Chapter 22: Accounting Changes and Error Analysis

Question 1

Dark period

Answer 1

Length of time between a company’s discovery that it will need to restate financial data and the subsequent disclosure of the restatement’s effect on earnings.

Question 2

FASB approach to changes in accounting principle

Answer 2

Changes should be reported retrospectively and previous statements should be reissued as if new principle had always been used

Question 3

When it is impossible to determine between a change in estimate & a change in principle

Answer 3

Consider the change as a change in estimate

“change in estimate effected by a change in principle”

Question 4

Change in estimate vs correction of an error

Answer 4

As long as the original estimate was done carefully/ in good faith then it is a change in estimate

if lack of expertise or bad faith led to a bad estimate then it is a correction of an error

Question 5

Disclosures for changes in estimates

Answer 5

• If change effects several periods: disclose effect on income from continuing operations and per share amounts
• if change in estimate is driven by a changed principle then you must explain what the new principle is preferable

Question 6

Disclosures

Question 7

Disclosures for changes in estimates

Answer 7

• If change effects several periods: disclose effect on income from continuing operations and per share amounts
• if change in estimate is driven by a changed principle then you must explain what the new principle is preferable

Question 8

Disclosures for corrections of errors

Answer 8

• that a restatement has occurred
• the nature of the error
• the effect of the correction on line items and per-share amounts
• cumulative effect on retained earnings and other components of equity or net assets as of the beginning of the earliest period presented

Question 9

Retrospective Accounting change requirements

Answer 9

• adjust financial statements for each prior period presented (so all presented on same basis)
• adjust carrying amounts of assets and liabilities as of the beginning of the first year presented (1st year presented = cumulative total to that point). Adjustment to Retained Earnings to offset
• disclose in year of change the effect on net income and EPS for all prior periods presented

Question 10

Types of changes in accounting

Answer 10

1) change in accounting principle
2) change in accounting estimate (based on new information)
3) change in reporting entity
+
4) errors in financial statements

Question 11

Disclosures for change in accounting principle

Answer 11

• nature of and reason for the change - why it is a preferable principle
• method of applying change:
  a) description of adjusted prior period information
  b) effect of change on income from continuing operations, net income, per share amounts (current periods and restatements)
  c) cumulative effect on RE and equity

Question 12

Direct effects of changes in accounting principle

Answer 12

Should be retrospectively applied

change in principle directly results in change in balance in account

Question 13

Indirect effects of changes in accounting principle

Answer 13

Any change to current or future cash flows of a company that results from making a change in accounting principle that is applied retrospectively

Do not change prior period amounts - all accounted for in current period

Question 14

When retrospective application of accounting principle change is impracticable

Answer 14

• retrospective effects cannot be determined / requires assumptions about intent / requires significant / unverifiable estimates

accounting principle prospectively applied from earliest date practicable to do so

• disclose effect of change and reason for omitting performance amounts for prior years

Question 15

Change in accounting principle

Answer 15

FASB requires retrospective approach (recast previous statements as in principle was always used

Question 16

Reporting changes in accounting estimate

Answer 16

Reported prospectively

changes accounted for in:

1) the period of change (if it is the only period affected)
2) the period of change and future period

normal aspect of business - retrospective changes not allowed

Question 17

Changes in reporting entity

Answer 17

retrospective approach

change in financial statements for all prior periods presented to reflect information for new entity for those periods

Disclose nature of change and reason for it

show change in income from continuing operations, net income, and EPS in 1st report post change only

Question 18

Correction of accounting errors

Answer 18

small ‘r’ restatement approach

do as prior period adjustments
- an adjustment to the beginning balance of retained earnings

if comparative statement are presented should restate any prior statements affected

Question 19

questions for error analysis

Answer 19

1) what type of error is involved?
2) what entries are needed to correct for the error?
3) after discovery of the error, how are financial statements to be restated?

Question 20

Balance sheet errors

Answer 20

Errors affecting ONLY the balance sheet

When discovered reclassify account to proper position

if comparative statements prepared: restate balance sheet for error year

Question 21

Income statement errors

Answer 21

If discover error in year error accrued: make reclassification entry

if a prior period error: no reclassification entry as all accounts have been closed. if preparing comparative statements then will need to restate the pertinent year

Question 22

Errors that involve both balance sheet and income statement

Answer 22

classified as either:

• counterbalancing
• non-counterbalancing

Question 23

Counterbalancing errors

Answer 23

errors that will be offset/ corrected over two periods

• two years combine into correct net income

if books already closed:

• if error counterbalanced: no entry
• if error not yet balanced: adjusting entry to retained earnings

If books not yet closed:

• if error counterbalanced: entry to correct error AND adjust the beginning retained earnings balance
• if not yet balanced - adjust beginning balance of retained earnings

Question 24

Non-counterbalancing errors

Answer 24

Balance sheet and income statement errors that take more than two periods to correct themselves

Question 25

Changes to/ from the equity method

Answer 25

when level of ownership changes

To equity method: use retrospective method

From equity method: use prospective method

Question 26

Change FROM equity method TO fair value method

Answer 26

Level of influence/ ownership decreases

Previously recognized earnings/ losses remain as investment carrying amount

simply start using fair value method at next reporting date (FV adjustments to unrealized holdings gain/ loss - income)

Question 27

Dividends in excess of percentage of earnings

Answer 27

(question: is this only when changing from equity to fair value or is it always??)

Any dividends received that exceed share of earnings should be accounted for as reduction of investment carrying amount (liquifying dividend)

Question 28

Change FROM fair value TO equity approach

Answer 28

use prospective approach- period of change and following

• add cost of acquiring additional interest to the cost basis of the instrument

May end up doing:
Dr equity investment (portfolio)
Cr Equity investment (equity method)

reclassify and adjust to eliminate fair value adjustment account (use Retained earnings and FV adjustment)