?
Year 1 = $9,000 (100,000 - 10,000 = 90,000)(90,000 /10 years)
year 2 = book value 100,000 - 9,000 = 91,000
91,000/5 years = 18,200 depreciation
Equipment is bought on Jan 1, year 1, for $100,000 with an estimated life of 10 years. On Jan 1, year 3, the entity changes to the double-declining balance method with no other changes.
On comparative statements for years 2 and 3, how much depreciation expense should be recognized?
years 1 & 2= 10,000 (100,000/10 years)
book value = 100,000 - 20,000 = 80,000
year 3 = 80,000 * 2/8 = 20,000
An entity has been in operation for several years. At the beginning of year 4, the entity decides to make a change in one of the accounting principles that it has been applying. However, the impact on the previous years cannot be determined.
How is this change reported?
if the previous effect of the change cannot be determined, the opening balance for the current year is based on the earlier method, and the new method begins to be applied prospectively. This sometimes occurs when an entity is switching to the last-in, first-out (LIFO) cost flow assumption.
An entity has been in operation for several years and, at the beginning of year 5, a change is made. This particular type of change is considered to be both a change in an estimation and a change in an accounting principle.
What reporting is appropriate for this change?
If a change is both a change in an estimation and a change in an accounting principle, it is reported as a change in an estimation.
An entity is preparing an income statement for year 3 and discovers that $20,000 in depreciation expenses in year 1 was never recorded. This has to be handled as prior period adjustment.
Ignoring any tax effect, what j/e will the entity record in year 3?
the entity should make this j/e
R/E 20,000
Accumulated Depreciation 20,000
Does the correction of an estimation qualify as prior period adjustment?
no- the correction of an estimation is recorded in the year in which the estimation is found to be incorrect. earlier figures are not adjusted, so no prior period adjustment is made in such cases
