Chapter 20 Flashcards
LIFO inventory method is popular because it reduces income and therefore reduces the amount of income taxes that must be paid currently. True or False
True. FIFO usually produces lower cost of goods sold and thus higher inventory than does LIFO, since the cost of goods available for sale each period is the sum of the cost of goods sold and the cost of goods unsold
What is the Retrospective Approach to financial statements?
financial statements issued in previous years are revised to reflect the impact of the change whenever those statements are presented again for comparative purposes. For each year reported in the comparative statements reported, the balance of each account affected is revised. In other words, those statements are made to appear as if the newly adopted accounting method had been applied all along or that the error had never occurred. Then, a journal entry is created to adjust all account balances affected to what those amounts would have been. if retained earnings is one of the accounts that requires adjustment, that adjustment is made to the beginning balance of retained earnings for the earliest period reported in the comparative statements of shareholders’ equity.
When the motivation is an objective other than to provide useful information, earnings quality strengthens.
False. Any time managers make accounting choices for any of the reasons discussed here, when the motivation is an objective other than to provide useful information, earnings quality suffers
Requiring neither a modification of prior years’ financial statements nor a journal entry to adjust account balances. Instead, the change is simply implemented now, and its effects are reflected in the financial statements of the current and future years only. This is the retrospective/prospective approach
Prospective
We must adjust the beginning balance of retained earnings for the earliest period reported in the comparative statements of shareholders’ equity if retained earnings is an account with balance requiring adjustment due to a change in accounting principle. True or False?
True
Are retained earnings reported differently between FIFO and LIFO?
Yes.Retained earnings is different because the two inventory methods affect income differently. Because cost of goods sold by FIFO is less than by LIFO, income and therefore retained earnings by FIFO are greater than by LIFO.
After switching to FIFO, the difference found out that Cost of goods sold would have been $400 million less if FIFO rather than LIFO had been used in years before the change. What must be done now?
- Journalize it (see slide 14) 2. Inventory must be INCREASED by that amount (as depicted in journal)
Define Disclosure Notes for accounting changes?
To achieve consistency and comparability, accounting choices once made should be consistently followed from year to year. Any change, then, requires that the new method be justified as clearly more appropriate. In the first set of financial statements after the change, a disclosure note is needed to provide that justification. The note also should point out that comparative information has been revised, or that retrospective revision has not been made because it is impracticable, and report any per share amounts affected for the current period and all prior periods presented.
If, for example, accounting records of prior years usually are inadequate to report the change retrospectively, what should be done?
Sometimes a lack of information makes it impracticable to report a change retrospectively so the new method is simply applied prospectively. The old, unadjusted account balance may be taken, and the new change in method would be depndant upon that number.
A change in depreciation methods is considered to be a change in accounting estimate that is achieved by a change in accounting principle. As a result, we account for such a change prospectively/retrospectively
Prospectively
A change in the method of depreciation (or amortization or depletion) is applied retrospectively or prospectively?
Prospectively. An exception to retrospective application of a change in accounting principle is a change in the method of depreciation (or amortization or depletion). Even though the company is changing its depreciation method, it is doing so to reflect changes in its estimates of future benefits. he undepreciated cost remaining at the time of the change would be depreciated straight-line over the remaining useful life.
Even though the company is changing its depreciation method, it is doing so to reflect changes in its: accounting principle/estimates of future benefits
Changes in estimates of future benefits. Technically they are both, only because a change to a new depreciation method requires the company to justify the new method as being preferable to the previous method, just as for any other change in principle. A disclosure note should justify that the change is preferable and describe the effect of a change on any financial statement line items and per share amounts affected for all periods reported.
Changes in Reporting entities are applied (retrospectively/prospectively)
Retrospectively - A change in reporting entity requires that financial statements of prior periods be retrospectively revised to report the financial information for the new reporting entity in all periods.
Previous years’ financial statements are retrospectively restated to reflect the correction of an error. True or False?
True - duh. And, of course, any account balances that are incorrect as a result of the error are corrected by a journal entry. If retained earnings is one of the incorrect accounts, the correction is reported as a prior period adjustment to the beginning balance in a statement of shareholders’ equity
Define a Reporting Entity
Can be a single company, or it can be a group of companies that reports a single set of financial statements. A change in reporting entity occurs as a result of (1) presenting consolidated financial statements in place of statements of individual companies or (2) changing specific companies that constitute the group for which consolidated or combined statements are prepared (when one company acquires another one)
True or False: When it’s not possible to distinguish between a change in principle and a change in estimate, the change should be treated as a change in estimate.
True - When the distinction is not possible, the change should be treated as a change in estimate. This treatment also is appropriate when both a change in principle and a change in estimate occur simultaneously.
How is an error taken care of if it is discovered in current reporting period?
If an accounting error is made and discovered in the same accounting period, the original erroneous entry should simply be reversed and the appropriate entry recorded
Define a prior period adjustment -
correction of errors is the situation that creates prior period adjustments. A prior period adjustment refers to an addition to or reduction in the beginning retained earnings balance in a statement of shareholders’ equity (or statement of retained earnings if that’s presented instead). Simply add a line item saying “Prior Period Adjustment” after the Balance on the next statement. Deduct the djustment amount to get the corrected balance. Then, show new balance after net income less dividends.
If a change in prior period with no effect to net income:
Reverse entry, but must issue a restatement to explain that they were aware of an error.
Difference between prospective vs retrospective application for error corrections
See slide 24
Give an example of a situation requiring an error correction
See Slide 3
Change in Acc Principle vs Estimate vs Reporting Entity
See slide 2
Name some motivations for change in Accounting Practices
See slide 8. -Changing business environment. -Effect on compensation, such as bonuses and stock options. -Effect on debt agreements. -Effect on union negotiations. -Issuance of new accounting standards. -Effect on income taxes. Management must justify the change. Hopefully, changes are made in the best interest of fair and consistent financial reporting, but that may not always be the case.
Example of Acc. Depreciation with n entity using SYD. The asset was purchased at the beginning of 2011for $63 million, has a useful life of five years, andan estimated residual value of $3 million.
See slide 22
On January 1, 2009, Towing Inc. purchased specialized equipment for $243,000. The equipment has been depreciated using the straight-line method and had an estimated life of 10 years and salvage value of $3,000. In 2013 the total useful life of the equipment was revised to 6 years. Calculate the 2013 depreciation expense.
See Slide 21
Why may a change in reporting entity occur?
See slide 25
Example of a change from SYD to Straight-Line. Acc depreciation is subtracted from cost (includgin salvage value)
See slide 23
Steps in Correction of Errors?
See slide 28
Prior Period Adjustment to RE example -
see slide 35
