FAR 2 Flashcards

Question

Wolf Company produces large pieces of machinery for use in the manufacturing industry. Blue Jay Manufacturing Company purchases a large piece of machinery from Wolf for use in Blue Jay's new production plant. Although Blue Jay could install the equipment on its own, management decides to include installation of the machinery in its contract with Wolf. Blue Jay agrees to a total contract price of $850,000 for both the equipment and the installation. Wolf does not offer a discount on the machinery if it completes the installation. The fair value of the equipment is $850,000, and its cost is $760,000. The fair value of the installation is $50,000, and the cost of the labor to Wolf is $40,000. How much of the contract price should Wolf allocate to the equipment and installation respectively? If a proportion is necessary, round to the nearest one hundredth of a percent (e.g..####) and round all answers to the nearest dollar. The table shows the following costs for Equipment and Installation: A's equipment is worth $850,000 and installation is worth $0. B's equipment is worth $800,000 and installation is worth $50,000. C's equipment is worth $807,500 and installation is worth $42,500. D's equipment is worth $802,740 and installation is worth $47,260.

Answer 1

Row D Wolf should allocate the total contract price of $850,000 to the equipment and the installation based on the proportion of fair value each component represents. The total fair value of the transaction is $900,000 ($850,000 fair value of the equipment plus $50,000 fair value of the installation). The equipment represents 94.44% ($850,000 / $900,000) of the fair value of the transaction, and the installation represents 5.56% ($50,000 / $900,000) of the fair value of the transaction. To allocate the transaction price to the equipment, multiply the total contract price by the proportion of the fair value the equipment represents ($850,000 × .9444). To allocate the transaction price to the installation, multiply the total contract price by the proportion of the fair value the installation represents ($850,000 × .0556). Wolf should allocate $802,740 to sales revenue from the sale of the equipment and $47,260 to service revenue from the installation.

Answer 2

Row B Because the machine and the installation are interdependent (installation requires unique knowledge that only Janelle Company possesses), there is only one performance obligation in this contract. Installation is not a separate performance obligation so it is not allocated a portion of the transaction price.

Answer 3

Identify distinct goods and/or services as separate performance obligations. Separate performance obligations should be identified based on goods and services that are distinct from each other. Once the separate performance obligations have been identified, then the transaction price may be allocated.

Answer 4

Able to be used by the customer on its own or with resources readily available to the customer and able to be separately identified from other promises in the contract. To be considered distinct, a good or service must meet two criteria. The customer must be able to benefit from the good or service on its own or with resources readily available, and the good or service must be distinguishable from other goods or services in the contract.

Answer 5

Calculating the proportion of the total stand-alone price represented by each performance obligation and multiplying the proportion by the total transaction price to allocate the transaction price to the separate performance obligations. The stand-alone prices for the performance obligations are totaled, and each stand-alone price per performance obligation is divided by the total of the stand-alone prices to calculate the proportion of the transaction price that will be assigned to each performance obligation. The total transaction price is multiplied by each proportion, and the resulting amount is allocated to the performance obligation.

Answer 6

Sales Returns and Allowances is a contra-revenue account. SR&A has a natural debit balance.

Answer 7

Commission revenue

Answer 8

Revenue from nonrefundable up-front fees should be recognized over the period that the goods or services are expected to be delivered. If the customer is expected to use the services for two years, then the revenue from the nonrefundable upfront fees is recognized evenly over the two-year period.

Answer 9

A bill-and-hold arrangement must meet the following criteria: 1. Substantive reason for the arrangement (e.g., customer's facility is not ready to receive the goods). 2. Seller separates the goods from other inventory and identifies them as belonging to the customer. 3. Goods are currently ready for transfer. 4. Goods cannot be used by or directed to another customer.

Answer 10

The agent facilitates the sales of goods or services to the customer. Goods or services are provided by the principal directly to the customer, and the agent facilitates the sale and connection between the customer and the principal. The agent will likely recognize commission revenue for facilitating the sale.

Answer 11

``` The journal entry at the inception of a servicetype warranty typically includes a: debit to cash or accounts receivable a credit to unearned warranty revenue (a liability account). ``` As the time covered by the servicetype warranty passes, the entity recognizes warranty revenue by: debiting the unearned warranty revenue account (this decreases the liability account) crediting warranty revenue

Answer 12

$12,000 By December 31, 20X3, two out of three years covered by the warranty have passed. The Unearned Warranty Revenue account would have one-third of the original amount left in it because Dot would recognize $12,000 of warranty revenue in each of the previous two years. $36,000 – $24,000 = $12,000 OR $36,000 × 1/3 = $12,000. Therefore, $12,000 in unearned warranty revenue would remain at December 31, 20X3.

Answer 13

Sales Returned and Allowances 50 Allowance for Sales Return and Allowances 50 Lavender expects 5 jars at $10 each ($50 total) to be returned. The adjusting journal entry on December 31 reflects the right of return by debiting Sales Returns and Allowances (a contra-revenue account) and crediting Allowance for Sales Returns and Allowances (a contra-asset account to Accounts Receivable).

Answer 14

$190,000 The effect of estimated returns is recognized in the month of sale. Net sales to be reported for the current month equal $200,000 less the returns expected on those sales (5%, or $10,000), or $190,000. The actual returns granted in the current month on previous months' sales were recognized as reductions in net sales in those previous months.

Answer 15

$675 Sara will recognize the $75 (10% of $750) commission expense and record the account receivable net of the commission expense amount.

Answer 16

$0 Sally does not recognize revenue until services have been provided. The nonrefundable up-front fee of $192 is recognized over the life of the contract, in this case, over 24 months.

Answer 17

1. The goods or services covered in the modification must be distinct from the original goods or services. 2. The consideration for the additional goods or services must reflect standalone pricing.

Answer 18

An entity may use a blended price approach. To calculate the blended price per product, the entity should multiply the remaining quantity of products from the original contract by the price from the original contract. Then the entity should multiply the additional quantity by the new price. The two resulting amounts are added together to calculate the total revenue left from the original contract and the contract modification. The total is divided by the total remaining quantity of product to be transferred.

Answer 19

Costs to fulfill a contract are recorded as an asset that is amortized over the contract period when the costs are directly traceable to the contract and are incremental (i.e., the costs would not have been incurred if the contract had not occurred).

Answer 20

A company may recognize “Forfeited Card Revenue” when the gift card has expired or when, based on past experience, the company deems that the customer has effectively forfeited the gift card.

Answer 21

In most cases, the initial franchise fee is recognized over the time period when the material services and conditions are provided by the franchisor. The fee is recorded as unearned revenue until the franchisor meets the conditions under the franchise agreement and recognizes the revenue.

Answer 22

$27,500. The finder's fee benefits the entire lease term and therefore is allocated evenly over the 10-year lease term. The finder's fee represents a direct, incremental cost that benefits more than one period. The slide shows the following calculation: Net rental income = rent revenue minus expenses associated with the property, that is 50,000 minus ($15,000/10 + $12,000 +$9,000) = $27,500.

Answer 23

$0 Before the franchisor (North) can recognize revenue, its activities pertaining to the franchise must be substantially complete. The earliest point at which substantial completion occurs is the commencement of operations by the franchisee. Operating activities will not begin until next year; therefore, North recognizes no fee revenue in the current year. The $10,000 received is recorded in a liability account.

Answer 24

I and III. For a new separate contract to be formed, the additional products must be distinct and the consideration for the additional products must reflect appropriate standalone pricing.

Answer 25

$21.67, the blended price for the products from the original contract and the modification. To calculate the blended price, 20 remaining products at $30 each represent revenue of $600 plus 25 additional products at $15 each represent revenue of $375. Total revenue left to be recognized over the remaining 45 products is $975. $975 divided by 45 products yields a blended price of $21.67 per product.

Answer 26

Recorded as an asset and amortized over four years The costs to fulfill the contract are a direct result of the contract so they are considered incremental. Because the contract is for four years, the company will benefit from the costs for a period exceeding one year. The costs should be recorded as an asset and amortized over the contract period of four years.

Answer 27

There is no effect.

Answer 28

When an overall loss is expected on the | contract

Answer 29

No revenue is recognized until the contract is | completed.

Answer 30

To avoid double counting of assets

Answer 31

Total gross profit through the period is less than the gross profit recognized in earlier periods and the current period profit is negative

Answer 32

Total revenue through year 2 based on the percentage of completion through year 2, less revenue recognized for year 1

Answer 33

The contra account is billings on contracts.

Answer 34

It is an inventory account—a current asset.

Answer 35

Cost recovery (zero-profit) method.

Answer 36

Total project cost less contract price, plus gross | profit recognized in previous years

Answer 37

Same as usual; total cost to date divided by | total estimated project cost

Answer 38

Percentage of completion | Completed contract

Answer 39

Overall loss, which is the total project cost less | the contract price

Answer 40

Recognize profit in proportion to the degree of completion. This method is required if estimates of the degree of completion at interim points can be made and reasonable estimates of the total project cost can be made.

Answer 41

$500,000 The project is 12.5% complete at the end of 20X5 ($2mn/$16mn). Total gross profit through the end of 20X5 is therefore $500,000 [= .125($20mn − $16mn)]. The $500,000 amount is the proportion of completion applied to the total contract profit of $4mn. 20X5 is the first year of construction; therefore no gross profit from previous years is subtracted. The entire $500,000 gross profit is recognized in 20X5.

Answer 42

$150,000 The gross profit recognized for the first two years must be computed first. Then, the difference between the $500,000 final total gross profit on the project (= $2.5mn − $2mn), and the gross profit for the first two years, is the amount of gross profit recognized in the last (third) year. The percentage of completion at the end of the first two years is 70% (= $500,000 + $900,000)/$2mn). The gross profit recognized through the end of year two is $350,000 [= .70($2.5mn − $2mn)]. Therefore, gross profit for year three is $150,000 (= $500,000 total gross profit on project − $350,000).

Answer 43

Total costs incurred to date to total estimated costs. The proportion of completion at the end of any year for a construction contract is the amount of work done, divided by the total amount of work required for the contract. Typically, cost is the measure of "work done." At the end of year three, the numerator is the cost incurred for all three years. The denominator is the total estimated cost of the project, which is the sum of (1) the cost incurred for all three years so far, plus (2) estimated costs to complete as of the end of year three. The percentage of completion changes each year, because both the numerator and denominator change. The gross profit to be reported for year three is the profit for all three years (using the proportion of completion just computed), less the profit already reported in the first two years.

Answer 44

Reduced $4,000 Total estimated project cost at the end of year 2 is $54,000 ($34,000 + $20,000). Note that this problem provides cumulative cost, rather than cost by year. There is an overall loss on this contract. Overall loss = $54,000 – $50,000 (contract price) = $4,000. Under the completed contract method, the overall loss is recognized immediately.

Answer 45

PC - Cost to date less overall loss CC - Cost to date less overall loss An overall loss is expected, because total estimated cost exceeds contract price. Under PC, the construction-in-progress account is increased by cost and gross profit. If the gross profit is negative (an overall loss), the loss is subtracted from construction in progress. The loss recognized in the year as overall loss becomes evident includes any previous profit. Therefore, the previously recognized gross profit is removed when the total loss is recognized. Under CC, the same idea applies, except that there is no gross profit from previous years to remove. The ending construction-in-progress balance is the same for both methods.

Answer 46

$0 The percentage of completion is ($2mn)/($2mn + $6mn) = 25%. This is the ratio of cost incurred to date, divided by the total project cost, which is the sum of cost to date and estimated remaining costs. Gross profit recognized is therefore .25($9mn − $2mn − $6mn) = $250,000. The contract price is $1mn more than the total estimated project cost. At 25% complete, the firm recognizes $250,000 of gross profit. The construction-in-progress balance is therefore $2mn + $250,000 = $2.25mn, the sum of cost to date, plus gross profit to date. With billings only $1.8mn so far, the firm reports a net asset equal to the difference between $2.25mn, the balance in construction in progress, and $1.8mn of billings. Billings are contra to construction in progress for reporting. This $450,000 difference is labeled "cost and profit in excess of billings on long-term contracts" in the balance sheet. No current liability is reported, because the asset balance (construction in progress) exceeds billings.

Answer 47

International standards require the cost recovery method when the percentage of completion method is not appropriate. Contrary to US GAAP, international standards require a modified version of completed contract—the cost recovery method, when the percentage of completion method is not allowed.

Answer 48

PC - −$142,000 CC - −100,000 The overall loss on this contract is $100,000—the excess of total estimated cost and contract price, as given in the problem. Under PC, the previously recognized gross profit (year one) must be removed. The $142,000 loss recognized in year two yields a $100,000 combined loss for both years—the amount of the overall loss. For CC, the overall loss is recognized immediately. There is no year-one gross profit to remove, because CC recognizes no gross profit until completion of the contract.

Answer 49

($1,000,000) With $2,000,000 actual costs incurred in year 1 and $6,000,000 of costs remaining, the firm expects to spend a total of $8,000,000 on this project. The contract price is $7,000,000. Therefore, the firm expects to lose $1,000,000 on this contract ($8,000,000 – $7,000,000). The entire loss is recognized even though the percentage of completion is only 25% ($2,000,000/($2,000,000 + $6,000,000)). With no previous years' profit, the loss recognized in year 1 is the full $1,000,000 (negative gross profit).

Answer 50

The cost to the firm of providing the pension benefits earned during the year.

Answer 51

Pension assets at market value

Answer 52

1. Discount rate | 2. Expected rate of return

Answer 53

1. Defined benefit | 2. Defined contribution

Answer 54

Plans can be contributory or | noncontributory.

Answer 55

Service cost to date + Interest cost to date − Benefits paid to date + Prior service cost +/− Net PBO gain or loss to date

Answer 56

Amount of required contribution not | paid

Answer 57

Accrual is the basis of accounting for | these plans.

Answer 58

Actuary | Trustee

Answer 59

1. Delayed recognition 2. Net reporting 3. Offsetting

Answer 60

Obligation for defined benefit plans; present value of unpaid benefits as of the balance sheet date

Answer 61

Fair value

Answer 62

Amount of pension expense reported if interest cost and expected return are equal. It is the present value of benefits earned for a period.

Answer 63

``` Growth in pension obligation for a period. Interest cost is the product of the projected benefit obligation at the beginning of year and the discount rate. ```

Answer 64

Expected return = Rate of return × | Beginning plan assets

Answer 65

Recognition of gains and losses for projected benefit obligation (PBO) and assets; amortization of previous net gain or loss

Answer 66

1. Changes in projected benefit obligation (PBO) 2. Difference between actual and expected return

Answer 67

The projected benefit obligation (PBO) | increases (PBO loss)

Answer 68

Service cost Service cost is included in compensation expense reported for the employees with whom the pension benefits are associated. Because the service cost component is included in the compensation expense line item, the subtotal for income from operations includes its effect.

Answer 69

Accumulated benefit obligation. Accumulated benefit obligation is the present value of all unpaid future retirement benefits as of the balance sheet date based on (1) service rendered to that date, and (2) current salary levels. Even if the pension benefit formula incorporates future salaries, accumulated benefit obligation uses current salary levels only to provide a more current measure of the pension liability.

Answer 70

$3mn pension asset. PBO and assets are netted for balance sheet reporting purposes. The firm has an overfunded plan and reports a $3mn asset ($23mn assets − $20mn PBO).

Answer 71

$50mn The beginning pension liability balance was $40mn ($200mn PBO − $160mn assets). With pension expense of $60mn and funding of $50mn, the pension liability increased an additional $10mn, yielding an ending pension-liability balance of $50mn ($40mn + $10mn). There is no information about amortization of PSC or net gain or loss, or difference between expected and actual return, or gain, loss or PSC during the period.

Answer 72

A liability of $6,100. The reported pension liability for a defined benefit pension plan is the difference between projected benefit obligation ($68,100) and the fair value of plan assets ($62,000), or $6,100. The two underlying amounts are reported in the footnotes, but are not recognized in the balance sheet. Only their difference, which is also the underfunded amount, is reported in the balance sheet as a liability.

Answer 73

At fair value. Fair value represents the most representationally faithful amount to be applied to pension obligation. Fair value is the current amount available for payment of pension benefits.

Answer 74

The statement of financial position. Funded status is the difference between projected benefit obligation and plan assets at fair value. Neither of these amounts is reported in the balance sheet (they appear in the notes only), but their difference is reported in the balance sheet as the reported pension liability for defined benefit plans. It is the amount the plan is "behind" in terms of having assets available for payment of benefits.

Answer 75

Liability of $200,000; asset of $300,000. Within the same firm, overfunded plans are not offset with underfunded plans because a plan's funds can be used only for the benefits payable under that plan. Plan A is underfunded $200,000 because its assets are less than its PBO—resulting in a pension liability. For plan B, the opposite occurs resulting in a pension asset of $300,000 ($1,000,000 plan assets − $700,000 PBO). Both amounts are reported separately.

Answer 76

$2.25mn This answer is the underfunded projected benefit obligation—the plan's funded status and most critical number for the pension plan. This is the amount shown in the balance sheet. It can also be an asset, if plan assets exceed projected benefit obligation.

Answer 77

$513,000 Reported pension liability is the difference between the projected benefit obligation (PBO) ($1,250,000) and the pension plan assets at fair value ($737,000). The difference is $513,000 and reflects the amount by which the pension plan is underfunded. This is shortfall of assets accumulated to pay benefits compared with the present value of those benefits or PBO, the main measure of the pension obligation. Only $737,000 of PBO is covered as of the balance sheet date.

Answer 78

Increase by the amount of pension | expense

Answer 79

Decrease by the amount of | contribution

Answer 80

There is no effect.

Answer 81

The pension information maintained in | the accounts.

Answer 82

The projected benefit obligation (PBO) | increases (PBO loss)

Answer 83

$1,652 Pension expense = $1,500 service cost + $280 interest cost (= $2,800 × .10) − $178 expected return + $50 amortization of PSC (= $500/10) = $1,652. When PSC is initially recorded, another comprehensive income account is debited for $500. The amortization of $50 credits that account and debits pension expense for $50.

Answer 84

PBO. Changes to PBO are recognized immediately. SC and interest cost are recognized as increases in pension expense and pension liability in the pension-expense entry. PSC, and PBO gains and losses are recognized immediately in the pension liability and other comprehensive income. PBO, however, is not recorded directly in one account; rather, it is reported in the notes to the financial statements.

Answer 85

A decrease in the liabilities of the entity. The plan is currently underfunded and remains underfunded after the asset increase. Reported pension liability is the underfunded amount, the difference between PBO and plan assets. This firm's reported pension liability decreased from $800,000 to $300,000 ($800,000 − $500,000) owing to the asset increase.

Answer 86

Retroactive increase in benefits for employee service already performed. This answer describes prior service cost (PSC). This increase in PBO is not merged with net gain or loss, but is rather treated separately, for purposes of computing pension expense. Amortization of PSC yields component 4; amortization of net gain or loss yields component 5.

Answer 87

$82,200 Projected benefit obligation (PBO), January 1, 2005 $72,000 Plus interest cost (growth in PBO), .10($72,000) $7,200 Plus service cost $18,000 Less benefits paid in 2005 ($15,000) PBO, December 31, 2005 $82,200

Answer 88

``` Beginning net gain or loss − Amortization of the beginning amount +/− Projected benefit obligation (PBO) change in the period +/− Asset gain or loss ```

Answer 89

The initial present value of the increased benefits for service already rendered

Answer 90

Decrease by the amount of | contribution

Answer 91

Straight-line or service method

Answer 92

This is a true statement.

Answer 93

Net gain or loss at the beginning of the | period

Answer 94

The projected benefit obligation (PBO) | increases (PBO loss)

Answer 95

Increase by the amount of pension | expense

Answer 96

Service cost to date + Interest cost to date − Benefits paid to date + Prior service cost +/− Net PBO gain or loss to date

Answer 97

The pension information maintained in | the accounts.

Answer 98

Service method.

Answer 99

1. Prior service cost | 2. Pension gains and losses

Answer 100

There is no effect.

Answer 101

Prior service cost (PSC) and PBO gains | and losses

Answer 102

Corridor (minimum) method

Answer 103

Recognition of gains and losses for projected benefit obligation (PBO) and assets; amortization of previous net gain or loss

Answer 104

They are recognized in other comprehensive income and pension liability

Answer 105

1. Changes in projected benefit obligation (PBO) 2. Difference between actual and expected return

Answer 106

The projected benefit obligation (PBO) | increases (PBO loss)

Answer 107

A debit balance of $70,000. Accumulated other comprehensive income (AOCI) is impacted by unexpected gains and losses from plan assets and unamortized portions of prior service costs from pension plan amendments. The net gain of $140,000 that has not previously been recognized in pension expense is reported as part of AOCI as a credit balance. The unamortized portion of prior service cost of $210,000 is reported as part of AOCI as a debit balance. The amount reported in AOCI related to the company's defined benefit pension plan is a net debit balance of $70,000.

Answer 108

$20,000 $20,000 is correct. Prior service cost is amortized over the average remaining life of the employees. The calculation of the average remaining service life of the employees is to add the remaining service lives of A (3 years), B (5 years), C (5 years), and D (7 years) for a total of 20 years and divide by the number of employees (20 years / 4 employees = 5 years). Therefore, the amortization of the prior service cost is $100,000 divided by 5 years, or $20,000.

Answer 109

Year 5, and following years only. Year 5 only is incorrect. Prior service costs are amortized over current (year 5) and future years.

Answer 110

$12,727 $12,727 is correct. The requirement is to determine the amount of net loss to be recognized as a part of net pension cost in Year 6. Under the corridor approach, only the unrecognized net gain or loss in excess of 10% of the greater of the PBO or the related fair value of the asset is amortized. In this case, the fair value ($1,650,000) is larger than the PBO ($1,530,000). The corridor is $165,000 (10% × $1,650,000). The unrecognized net loss ($235,000) exceeds the corridor by $70,000 ($235,000 – $165,000). This excess is amortized over the average remaining service period of active employees expected to participate in the plan ($70,000 / 5.5 = $12,727).

Answer 111

$454,000 $430,000 is incorrect. A defined benefit pension plan can have up to five components that must be used to determine net pension cost each year [service cost for the period, plus interest cost on the projected benefit obligation, minus expected return on plan assets, plus prior service cost amortization, and plus (or minus) amortization of actuarial unrealized losses (or gains)]. Here, there are four of these components. (1) The service cost for the year is $290,000. (2) The projected benefit obligation is increased from $3 million to $3.4 million by the prior service cost, so the interest on the projected benefit obligation is $3.4 million multiplied by 6%, or $204,000. (3) The income on the plan assets is $2 million multiplied by 4%, or $80,000. (4) The prior service cost is amortized to the net pension cost over the average remaining service life of the employees. That amortization increases the cost by $40,000 ($400,000 / 10 years). Hence, the net pension cost is $290,000 plus $204,000 less $80,000 plus $40,000, or $454,000.

Answer 112

$550,000 Under the corridor approach, the corridor amount is calculated as 10% of the greater of the beginning-of-year PBO or the beginning-of-year fair value of plan assets. In this case, the fair value of the plan assets ($5,500,000) is larger than the PBO ($5,000,000). Therefore, corridor should be calculated using the fair value of the plan assets. The corridor is $550,000 ($5,500,000 × 10%).

Answer 113

$17,500 The corridor approach is applied to determine the amount of net loss to amortize (recognize) as part of pension expense. Under the corridor approach, the unrecognized net gain or loss in excess of 10% of the greater of the beginning-of-year PBO or the beginning-of-year fair value of plan assets is amortized. In this case, the fair value of the plan assets ($5,750,000) is larger than the PBO ($5,525,000). Therefore, corridor should be calculated using the fair value of the plan assets. The corridor is $575,000 ($5,750,000 × 10%). To calculate corridor amortization, the amount in excess of corridor must be amortized over the remaining service period. $175,000 is the amount in excess of corridor ($750,000 – 575,000). This amount should be divided by the remaining service period to calculate the corridor amortization of $17,500 ($175,000 ÷ 10 years).

Answer 114

$85,000 Under the corridor approach, the corridor amount is calculated as 10% of the greater of the beginning-of-year PBO or the beginning-of-year fair value of plan assets. In this case, the fair value of the plan assets ($3,500,000) is larger than the PBO ($3,000,000). Therefore, corridor should be calculated using the fair value of the plan assets, not the PBO. The corridor is $350,000 ($3,500,000 × 10%), and the amount in excess of corridor is $85,000 ($435,000 – $350,000).

Answer 115

The entire PSC amount, at present value, is recognized immediately in pension expense. PSC is recognized immediately in pension expense and DBO.

Answer 116

``` Under IFRS, the discount rate used to compute interest cost must also be used to compute expected return on plan assets. Therefore, net interest cost is the difference between interest cost and expected return on plan assets. In contrast, under U.S. standards, expected return is based on any reasonable rate of return chosen by management. As a result, the asset gain or loss for IFRS will not be the same amount as per U.S. standards. ```

Answer 117

``` We know this is in regard to IFRS because of the terminology “past service cost” instead of “prior service costs” (U.S. GAAP). Under international standards, past service costs are expensed immediately in pension expense as part of service cost. ```

Answer 118

The entity that administers pension plans is required to separately provide accrual-based financial statements for the plans it administers.

Answer 119

``` Under international standards, pension expense is reported in separate components rather than as a single amount on the income statement. These components are: service cost (including past service cost) and net interest cost (interest cost netted against expected return). ```

Answer 120

Pension gains/losses for U.S. standards are called “remeasurement gains/losses” for international standards.

Answer 121

The firm's earnings will not be affected. Pension gains and losses are recognized immediately and in full in accumulated other comprehensive income. However, they are not subsequently amortized to earnings.

Answer 122

Other comprehensive income is immediately increased. OCI is increased through the increase in pension gains/losses—OCI.

Answer 123

Postretirement healthcare coverage

Answer 124

Accumulated postretirement benefit | obligation (APBO)

Answer 125

1. Service cost 2. Interest cost 3. Expected return on assets 4. Amortization of prior service cost 5. Amortization of net gain or loss at January 1 6. Amortization of transition obligation

Answer 126

``` When the benefits meet the four criteria of "Accounting for Compensated Absences." When the benefits do not meet those four criteria, then "Accounting for Contingencies" is followed. ```

Answer 127

``` When firms elected to recognize immediately the entire accumulated postretirement benefit obligation (APBO) as an accounting change, decreasing income in the year of transition ```

Answer 128

The basis is accrual.

Answer 129

``` Compute EPBO (present value of benefits expected to be paid); then multiply EPBO by the fraction of the required service period represented by service to date (yields accumulated postretirement benefit obligation [APBO]). ```

Answer 130

Full eligibility date

Answer 131

Full eligibility date

Answer 132

Service cost will not be computed for the employee during her last three years of service to the firm. The employee's full eligibility date occurs seven years from today. At that time, she is fully eligible for 75% coverage. The last three years of her service do not increase the level of her benefit. There is no additional service cost beyond that date, although interest cost will continue. If she were expected to work 15 years after today, her full eligibility would not occur until 15 years from now, at which time she would be fully eligible for 100% coverage and service cost would continue through that date.

Answer 133

$209mn Beginning post-retirement benefit liability equals $200mn ($300mn APBO − $100mn assets). Post-retirement benefit expense: $40mn SC + $15mn interest cost (.05 × $300mn) − $6mn expected return (.06 × $100mn) + $5mn amortization of PSC ($50mn/ten) − $2mn amortization of net gain ($20mn/10) = $52mn. Entry: dr. post-retirement benefit expense 52, dr. postretirement gain/loss-OCI 2, cr. PSC-OCI 5, cr. post-retirement benefit liability 49. There is a $4mn asset gain = $10mn actual return − $6mn expected return. Entry: dr. postretirement benefit liability 4, cr. postretirement gain/loss-OCI 4. Entry for actuarial gain: dr. postretirement benefit liability 16, cr. post-retirement gain/loss-OCI 16. Entry for funding: dr. post-retirement benefit liability 20, cr. cash 20. From the entries: ending post-retirement benefit liability = 200 beginning + 49 − 4 - 16 − 20 = 209. Alternatively, ending post-retirement benefit liability = $200mn beginning post-retirement benefit + $40mn SC + $15mn interest cost − $10mn actual return − $16mn actuarial gain − $20mn funding = $209mn.

Answer 134

Employee is fully eligible for benefits. Post-retirement healthcare benefits often are provided in terms of percentage of total coverage. For example, an employee may have to work 20 years to attain 50% healthcare coverage during retirement, and 30 years to attain 100% coverage. If the employee is expected to work 25 years, then the 50% coverage is the level built into the expense and liability computations, and the accrual period is the first 20 years of service. After serving 20 years, the employee earns no more benefit. Therefore, the full eligibility date is the date by which the employee has served the required number of years to attain the level of benefits the employee is expected to attain.

Answer 135

Per capita claims The per capital claims cost is the basis for computing the obligation reported for a post-retirement healthcare plan. These costs are estimated based on historical norms adjusted for estimated healthcare cost-trend rates and are affected by the estimated age of employees at retirement, their health, and other factors. Only post-retirement healthcare plans require this type of estimate. Pension benefits, for example, are based on variables such as age at retirement, number of years of service, and final salary. Both defined-benefit pension plans and post-retirement healthcare plans involve the other three answer alternatives. Both have service-cost and interest-cost components for their respective expenses, and both can incur prior-service cost.

Answer 136

Noncurrent asset. The excess of plan assets over the benefit liability (accumulated postemployment benefit liability or APBO) is reported as an asset and is classified as noncurrent. The plan assets and APBO are not reported separately but rather are offset. Given the long-term nature of such plans, the asset is classified as a noncurrent asset. Overfunded means plan assets exceed the plan's obligation. An asset is reported, and it is classified as noncurrent. When plan assets exceed the plan liability (an overfunded plan), the difference is reported as an asset. The asset and liability are not reported separately.

Answer 137

``` It provides an employee with the option to purchase shares of the employer firm's stock at a fixed price in the future, after a reasonable service period. ```

Answer 138

They are reported as a component of | income from continuing operations.

Answer 139

The fair value of options granted is estimated using an option pricing model at the grant date.

Answer 140

Grant date

Answer 141

The fair value at grant date of options | expected to vest

Answer 142

Higher prices yield higher fair values

Answer 143

The service period—grant date to first | exercisable date

Answer 144

``` Cash and owners' equity are increased by the cash paid in by the employees; retained earnings are reduced by the amount of compensation expense recognized. ```

Answer 145

There is no change in compensation | expense or owners' equity.

Answer 146

Expected forfeitures reduce total | compensation expense.

Answer 147

``` Compensation expense in a period of change is the amount resulting in total compensation expense through the period of change that equals the fraction of the service period elapsed multiplied by the new estimate of total compensation expense. ```

Answer 148

Stock option plans that stagger the | vesting dates

Answer 149

Treat as one plan or Treat each group with different vesting dates as separate plans.

Answer 150

``` At end of each period, recompute the total compensation expense based on the performance level expected to be achieved. Recognize the compensation expense for the period in the amount that results in total compensation through the period equaling the fraction of the service period elapsed times the new estimate of the total compensation expense. ```

Answer 151

Reverse the compensation expense and the associated owners' equity account for the amount of expense recognized in previous periods.

Answer 152

It is the same as for fixed stock option | plans if the target is met.

Answer 153

There is no change in compensation | expense or owners' equity

Answer 154

$500,000 Total share-based compensation expense is measured at the grant date by multiplying the number of options by the fair value of each option. The annual share-based compensation expense is calculated by dividing the total share-based compensation expense by the vesting or service period. The employees were granted 100,000 options, each of which had a fair value of $15 at the grant date. Total shared-based compensation expense is $1,500,000 (100,000 options multiplied by $15). Total shared-based compensation expense of $1,500,000 divided by the three-year vesting period results in an annual share-based compensation expense of $500,000. Assuming none of the employees forfeit their options, share-based compensation expense of $500,000 will be recognized at the end of years 1, 2, and 3.

Answer 155

Is based on the value of the option at the grant date, adjusted for forfeitures. The fair value of the option sets the compensation expense to be recognized for each option expected to be vested. Applying the forfeiture rate ensures that only options expected to be vested will be entered into the calculation.

Answer 156

The contributed capital increase from recording compensation expense is left intact. Expiration of stock options does not cause reversal of compensation expense because, at the grant date, the firm did provide value to the employee, given that the option had a fair value at that time. The expense recognized for stock option plans is not based on the expected value of the employee services; rather, it is based on the value of what was given by the employer to the employee. There is no retroactive adjustment reducing previous expense. Rather, the firm reclassifies the paid-in capital account generated from the stock option grant.

Answer 157

Date of grant. The fair value on the grant date is used for measuring compensation expense, because, on that date, the employer has given a resource of value to the employee. The vesting date is the date on which the award or option is no longer contingent on continued employment. The employee received value at the grant date. The exercise date is the last date on which the employee has any involvement with the option or award. The value is measured at grant date, the date the employer conveyed value to the employee.

Answer 158

$12,500 of compensation expense per year for four years. Total compensation expense is the product of the fair value of one option at the grant date ($5) and the number of options granted (10,000). The result is $50,000 of total compensation expense. This total is allocated equally to each year in the service period. The service period is the period from grant date to vesting date (first exercisable date), or 4 years. Annual compensation expense is $50,000/4 = $12,500.

Answer 159

The number of shares awarded times the market price of the stock at grant date

Answer 160

Paid-in capital from stock award.

Answer 161

``` Plans awarded for continuing employment, but the employee cannot sell the stock (the main restriction) until the award is vested, and the employee may not receive the shares until the award is vested. ```

Answer 162

1. Gross method | 2. Net method

Answer 163

Deferred compensation expense.

Answer 164

Reversal of previously recognized | compensation expense

Answer 165

The classification is Contra owners' | equity.

Answer 166

$13,500 Total compensation expense at grant date is $60,000 (3,000 × $20). The service period is four years (20x5 − 20x8). Annual expense recognized is $15,000 ($60,000/4). Through 20x6, a total of $30,000 of compensation expense is recognized. After the forfeit, only 2,900 shares remain to be awarded. Annual compensation expense for the remaining two years before considering forfeited shares is therefore $14,500 [(2,900 × $20)/4]. The expense for the two years associated with the 100 shares forfeited is $1,000 [(100 × $20)/2]. For 20x7, subtracting the reversal of the $1,000 yields $13,500 as the final amount of expense to be recognized. Another way to calculate the $14,500 is: ($60,000 original total compensation expense − $30,000 expense for x5 and x6 − $1,000 expense for x7 and x8 on forfeited shares)/2.

Answer 167

$175,000 Total compensation expense is computed as the fair value of the stock awarded, and is allocated evenly over the vesting period. The fair value at award date is the fair value used for this computation. The two awards are treated as separate awards, each with four year amortization periods. The total expense for year 2 is the sum of the compensation expense to be recognized for each plan for year 2 and is computed as 10,000($20)/4 + 20,000($25)/4 = $175,000. Total fair value is not updated after the award date.

Answer 168

The account credited is Liability.

Answer 169

``` Employee receives the difference between the stock price at grant date and the stock price at the exercise date. The employee pays nothing. The employee specifies the benefit in either cash or stock. ```

Answer 170

Number of rights times the difference between the stock price at date of exercise and the stock price at grant date

Answer 171

The difference between grant date | price and the price at exercise date

Answer 172

``` When the stock price falls to a level causing the total compensation expense through the end of the period to be less than the compensation expense recognized in previous periods ```

Answer 173

The total amount of compensation expense for a restricted stock award plan is determined at the grant date. Total compensation expense is the product of the number of shares in the award and the market price of stock at the grant date. This amount is recognized over the service period required for the employee to receive or keep the shares. Compensation expense is recognized over the service period required for the employee to keep the stock. No stock-based plan recognizes the total amount of compensation expense in one transaction. For stock-appreciation rights plans payable in cash, compensation continues until the exercise date, at which time the fair value of the right is known. The amount paid to the employee is the difference between the market price at exercise date and the stock price at grant date. Compensation recognized in a given reporting period can be negative (credited) if the total fair value of the plan declines to the point that compensation to be recognized through the current year is less than the compensation expense recognized in previous periods.

Answer 174

The amount of income tax expense that | is not currently due

Answer 175

The amount of income tax expense that is not currently due. It equals the net sum of the change in the deferred tax accounts.

Answer 176

The amount of income tax the firm | must pay on taxable income for a year.

Answer 177

Income before tax for tax purposes

Answer 178

Income before income tax for financial accounting purposes determined by applying generally accepted accounting principles

Answer 179

``` The amount of income taxes due for the year (same as income tax liability) ```

Answer 180

The process of measuring and recognizing the total income tax consequences of transactions in the year

Answer 181

``` The account reported in the income statement that measures the income tax cost for the year's transactions affecting income from continuing operations. It is the net sum of the income tax liability and the net change in the deferred tax accounts. ```

Answer 182

To recognize the amount of deferred tax liabilities and deferred tax assets reported for future tax consequences. From a financial reporting perspective, a primary objective of accounting for income taxes is to recognize and measure the deferred tax consequences (e.g. deferred tax assets and deferred tax liabilities) of temporary differences between pretax financial income and taxable income.

Answer 183

Report a net noncurrent deferred tax asset in the noncurrent assets section of the balance sheet. The company should report a net noncurrent amount on the balance sheet. Because the deferred tax asset is greater than the deferred tax liability, the two netted together result in an overall net noncurrent deferred tax asset amount.

Answer 184

Sum of the net changes in deferred tax assets and deferred tax liabilities. Total income tax expense is the sum of the current and deferred portions. The current portion is the income tax liability for the year. The deferred portion is the net sum of the changes in the deferred tax accounts. ``` Consider the tax-accrual entry for a year, assuming no estimated tax payments have been made: Dr. Income tax expense 20 Dr. Deferred tax asset 3 Cr. Deferred tax liability 5 Cr. Income tax payable 18 ``` Total income tax expense = 20 = current tax expense + deferred tax expense = $18 + $2 The $2 deferred tax expense equals the increase in the deferred tax liability of $5, less the increase in the deferred tax asset of $3.

Answer 185

Recognition of assets and liabilities. FAS 109 adopted the asset/liability approach. The deferred tax expense is the net change in the deferred tax accounts for the year. Deferred tax accounts are measured at the enacted tax rate for the period in which the future temporary differences reverse. Rather than base income tax expense on accounting income adjusted for permanent differences, as was the case before 109, income tax expense is now the sum of current income tax expense (the income tax liability for the year) and the net change in deferred tax accounts. The expense is a residual amount, based on the changes in assets and liabilities. Matching is no longer the conceptual basis for measurement.

Answer 186

Sum of the net changes in deferred tax assets and deferred tax liabilities. The net amount of deferred tax expense or benefit is that amount that is not recognized in current period income. A simple equation describes the total tax effects for a period: income tax expense or benefit + deferred income tax expense or benefit = current tax liability. The deferred income tax expense or benefit can further be described as the net change in both types of deferred tax accounts.

Answer 187

Current-year differences are used.

Answer 188

Income tax expense is not increased.

Answer 189

Tax-free interest income Life insurance expense premiums on key employee Proceeds from life insurance on key employee Dividends received deduction Fines and penalties

Answer 190

Income tax liability is not increased.

Answer 191

Income tax expense is not reduced.

Answer 192

The amount is $8,000.

Answer 193

The effect of a permanent difference on income tax expense is the same as its effect on the income tax liability for the period.

Answer 194

An amount that appears in the tax return or income statement but never both

Answer 195

$2,375 The future temporary difference at December 31, 20X4 is $9,500, the amount of insurance expense to be recognized for financial-reporting purposes. The entire $19,000 deduction was taken for tax purposes in 20X4. Therefore, no further deduction will be taken beyond 20X4. The difference is taxable, because future taxable income exceeds future pre-tax accounting income from transactions through 20X4. The deferred tax liability uses the future tax rate, because that is the rate at which the deferred taxes will be paid. The ending deferred tax liability for 20X4 = $2,375 = .25($9,500).

Answer 196

$0 Both listed items are permanent differences. These are differences that never reverse and are not used in the determination of deferred tax accounts. Both income tax expense and income tax liability are affected the same way by these items. A deferred income tax liability is based on future taxable differences at the end of the reporting year. There are no such differences. Therefore, there is no deferred tax liability.

Answer 197

A taxable temporary difference

Answer 198

An item of revenue or expense that, over the total life of the item, will affect pretax accounting income and taxable income in the same total amount but will be recognized in different amounts in any given year for financial reporting and tax purposes

Answer 199

1. Taxable temporary differences | 2. Deductible temporary differences

Answer 200

They cause deferred tax assets.

Answer 201

Differences that initially cause a | postponement in the payment of taxes.

Answer 202

Differences that initially cause a | prepayment of taxes.

Answer 203

Deductible difference.

Answer 204

Future reversing temporary differences | are used.

Answer 205

The future tax effect of a future | deductible difference

Answer 206

A temporary difference that causes future taxable income to be less than future book income

Answer 207

Taxable difference

Answer 208

$96,000 The tax liability is the tax rate times taxable income = .30($600,000 − $60,000 − $120,000 − $100,000) = $96,000. The municipal- bond interest is tax exempt, but included in pre-tax accounting income of $600,000 and therefore is subtracted when computing taxable income. The excess depreciation is also subtracted, because pre-tax accounting income reflects only depreciation recorded for financial accounting purposes. The proceeds on life insurance are included in pre-tax accounting income, but are not taxable and are therefore subtracted in computing taxable income.

Answer 209

I and II. Deferred tax liabilities are the future tax effects of future taxable temporary differences. Such differences cause future taxable income to exceed future pre-tax accounting income. I. An increase in pre-paid insurance implies that future accounting insurance expense will exceed future tax insurance expense. Therefore, future taxable income will increase relative to future pre-tax accounting income. This increases the deferred tax liability. II. An increase in rent receivable implies that future tax-rent revenue will exceed future accounting-rent revenue. A rent receivable is recorded when accounting-rent revenue is recognized before cash is received. Cash will be received in the future, which will be recognized as rent revenue for tax, but no revenue will be recognized for accounting. Therefore, again, future taxable income will increase relative to future pre-tax accounting income. III. An increase in warranty obligations implies that future tax-warranty expense will exceed future accounting-warranty expense. Accounting has recognized the warranty expense in the year of sale, whereas tax-warranty expense is recognized in the year the repairs are made. This time, future taxable income will decrease relative to future pre-tax accounting income. This increases the deferred tax asset, rather than the deferred tax liability. Therefore, only I and II increase the deferred tax liability.

Answer 210

Asset - No Liability - YES More profit will be recognized under completed contract in year three for tax purposes than will be recognized under percentage-of-completion in year three for accounting purposes. The entire profit will be recognized under completed contract (tax purposes) in year three. But a portion of income has already been recognized for accounting purposes before year three. Therefore, less income will be recognized in year three for accounting purposes. Consequently, at the end of year two, there is a future taxable difference because future taxable income will exceed future pre-tax accounting income. Taxable differences give rise to deferred tax liabilities.

Answer 211

$22,800 The tax liability is 30% of taxable income. Pre-tax accounting income $90,000 Plus advance rent $16,000 (taxable, but not included in pre-tax accounting income) Less municipal bond income ($20,000) (this is included in pre-tax accounting income, but is not taxable) Less depreciation for (10,000) tax in excess of depreciation for the books Equals taxable income $76,000 Times tax rate x .30 Equals income tax liability $22,800

Answer 212

An item is included in the calculation of net income in one year and in taxable income in a different year. This answer describes one category of temporary difference. In general, a temporary difference is one for which the item's recognition takes place at a different rate or time for financial reporting and the tax return. However, the total impact of the item is the same over its life, for both systems of reporting.

Answer 213

Product of permanent difference and stated rate divided by pretax accounting income

Answer 214

Enacted future tax rates (which would be the same as the current tax rate if rates have not been changed)

Answer 215

Taxable income excludes them; this exclusion is reflected in income tax expense—a plug figure.

Answer 216

It considers current-period temporary | and permanent differences.

Answer 217

It is a derived amount or plug figure, the net change caused by the changes in deferred tax accounts and the income tax liability

Answer 218

$8,750 The deferred tax liability is based solely on the depreciation temporary difference. Permanent differences do not enter into the determination of deferred tax accounts. This is the first year of operations. Therefore, the depreciation difference in this year must equal the net future temporary difference. The deferred tax liability balance at the end of the year is therefore $8,750 ($25,000 × .35). Future enacted tax rates are used because they are the rates that will be in effect when the future tax consequences will be realized. The permanent difference should not be included in the computation. Deferred tax accounts reflect the anticipated effect of future temporary differences only. Depreciation is the only difference to be considered in this question.

Answer 219

$10,000 The deferred tax liability ending balance in this problem equals the change in the deferred tax liability for the period, because the firm adopted SFAS No. 109 in this period. The change in the deferred tax liability is the future tax effect of the amount of income from the investment that is expected to be taxable in the future, using enacted tax rates. That amount is $10,000 = .25(.20)(.40)($750,000 − $250,000). The ($750,000 − $250,000) amount represents the total future earnings difference between tax and book accounting. The .20 represents the proportion of income that will ultimately be taxed, and the .25 is the future enacted tax rate. The .40 is the proportion ownership. The final result, $10,000, is the anticipated future tax liability, based on current transactions.

Answer 220

$9,000 The deferred tax liability is the future enacted tax rate, multiplied by the future taxable temporary difference. The future temporary difference is the amount of income from the investment, based on Rex's earnings through 20X5 only, that is expected to be taxable in the future, using enacted tax rates. No additional income for financial-accounting purposes will be recognized on Rex's 20X5 income, because the equity method has recognized Bart's entire share in 20X5. The future temporary difference is (.20)(.30)($900,000 − $300,000). Rex has paid $300,000 dividends so far and will pay the remaining $600,000 in the future. Bart's share is 30%, and only 20% will be taxed, owing to the dividends-received deduction. Multiplying that future temporary difference by the future tax rate of .25 yields the ending deferred tax liability of $9,000 = .25(.20)(.30)($900,000 − $300,000). The future tax rate is used, because that is the rate applicable when the difference reverses.

Answer 221

$39,000 The life-insurance proceeds represent a permanent difference and therefore do not contribute to the deferred tax liability. Only temporary differences affect deferred tax accounts. The future temporary differences for depreciation are multiplied by the enacted tax rates in effect in the reversing period. The $39,000 ending deferred tax liability for 20X5 is the sum of the tax effects of these differences: [$50,000(.35) + $40,000(.35) + $20,000(.25) + $10,000(.25)] = $39,000. The future enacted rates are used because those are the rates in effect when the differences reverse.

Answer 222

28.5% The effective tax rate is the ratio of income tax expense to pre-tax accounting income. income tax expense equals income tax liability in this case, because there are no temporary differences. Both the interest revenue and life-insurance premiums are permanent differences. The income tax liability is the product of the income tax rate and taxable income. Taxable income is $190,000 ($200,000 − $20,000 non-taxable interest included in the $200,000 + $10,000 non-deductible insurance premiums subtracted from $200,000). The income tax liability (and income tax expense) equal $57,000 (.30 × $190,000). The effective tax rate is .285 ($57,000/$200,000).

Answer 223

$84,000 income tax expense reflects the tax effects of permanent differences as measured by the tax code. Because there are no temporary differences, income tax expense equals the income tax liability for the period or: $.30($280,000) = $84,000. This reflects the tax ultimately payable on 20X5 transactions. Therefore, income tax expense should also reflect that amount, in the absence of temporary differences.

Answer 224

Change in income tax rate for 20X5. Current income tax expense is the income tax liability for the year. A change in 20X5's tax rate changes the tax on taxable income and therefore current income tax expense. A change in the 20X6 tax rate, even if enacted in 20X5, would not change current income tax expense. It would change deferred income tax, however. The other two answer alternatives are amounts that must be paid in 20X5, but are not recognized as current income tax. These amounts are separately payable to the taxing authority and are not computed as part of taxable income for 20X5. Therefore, current income tax for 20X5, which is income tax liability for 20X5, is unaffected by these items.

Answer 225

$18,000 The only difference between taxable income and accounting income that results in a future tax benefit is the estimated warranty costs. The future tax benefit is $18,000, which is computed as .30($60,000). In the future, $60,000 of warranty costs will be deductible, yet these costs have reduced accounting earnings as of December 31, Year 1. Therefore, future taxable income will be reduced by $60,000 as a result of transactions through December 31, Year 1. That benefit is recorded as a deferred tax asset. The $18,000 amount reduces Year 1 income tax expense relative to income tax payable, because the payable does not reflect the warranty deduction in Year 1. It is not deductible until later years. The insurance premiums and municipal-bond interest are permanent differences and do not result in future tax benefits.

Answer 226

$23,400 The current provision for income taxes is the tax liability for the year: taxable income times the tax rate. Taxable income = $100,000 + $8,000 − $35,000 + .20($25,000) = $78,000. Therefore, current income tax expense (also the firm's tax liability) is $23,400 ($78,000 × .30). The $8,000 is added to pre-tax accounting income, because the latter income amount reflects $8,000 more depreciation than should be reflected in taxable income. The $35,000 is subtracted, because it is included in pre-tax accounting income, but is not included in taxable income. Only 20% of the dividends received is taxable owing to the 80% dividends-received deduction. The equity in income of the investee is not taxable income.

Answer 227

It decreases the required ending | deferred tax liability balance.

Answer 228

Income tax liability +/− Change in the | deferred tax accounts

Answer 229

Required ending deferred tax liability balance – Beginning deferred tax liability balance

Answer 230

Both current and future enacted tax | rates are reflected.

Answer 231

It is the product of the sum of future taxable differences and the future enacted tax rate.

Answer 232

The average future enacted tax rate is used to determine the change in deferred tax accounts.

Answer 233

$8,000 The total future taxable difference at the end of 20X5 is $20,000. Therefore, the balance in the deferred tax liability account is .40($20,000) = $8,000. Taxes payable in the future (after 20X5) will increase $8,000 as a result of transactions in 20X5 and earlier.

Answer 234

$162,500 Total income for the three years under the two methods is: Percentage-of-completion: $1.75mn ($300,000 + $600,000 + $850,000) Completed-contract: $1,100,000 ($400,000 + $700,000) Difference $650,000 This difference is also the future difference in earnings to be recognized under the two methods, because both methods ultimately recognize the same total amount of income. Completed contract (for tax purposes) will recognize $650,000 more income than percentage of completion (for book purposes) after 20X5. Therefore, the difference is taxable and gives rise to a deferred tax liability of $162,500 ($650,000 × .25). The future enacted tax rate is applied, because that is the rate at which the deferred tax liability will be paid.

Answer 235

$24,000 The $24,000 current tax liability is the current tax rate times taxable income: $24,000 = .30($100,000 − $20,000).

Answer 236

$153,000 The current provision for income tax, also called the tax liability for the year, is the current tax rate multiplied by taxable income: .34 × $450,000 = $153,000.

Answer 237

There should be no reduction in Miro's deferred tax liabilities or deferred tax assets in 2002. A change in method of depreciation is treated as an estimate change. The remaining book value is allocated over the remaining useful life of the asset. Therefore, the total future difference between book and tax depreciation as of the beginning of 20X2 remains unchanged. That difference is $18,000, the difference between book and tax depreciation through the end of 20X1. The pattern of reversal of this difference in the future has changed owing the change in method, but the total difference remains unchanged. Therefore, there is no reduction in the deferred tax asset at the beginning of 20X2.

Answer 238

$51,600 The current portion of income tax expense is the tax liability for the year. The tax rate for the current year is applied to taxable income to compute this amount: .40($129,000) = $51,600.

Answer 239

$41,000 Income tax expense for the year is a derived amount and is the net sum of the income tax liability and the changes in the deferred tax accounts for the year. The income tax liability is the product of taxable income and the current-year tax rate, or $120,000(.35) = $42,000. The changes in the deferred tax accounts are the differences between the beginning and ending balances of those accounts. From the data, the deferred tax liability increased $5,000 for the year and the deferred tax asset increased $6,000. With the two liabilities increasing a total of $47,000 and the deferred tax asset increasing $6,000, income tax expense is the difference, or $41,000. ``` The tax accrual journal entry is: dr. Income tax expense 41,000; dr. Deferred tax asset 6,000; cr. Deferred tax liability 5,000; cr. Income tax payable 42,000. ``` The increase in the deferred tax asset represents a future reduction in income tax recognized in income tax expense for the current year. The increase in the deferred tax liability represents a future increase in income tax recognized in income tax expense for the current year.

Answer 240

``` 1. History of unused net operating losses 2. History of operating losses 3. Losses expected in future years 4. Very unfavorable contingencies 5. Very brief carryback or carryforward period ```

Answer 241

The classification is contra deferred tax | asset.

Answer 242

Expectation of future taxable income Taxable income in prior years within the carryback period Future taxable differences Tax planning strategies

Answer 243

Enough to reduce deferred tax asset to amount that has a better than 50% chance of being realized.

Answer 244

When there is a 50% or less chance of the deferred tax asset being fully realized

Answer 245

$900 (deferred tax asset balance is $1,200, but only $300 is expected to be realized)

Answer 246

It suggests that the deferred tax asset | will not be realized.

Answer 247

$10,000 Income tax expense is the net sum of the income tax liability for the year, the changes in the deferred tax accounts, and the change in the valuation account for deferred tax assets. Tax liability (current portion of income tax expense): $13,000 Less increase in deferred tax asset: $20,000 − $15,000 ($5,000) Plus increase in valuation account: .10($20,000) $2,000 Equals income tax expense $10,000 The increase in the deferred tax asset causes income tax expense to decrease relative to the tax liability, because, as a result of transactions through the end of the current year, future taxable income will be reduced. This reduction is not realized in the current year as a reduction in the tax liability. Therefore, the anticipated future reduction is treated as an asset at the end of the current period. When realized, the asset is reduced in a future year. The increase in the valuation allowance, which is contra to the deferred tax asset, reduces the deferred-tax-asset effect, because it is an amount of the deferred tax asset not likely to be realized.

Answer 248

``` Recognize a reduction in income tax expense for the largest amount for which the cumulative probability of realization exceeds 50%, and recognize an additional liability for the unrecognized portion. ```

Answer 249

Reduce the income tax expense for the difference between the benefit recognized in the previous year and the actual benefit.

Answer 250

A position taken on the firm's tax return that reduces income tax but that may be challenged by the taxing authorities

Answer 251

Reduce the income tax expense for the difference between the benefit recognized in the previous year and the actual benefit.

Answer 252

Report a liability for the uncertain tax position in addition to the income tax liability.

Answer 253

Greater than 50%

Answer 254

$2,000 decrease. Income tax expense was reduced two years ago by $20,000, but the final benefit upon resolution is $22,000. The $2,000 increase in benefit is recognized in the year of resolution. The resolved benefit exceeds the $20,000 benefit taken previously. The firm has been awarded a $2,000 tax reduction, not yet recognized. This amount is recognized in the current year. $20,000 of the benefit was recognized two years ago. Only the additional $2,000 is recognized in the current year as a change in estimate.

Answer 255

$25,000 This is the largest amount, which has at least a 50% probability of occurring. The cumulative probability through this amount is 60%. A liability is recognized for the $15,000 of the total $40,000, which has less than a 50% chance of occurring. The purpose of the cumulative probability approach is to identify the largest amount, which has at least a 50% probability of occurring. In this case, the amount is $25,000. There is a 60% chance of at least that much benefit occurring.

Answer 256

The classification is all noncurrent.

Answer 257

Both the carryback-carryforward option and the carryforward-only option.

Answer 258

They have no effect; taxable differences | yield deferred tax liabilities.

Answer 259

It is the product of the future enacted tax rate and the sum of future deductible differences plus unused NOL carryforward.

Answer 260

Two years back, 20 years forward

Answer 261

DR: Deferred Tax Asset | CR: Income Tax Benefit

Answer 262

End-of-period sum of future deductible differences plus unused NOL carryforward, times future enacted tax rate, less beginning deferred tax asset

Answer 263

DR: Refund Receivable | CR: Income Tax Benefit

Answer 264

It increases net income.

Answer 265

Apply interperiod tax allocation as usual; there are no beginning deferred tax balances to use.

Answer 266

It is the product of the enacted future tax rate and NOL remaining to carryforward.

Answer 267

An expectation of higher future tax | rates

Answer 268

The effective length of the taxing | period is 23 years.

Answer 269

The carryback-carryforward option

Answer 270

The tax rate paid on taxable income for | the previous two years.

Answer 271

Carryback carryforward option | Carryforward-only option

Answer 272

False. The total of all deferred tax assets and deferred tax liabilities must be disclosed.

Answer 273

Include in the ending DTA the full NOL multiplied by the future enacted tax rate.

Answer 274

It is the product of enacted future tax rate and the net operating loss (NOL) remaining to carryforward.

Answer 275

Include in the ending DTA for the portion of NOL remaining after being used in the carryback multiplied by the future enacted tax rate.

Answer 276

Close the accounts against income tax expense (e.g., closing a deferred tax asset increases income tax expense).

Answer 277

The taxable income two years before the year of the NOL is used first, then one year before the NOL

Answer 278

Negative taxable income (strictly a tax | term)

Answer 279

Deferred income tax expense is the net change in deferred tax accounts for the year. Because the firm began the year without any deferred tax accounts, that change equals the net sum of the ending deferred tax accounts for 20X4. Enacted tax rates are used to compute the change in deferred tax accounts. Ending deferred tax liability (from depreciation temporary differences): $2,000(.25) − $1,200(.30) $140 Less ending deferred tax asset (from warranty temporary difference): $300(.25) + $100(.30) ($105) Equals net change in deferred tax accounts, and deferred income tax expense $35 The 20X5 temporary difference for depreciation is subtracted from the 20X6 difference, because the 20X5 difference is an originating difference, whereas the 20X6 difference is the reversing difference.

Answer 280

Income from continuing operations. The tax benefit of the carry-forward reduced taxes on Year 2 income from continuing operations, as indicated in the question. Therefore, the benefit is included in income from continuing operations.

Answer 281

($2,400) The unused net operating loss (NOL) at the beginning of the year is $20,000 (= $6,000/.3). The firm pays no tax for the current year, because $12,000 of the NOL is used to absorb the $12,000 of taxable income. $8,000 of the NOL remains to carry forward to the next year. Also, there is a future temporary difference of $20,000 from the future warranty deduction ($30,000 − $10,000 current-year claims). In total, then, the basis for the ending deferred tax asset is $28,000 (= $8,000 + $20,000). The ending deferred tax asset balance is $8,400 (= $28,000 × .3). The beginning deferred tax asset balance is $6,000. Therefore, the deferred tax asset is increased by $2,400 and income tax benefit of that amount also is recorded (credited) in the tax-accrual entry.

Answer 282

I and III only. Deferred income tax accounts are not affected by permanent differences, because their effect on income tax is the same as their effect on income tax liability. But temporary differences and operating loss and tax-credit carry-forwards produce deferred tax accounts. Temporary differences cause both deferred tax liabilities and assets to be recognized. Operating loss and tax credit carry-forwards generate only deferred tax assets. To fully understand the nature of deferred tax accounts, the types and amounts of I and III are reported in a detailed footnote. For example, depreciation differences are major causes of deferred tax liabilities.

Answer 283

1. Retrospective | 2. Prospective

Answer 284

Retrospective (restatement)

Answer 285

Retrospective

Answer 286

Comparability

Answer 287

``` A change from one generally accepted accounting principle to another when there are at least two acceptable principles or when the current principle used is no longer generally accepted. ```

Answer 288

Prospective

Answer 289

1. Change in accounting principle 2. Change in accounting estimate 3. Change in reporting entity

Answer 290

Accounting principle changes | Error corrections

Answer 291

Retrospective method

Answer 292

First day of the year of change

Answer 293

Change in estimate

Answer 294

As an adjustment to the beginning Year 2 inventory balance with an offsetting adjustment to beginning Year 2 retained earnings Changes in accounting principles are applied retrospectively. Therefore, the beginning inventory of the earliest year presented is adjusted as if FIFO had always been applied. The earliest year presented is Year 2. Therefore, the beginning inventory and beginning retained earnings of Year 2 would be adjusted for the cumulative effect of the principle change.

Answer 295

As a Prior period adjustment (net of tax), by adjusting the beginning balance of retained earnings. The accrual basis of accounting is required by GAAP. A change from an inappropriate method to the correct method is treated as an error correction. The procedure requires retrospective application, resulting in an after-tax cumulative adjustment to prior years' earnings (called a Prior period adjustment) to the beginning balance in retained earnings.

Answer 296

As a component of income from continuing operations, in the period of change and future periods if the change affects both. When an accounting principle change cannot be distinguished from an estimate change, it is accounted for as an estimate change. Changes in accounting estimate are accounted for currently and prospectively and are reported in income from continuing operations. The relevant accounts affected by the change are adjusted for the current and future years. The change is not retroactively applied.

Answer 297

Completed-contract method of accounting for long-term construction-type contracts to the percentage-of-completion method. Accounting-principle changes such as this one are recorded by retroactively restating prior-year financial statements. The entry to record the change results in an adjustment to the beginning balance of retained earnings in the year of the change. Changes in depreciation method are treated as estimate changes. There is no catch-up adjustment. Longer useful life of equipment to shorter useful life is an estimate change and is handled currently and prospectively. Retained earnings are not adjusted and no catch-up adjustment is recorded. Cash basis of accounting for vacation pay to the accrual basis would be accounted for as a correction of an error. The accrual basis is the required method of accounting for vacation pay. The change from an erroneous accounting principle to the correct one is an error correction and would require restatement of Prior period financial statements and Prior period adjustment if prior years' earnings were affected. The accounting treatment for error corrections and principle changes is similar, however.

Answer 298

$50,000 The failure to accrue warranty expense is an accounting error. It gives rise to a Prior period adjustment in the year of discovery (2004). Prior period adjustments are limited to corrections of errors affecting prior-year net income. They adjust the beginning balance of retained earnings in the year of correction. The change in depreciation method is an estimate change, which is reported in earnings. It is not a Prior period adjustment.

Answer 299

Prior period adjustment resulting from the correction of an error. The cash basis of accounting is not acceptable under GAAP. Therefore, the change to the accrual basis is a change from an unacceptable method or basis of accounting to an acceptable method or basis. Such a change is treated as an error correction, which is reported as a Prior period adjustment. This adjustment is to the beginning balance in retained earnings for the current year. Prior period adjustments do not result from changes in accounting principle. Although retained earnings is adjusted, the adjustment is a Prior period adjustment, rather than a cumulative effect of accounting principle change. The correction does not affect current-year income at all. Rather, it is treated as a Prior period adjustment, which is an adjustment to the beginning balance of current-year retained earnings. The FASB has eliminated the category for extraordinary gains and losses, therefore extraordinary items no longer exist.

Answer 300

Retained earnings

Answer 301

``` Retained earnings (cumulative effect of change) ```

Answer 302

The difference in inventory balance for the new and old methods, at the beginning of the year of change

Answer 303

The pretax cumulative effect multiplied | by the tax rate

Answer 304

The effect of the change on years | before the earliest year reported

Answer 305

Change to last in first out (LIFO)

Answer 306

$5,000 decrease. The cumulative effect is computed as of the beginning of the year of change (2005), because the new method (WA) is used in 2005 to compute cost of goods sold and ending inventory. The pre-tax effect of the change on the previous three years is the difference between ending 2004 inventory under the two methods. The only income account affected by the method change is cost of goods sold. The cumulative effect adjusts the beginning of 2005 retained earnings balance. At the beginning of operations in 2002, there was no beginning inventory. Purchases are the same under either method. Therefore, the difference in cost of goods sold and therefore pre-tax income for the three years between the two methods is $5,000 = ($83,000 − $78,000). WA recognizes more cost of goods sold. Therefore, the cumulative effect reduces 2005 pre-tax income by $5,000.

Answer 307

$4,200 $6,000 is the cumulative pre-tax income difference between the two methods as of January 1, 2005. The after-tax difference is .70($6,000) or $4,200. Accounting changes are measured as of the beginning of the year of change. The $6,000 represents the total difference in cost of goods sold between the two methods for the entire life of the firm, because under weighted-average, the firm has $6,000 more in inventory than under FIFO at January 1, 2005. This is the "ending" inventory for that firm, as of that date, for the firm's entire existence. The $6,000 difference completely explains the pre-tax difference in income under the two methods for years up to January 1, 2005; the $4,200 is the after-tax difference. Cumulative effects are reported net of tax as an adjustment to the beginning balance of retained earnings in the year of the change.

Answer 308

Adjustment to retained earnings. Accounting-principle changes are reported as an adjustment to retained earnings at the beginning of the year of change. Prior financial statements are retrospectively adjusted. Accounting-principle changes are not classified as Prior period adjustments (adjustments to the beginning retained earnings balance). Only corrections of errors in prior-year income are classified as Prior period adjustments.

Answer 309

Prospective

Answer 310

Estimate change

Answer 311

None (The prospective approach is | applied.)

Answer 312

The new information triggering the | change is not applicable to prior years.

Answer 313

``` Prospective approach (same as estimate change) ```

Answer 314

Compute book value at the beginning | of the year of change.

Answer 315

Effect of the change on income from continuing operations and net income for the year of change

Answer 316

The change in estimate is applied as of the beginning of 2005 for current and future periods. This is an accounting-estimate change. These accounting changes are handled currently and prospectively by applying the new estimate to the current and future periods, if affected. The effect of the change on prior years' earnings is not computed, because the new information causing the estimate change was not known at that time. Cumulative effects are reported for accounting principle changes, not estimate changes, because the effect of the change on prior years is computed and reported for accounting principle changes only.

Answer 317

$292,000 This is a change in estimate. The new estimated useful life and salvage value are applied to the book value at the beginning of the year of the estimate change. Accumulated depreciation, January 1, 2005 = $528,000(3/8) = $198,000 Book value, January 1, 2005 = $528,000 − $198,000 = $330,000 Depreciation, 2005 = ($330,000 − $48,000)/(6 − 3) = $94,000 Accumulated depreciation, 31 December 2005 $292,000 The denominator of the 2005 depreciation calculation (6 − 3) is the new total useful life of six years, less the three years for which the asset has been used as of January 1, 2005.

Answer 318

Estimate change recognizing $4,000 of depreciation in year 3. A change in depreciation method is accounted for as an estimate change. The remaining book value at the beginning of the year of change is allocated over the remaining useful life using the new method. Book value January 1, year 3 = $50,000 - ($50,000/10)2 = $40,000. Estimated remaining machine hours at January 1, year 3 = $50,000 − $8,500 − $3,500 = $38,000. Depreciation expense for 2005 = 3,800($40,000/38,000) = $4,000.

Answer 319

$600 The book value at the beginning of the year of the change in estimated useful life is used as the base for subsequent depreciation. After four years, the book value remaining is one-fifth of its original cost, because there is no salvage value and the firm uses SL depreciation. That remaining book value is spread equally over four more years, yielding $600 of depreciation in each of those years. Book value at the beginning of year five = $12,000 − 4($12,000/5) = $2,400. Depreciation expense for year five = $2,400/4 = $600. The four years remaining include year five.

Answer 320

Cumulative effect of accounting principle change - NO Deferred income tax adjustment - NO The change in expected service life is an accounting-estimate change. These are handled currently and prospectively. No attempt is made to compute the effect of the change on prior years' income, because the new information was not available at that time. With no catch-up adjustment, there is no change in deferred taxes, because future differences between book and tax depreciation have not been changed.

Answer 321

Whenever it is impossible to determine whether a change in accounting estimate or a change in accounting principle has occurred, the change should be considered a change in estimate. When it is impossible to determine whether the change is an estimate or a change in accounting principle, the change should be considered a change in estimate and accounted for prospectively.

Answer 322

$489,600 This is a change in accounting estimate. The beginning 2007 patent balance is $714,000(12/15) = $571,200, because three years of amortization would have been recorded as of that date, based on 15 years. Amortization in 2007, therefore, is $571,200(1/7) = $81,600. As of the beginning of 2007, only seven years remain in the useful life, because the total useful life as of that date was changed to ten years, and the patent had been used for three years as of that date. Therefore, the ending net balance in the patent is $571,200 − $81,600 = $489,600.

Answer 323

$5,000 The asset has a depreciable base of $46,000-$1,000=$45,000. The depreciation expense for years one through four is $45,000/12=$3,750. Accumulated depreciation after four years is $3,750 × 4 =$15,000. The carrying value after four years is $46,000-$15,000=$31,000. Depreciation based on the new estimated useful life is $31,000-$1,000 = $30,000 for the depreciable base. The remaining useful life is 10-4=6 years. Depreciation for the current year is $30,000/6 = $5,000.

Answer 324

By restating the financial statements of all prior periods presented. The elimination of foreign-currency controls would legitimately change the status of the foreign sub from non-consolidated to consolidated. This causes a change in the reporting entity, since both companies must now be reported together. A change in reporting entity utilizes the retrospective method.

Answer 325

Retrospective

Answer 326

All years before the earliest year in the | statement affected by the error

Answer 327

Change in retained earnings for error | corrections

Answer 328

All years affected by the error through | the beginning of the year of change

Answer 329

Prior-period adjustment

Answer 330

In the period of change and future periods if the change affects both. Accounting-estimate changes are treated currently and prospectively (in the future). If the change affects only the current period, then only current-period earnings is affected. More frequently, though, the change affects future periods as well. Then, current and future earnings are affected. An estimate change is never treated retroactively. Prior-year earnings are never adjusted for a change in estimate, because the information giving rise to the change could not have been known in prior periods.

Answer 331

$428,000 The 2005 statement of retained earnings must disclose a Prior period adjustment to the beginning retained-earnings balance for the amount required to correct prior-year net income. 2004 insurance expense actually recognized (in error) $60,000 Less 2004 correct insurance expense - the amount that should have been recognized ($60,000/3 - a three-year policy) (20,000) Equals the error in pre-tax income before 2005(income understated) $40,000 Times (1 - tax rate) to determine after-tax error x .70 Equals the error correction, the amount by which retained earnings at January 1, 2005 must be increased(the Prior period adjustment) $28,000 Plus unadjusted retained earnings at January 1, 2005 $400,000 Equals adjusted retained earnings at January 1, 2005 $428,000

Answer 332

$10,000 The year-one error has no bearing on the amount of depreciation to be recognized in subsequent years. Annual depreciation is $10,000 (= $100,000/10). In year two, a Prior period adjustment will be recorded, correcting beginning retained earnings and accumulated depreciation. Year-one statements reported comparatively with year two's statements will be shown correctly. Year two will report $10,000 of depreciation expense.

Answer 333

Understatement of accumulated depreciation of $40,000. Accumulated depreciation is a pre-tax amount. The journal entry omitted in the past is: dr. Depreciation expense, $40,000; cr. Accumulated depreciation, $40,000. The beginning balance of accumulated depreciation in the year the error was discovered is understated by $40,000 because that amount was not recorded in a prior year.

Answer 334

Carlton's income statement will have to be revised to include the earnings-per-share data. All publicly traded companies are required to report EPS information. However, only the current year is affected. Restatement of prior-year statements is not required.

Answer 335

Effect of a failure to provide for uncollectible accounts in the previous period. This is an error correction. The correction of an error affecting the income of prior periods is accounted for as a Prior period adjustment. This adjustment corrects the beginning retained earnings balance in the period the error was discovered, thereby correcting the retained earnings carried forward from earlier periods.

Answer 336

$230,000 debit. The after-tax amount of the overstatement of 2004 earnings is $230,000 ($300,000 − $70,000 tax effect). 2004 income is overstated by this amount, because the expense and tax effect were not recorded. Ending 2004 retained earnings is overstated by $230,000. Therefore, beginning 2005 retained earnings must be decreased (debited) $230,000. This is accomplished by adjusting the beginning 2005 retained earnings balance with a Prior period adjustment of $230,000 (debit).

Answer 337

The financial statements for years 1 and 2 should be restated; the cumulative effect of the error on years 1 and 2 should be reflected in the carrying amounts of assets and liabilities as of the beginning of year 3. When there is an error in prior period financial statements and those statements are presented with the current year, the error should be corrected in years 1 and 2 so they are comparative to year 3. The effect of the error should be reflected in the year 3 beginning balances of the appropriate assets and liabilities.

Answer 338

$0 Neither of the changes listed are Prior period adjustments (PPA). A PPA is an adjustment to the beginning retained earnings balance that corrects the effect on retained earnings of errors in reporting prior-year income. A PPA is not a voluntary accounting change. The change in inventory method is an accounting principle change, which requires the recording of a cumulative effect of accounting change as an adjustment to retained earnings. This account measures the effect of the change on prior-year net income. The change in depreciation method is treated as an estimate change. The remaining book value at the beginning of the year of change is allocated to the remaining useful life using the new depreciation method.

Answer 339

2003 ending working capital - Overstated 20x4 ending retained earnings -No Effect The entry that should have been accrued at the end of 2003 is: dr. Commission expense xxx cr. Commission payable xxx Working capital (current assets, less current liabilities) is overstated, because current liabilities (via unrecorded commission payable) are understated. By the end of 2004, the error has counterbalanced. The commission expense attributable to 2003 (in the above entry) would have been recognized as expense upon payment in 2004. Although earnings of both years are in error, the ending retained earnings balance for 2004 is correct.

Answer 340

The correction of a mathematical error in the calculation of prior years' depreciation. A Prior period adjustment is defined as the correction of an error affecting prior-year income. The adjustment reverses the error by correcting beginning retained earnings in the year of discovery. If depreciation in a prior year is misstated, then income in that year is also incorrect, as well as the balance in retained earnings. The Prior period adjustment corrects retained earnings and accumulated depreciation. A change in depreciation method is treated as an estimate change. The book value at the beginning of the year of change is allocated to the remaining years of useful life. Prior periods are unaffected by estimate changes. A Prior period adjustment corrects an error in the reported income of prior years. Disposal of assets before the end of their estimated useful lives is a common occurrence. The asset and accumulated depreciation are removed from the accounts and a gain or loss is recognized. There is no effect on prior periods. Estimate changes are treated currently and prospectively - the change is applied to current years and future years, if affected. The book value at the beginning of the year of change is allocated to the remaining years of useful life using the new estimated remaining useful life.

Answer 341

The correction of a mathematical error in the calculation of prior years' depreciation. A Prior period adjustment is defined as the correction of an error affecting prior-year income. The adjustment reverses the error by correcting beginning retained earnings in the year of discovery. If depreciation in a prior year is misstated, then income in that year is also incorrect, as well as the balance in retained earnings. The Prior period adjustment corrects retained earnings and accumulated depreciation. A change in depreciation method is treated as an estimate change. The book value at the beginning of the year of change is allocated to the remaining years of useful life. Prior periods are unaffected by estimate changes. A Prior period adjustment corrects an error in the reported income of prior years. Disposal of assets before the end of their estimated useful lives is a common occurrence. The asset and accumulated depreciation are removed from the accounts and a gain or loss is recognized. There is no effect on prior periods. Estimate changes are treated currently and prospectively - the change is applied to current years and future years, if affected. The book value at the beginning of the year of change is allocated to the remaining years of useful life using the new estimated remaining useful life.