Chapter 22 Flashcards
What was the erroneous entry made by Huggins for estimated bad debts?
No entry made
Huggins failed to accrue an allowance for doubtful accounts of $7,000.
What should Huggins have recorded for bad debt expense?
Bad Debt Expense 7,000, Allowance for Doubtful Accounts 7,000
This entry would have correctly accrued the bad debt expense.
What was the result of Huggins’s error in accruing bad debts?
Understatement of bad debt expense, overstatement of income by $7,000.
What correcting entry is made if Huggins discovers the understatement of income in 2020?
Retained Earnings 7,000, Allowance for Doubtful Accounts 7,000.
What happens if the error is discovered at the end of 2020?
Retained Earnings 7,000, Bad Debt Expense 7,000.
What was the pretax effect of the errors on Huggins’s income for 2019?
$ (20,500).
What was the after-tax effect of the errors on Huggins’s income?
$ (16,195).
What adjustment did Werner make regarding the change from LIFO to FIFO?
Increase of $39,500 in retained earnings at January 1, 2019.
What was the erroneous entry for the purchase of inventory recorded by Huggins?
Purchases 17,000, Accounts Payable 17,000.
What should have been the correct entry for the inventory purchase?
Purchases 27,000, Accounts Payable 27,000.
What effect did the understatement of purchases have on financial statements?
Understatement of Cost of Goods Sold in 2019, overstatement of income.
What entry does Huggins make if it discovers the overstatement of income at the end of 2020?
Retained Earnings 10,000, Accounts Payable 10,000.
What was Huggins’s ending inventory error at December 31, 2019?
Understated by $5,000.
What correcting entry is made if Huggins discovers the ending inventory error?
Inventory 5,000, Retained Earnings 5,000.
What is the impact of the error in inventory on financial statements if discovered in 2021?
No correcting entry is made as the amount has counterbalanced.
What correcting entry does Huggins make for the omission of prepaid expense?
Insurance Expense 500, Prepaid Insurance 500, Retained Earnings 1,000.
What is the effect of the noncounterbalancing error on supplies expense?
Supplies expense is overstated by $10,000.
What adjusting entry does Stewart Company need to make for the long-lived asset error?
Not applicable; it should have capitalized the asset.
What cumulative effect adjustment did Werner make for the change to FIFO?
Inventory 70,000, Retained Earnings 55,300, Deferred Tax Liability 14,700.
What was the effect on net income when adjusting from LIFO to FIFO?
$20,000 increase.
What should Huggins have recorded for interest revenue accrued on December 31, 2019?
Interest Receivable 500, Interest Revenue 500.
What is the correcting entry made if Huggins discovers the interest revenue error?
Interest Revenue 500, Retained Earnings 500.
What was the error made regarding the omission of unearned revenue?
Recorded as Rent Revenue instead of Unearned Revenue.
What entry does Huggins make to correct the unearned revenue error if discovered in 2020?
Retained Earnings 10,000, Rent Revenue 10,000.
What is the impact of the correction to Huggins’s financial statements if the error is not discovered until 2021?
Restatement of 2019 and 2020 financial statements.
What is the cumulative difference between LIFO and FIFO inventory?
$70,000
This represents the difference in income before taxes as well.
What journal entry reflects the retrospective adjustment when changing from LIFO to FIFO?
Inventory: $70,000, Retained Earnings: $55,300, Deferred Tax Liability: $14,700
What does the increase in Retained Earnings represent after changing from LIFO to FIFO?
Cumulative effect of the change from LIFO to FIFO for 2018 and 2019, net of income taxes
What are the two methods of reporting accounting changes according to GAAP?
- Retrospective adjustment method
- Prospective method
What is a change in accounting principle?
A change from one generally accepted accounting principle to another
How is a change in accounting estimate defined?
A revision of an estimate used in the accounting process
What is a change in a reporting entity?
A change in the type of entity being reported
What are errors in accounting?
Mathematical mistakes, mistakes in GAAP application, or oversight of facts
What is the primary objective of financial reporting?
To provide useful information for decision-making by investors, lenders, and creditors
What is the retrospective adjustment method?
Requires revision of previously issued financial statements for comparative purposes
What is the prospective method?
Does not require adjustments to previously issued financial statements
How is a change in accounting principle accounted for?
By retrospective application of the new accounting principle
How is a change in accounting estimate accounted for?
Prospectively in the period of change and future periods if affected
What is the effect of a change in accounting estimate on financial statements?
Recorded in the period of the change and future periods
What is the initial adoption of a generally accepted accounting principle?
Does not include a change in accounting principle
What should be disclosed when a change in accounting principle occurs?
- Nature and reason for the change
- Description of prior period information
- Effect on income and other financial statement line items
- Cumulative effect on retained earnings
What is a counterbalancing error?
An error that is automatically corrected in the next accounting period
What is a noncounterbalancing error?
An error that is not offset in the next accounting period
What are the steps for correcting an error?
- Analyze the original erroneous journal entry
- Determine the correct journal entry
- Evaluate additional errors
- Prepare the correcting entry
What is the impact of failing to accrue a liability at the end of the period?
Understates interest expense and omits interest payable
What is the effect of a change in accounting principle on net income?
Increases or decreases based on the specific change
What is the direct effect of a change in accounting principle?
The amount by which prior years’ income is increased or decreased due to the change
What is the indirect effect of a change in accounting principle?
The impact on other financial statement items or accounts not directly related to the change
What must a company do if retrospective adjustment is impracticable?
Apply the new accounting principle prospectively
How is a change in accounting estimate illustrated using Harris Company?
Revised periodic depreciation expense calculated based on new estimates
What is the accounting treatment for errors affecting both the income statement and balance sheet?
Classified as counterbalancing or noncounterbalancing errors
What is the direct effect of a change in accounting principle?
The amount by which a company’s prior years’ income is increased or decreased specifically as a result of the change in accounting principle.
What is the indirect effect of a change in accounting principle?
The amount by which the company’s prior years’ income is affected by how the change in principle affects other elements of income.
In determining the amount of retrospective adjustment, what does a company recognize when both direct and indirect effects are present?
Only the direct effect (net of applicable income taxes).
What was the effect of the change from LIFO to FIFO on Werner Company’s 2020 net income?
$7,900 increase.
What was the increase in inventory for Werner Company as reported under FIFO for 12/31/2020?
$80,000.
What is the accounting treatment for a correction of a material error discovered in the current period?
It is accounted for as a prior period adjustment (prior period restatement).
List common issues involved in restatements.
- Revenue recognition
- Expense recognition
- Deferred compensation
- Liabilities and accrual estimate failures
- Cash flow statement classification errors
- Tax expense issues.
What effect did Loop Industries’ error have on its 2017 net loss?
An overstatement of $4,700,000.
How does GAAP define a change in reporting entity?
It results in financial statements that are those of a different reporting entity.
What must a company disclose when it makes a change in reporting entity?
A description of the change, the reason for it, and the effect on income before extraordinary items and related earnings per share.
What are the categories of errors that affect financial statements?
- Errors affecting only the balance sheet
- Errors affecting only the income statement
- Errors affecting both the income statement and balance sheet.
What is the first step in accounting for the correction of an error?
Compute the cumulative effect of the error on prior period financial statements.
What must be adjusted in financial statements when correcting an error?
Each item in each financial statement that is affected by the error.
What is the definition of a change in accounting estimate effected by a change in accounting principle?
A situation where a company changes from capitalizing a cost to recording it as an expense due to changes in estimated benefits.
What is the annual depreciation expense reported by Dowson for the year 2020 after changing its method?
$3,000.
True or False: A correction of an error is considered an accounting change under GAAP.
False.
What must be disclosed when financial statements have been restated due to an error?
A statement that previously issued financial statements have been restated and a description of the nature of the error.
What was the adjustment to Loop Industries’ common stock issuable after correcting the error?
$4,700,000 decrease.
What does ASC 718 impact in relation to stock-based compensation?
The timing of recognition of stock-based compensation expense.
Fill in the blank: A company accounts for the correction of a material error as a _______.
prior period adjustment.
