Section 3A - Acct Changes & Error Correction Flashcards

1
Q

In Year 6, Stuckey Corporation determined that the 6-year estimated useful life of a machine purchased for $198,000 in January of Year 3 should be extended by 2 years. The machine is being depreciated using the straight-line method and has no salvage value.

In addition to the extension of the useful life, Stuckey also determines the asset will have a salvage value of $12,000 at the end of its useful life. What amount of depreciation expense should Stuckey report in its financial statements for the year ending December 31, Year 6?

$33,000

$17,400

$19,800

$34,800

A

$17,400

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2
Q

Changes in accounting estimates are handled on a ___basis in the current year and future years. t/f

Note disclosure includes an explanation and justification for the change and the impact on current income and ___

Changes in a depreciation, amortization, and depletion method must be reported as a change in accounting ___

A

prospective

EPS

estimate.

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3
Q

During 20X1, Krey Co. increased the estimated quantity of copper recoverable from its mine. Krey uses the units of production depletion method. As a result of the change, which of the following should be reported in Krey’s 20X1 financial statements?

  1. Both cumulative effect of a change in accounting principle and pro forma effects of retroactive application of new depletion base
  2. Pro forma effects of retroactive application of new depletion base
  3. Neither cumulative effect of a change in accounting principle nor pro forma effects of retroactive application of new depletion base
  4. Cumulative effect of a change in accounting principle
A

Neither cumulative effect of a change in accounting principle nor pro forma effects of retroactive application of new depletion base

An increase in the estimated quantity of copper recoverable from its mine represents a change in accounting estimate.

FASB ASC 250-10-45-17 provides that a change in accounting estimate be accounted for in the period of change or the period of change and future affected periods if both are affected by the change. Also, “a change in an estimate should not be accounted for by restating amounts reported in financial statements of periods or by reporting pro forma amounts for prior periods.”

Therefore, no is the appropriate answer for both suggested treatments.

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4
Q

How should the effect of a change in accounting principle that is inseparable from the effect of a change in accounting estimate be reported?

By restating the financial statements of all prior periods presented

As a component of income from continuing operations

As a correction of an error

By footnote disclosure only

A

As a component of income from continuing operations

FASB ASC 250-10-45-18 requires that whenever a change in accounting principle is inseparable from a change in an accounting estimate, the change should be considered as a change in estimate. Changes in estimates are handled prospectively.

That is, previously reported information in previous financial statements is not adjusted, nor is a cumulative effect of the change reported. Prospective treatment only requires utilization of the change(s) in the current period as it effects the current period’s income.

It is part of income from continuing operations because no special disclosure is required on the face of the income statement under the prospective approach.

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5
Q

Accounting changes are classified into the following three general categories for purposes of financial statement presentation:

  1. Changes in accounting ___
  2. Changes in accounting ___
  3. Changes in reporting___

These three types of accounting changes, along with the corrections of errors, require special ___in the financial statements to enhance comparability among accounting periods.

A

principle

estimate

entity

disclosure

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6
Q

Tack, Inc., reported a retained earnings balance of $150,000 on December 31, 20X1. In June 20X2, Tack discovered that merchandise costing $40,000 had not been included in inventory in its 20X1 financial statements. Tack has a 30% tax rate. What amount should Tack report as adjusted beginning retained earnings in its statement of retained earnings at December 31, 20X2?

$122,000

$150,000

$178,000

$190,000

A

$178,000

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7
Q

A correction of an error in prior years’ financial statements is reported in the year of correction by __all prior years affected by the error.

The cumulative effect of the error on periods prior to those presented must be reflected in the ___amounts of the assets and liabilities as of the beginning of the earliest year presented in the current period’s financial report.

In addition, the offsetting amount of this cumulative effect must be reported as an adjustment to the opening balance of ___of the earliest year presented in the current period’s financial report.

he FASB chose to use the term “___application” to describe the manner of reporting a change in accounting principle or a change in reporting entity, and to use the term “___” only to refer to the correction of an error.

A

restating

carrying

retained earnings

retrospective, restatement

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8
Q

On January 1, year 3, a company changed its inventory costing method from LIFO to FIFO. The company’s year 3 financial statements contain comparative information for year 2. How should the company present the year 1 effect of the change in accounting principle in its year 3 comparative financial statements?

As an extraordinary item in the year 2 income statement

As a note disclosure only

As part of income from continuing operations in the year 2 income statement

As an adjustment to the beginning year 2 inventory balance with an offsetting adjustment to beginning year 2 retained earnings

A

As an adjustment to the beginning year 2 inventory balance with an offsetting adjustment to beginning year 2 retained earnings

  • Changing from LIFO (last in, first out) to FIFO (first in, first out) is considered a change in accounting principle. The FASB requires that in the absence of a specific statement by the FASB to the contrary, accounting changes should be accounted for using the retrospective approach.
  • Under this approach, all prior years’ financial statements presented should be restated and the cumulative effect of the change should be reported in the retained earnings statement (or in the statement of changes in stockholders’ equity) as an adjustment of the beginning-of-period balance of retained earnings of the earliest year presented, which would be year 2 for this question.
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9
Q

Changing from LIFO (last in, first out) to FIFO (first in, first out) is considered a change in accounting ___.

The FASB requires that in the absence of a specific statement by the FASB to the contrary, accounting changes should be accounted for using the ___approach.

A

principle.

retrospective

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10
Q

Retrospective Approach

Under this approach, all prior years’ financial statements presented should be ___and the cumulative effect of the change should be reported in the ___statement (or in the statement of changes in stockholders’ equity) as an adjustment of the beginning-of-period balance of retained earnings of the earliest year presented.

A

restated

retained earnings

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11
Q

Conn Co. reported a retained earnings balance of $400,000 at December 31 of the previous year. In August of the current year, Conn determined that insurance premiums of $60,000 for the 3-year period beginning January 1 of the previous year had been paid and fully expensed in that year. Conn has a 30% income tax rate. What amount should Conn report as adjusted beginning retained earnings in its current-year statement of retained earnings?

$420,000

$442,000

$440,000

$428,000

A

$428,000

Conn should report $428,000:

Beg. Ret. Earn. as originally reported $400,000
Over exp of $40k – Tax of 30% ($12,000) 28,000
Corrected beginning retained earnings $428,000

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12
Q

Mellow Co. depreciated a $12,000 asset over five years, using the straight-line method with no salvage value. At the beginning of the fifth year, it was determined that the asset will last another four years. What amount should Mellow report as depreciation expense for Year 5?

$600

$1,500

$900

$2,400

A

600

The change in the estimated useful life of a fixed asset is a change in accounting estimate that must be accounted for prospectively. The book value at the end of Year 4 is $2,400 ($12,000 - ($12,000 × 4 years ÷ 5 years)). This $2,400 must be allocated to depreciation expense over the remaining 4-year period ($2,400 ÷ 4 = $600).

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13
Q

On March 15, year 2, a calendar-year company issued its year 1 financial statements. On March 1, year 2, a fire destroyed the company’s only manufacturing plant. Which of the following statements is correct regarding the treatment of the loss in the December 31, year 1, financial statements?

  1. The loss should not be recognized or disclosed in the year 1 financial statements.
  2. The loss should be disclosed and not recognized in the year 1 financial statements.
  3. The loss should be recognized in the year 1 financial statements.
  4. Any probable insurance recoveries should be recognized in the year 1 financial statements.
A

The loss should be disclosed and not recognized in the Year 1 financial statements.

There are two types of subsequent events. Type 1 events are recognized in the financial statements and consist of events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements (that is, recognized subsequent events). Type 2 events are not recognized and consist of events that provide evidence about conditions that did not exist at the date of the balance (as is the case for this situation).

Some Type 2 subsequent events may be of such a nature that they must be disclosed to keep the financial statements from being misleading. For such events, an entity shall disclose the nature of the event and an estimate of its financial effect. Destruction of the only manufacturing plant would be a disclosure Type 2 eve

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14
Q

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued or are available to be issued. There are two types of subsequent events:

  1. The first type consists of events or transactions that provide additional evidence about conditions that ___at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements (that is, recognized subsequent events).
  2. The second type consists of events that provide evidence about conditions that ___at the date of the balance sheet but arose after that date (that is, nonrecognized subsequent events).
A

existed

did not exist

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15
Q

An entity must not recognize subsequent events(which means make an AJE to recognize it…..but should DISCLOSE regardless) that provide evidence about conditions that did not exist at the date of the balance sheet but arose after the balance sheet date but before financial statements are issued or are available to be issued. The following are examples of nonrecognized subsequent events:

  1. Sale of __
  2. Business ___
  3. Settlement of ___
  4. Loss of plant/inventory from a ___
  5. Losses on ___
  6. Changes in the ___ of assets/liabilities
  7. Entering into a significant ___ or ___ liability
A

bond/capital stock

combination

litigation

fire/natural disaster

receivables

FV

commitment/contingency

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16
Q

Some nonrecognized subsequent events may be of such a nature that they must be disclosed to keep the financial statements from being misleading. For such events, an entity shall disclose the following:

a. The __of the event
b. An ___of its financial effect, or a statement that such an estimate cannot be made

A

nature

estimate

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17
Q

Foy Corp. failed to accrue warranty costs of $50,000 in its December 31, 20X1, financial statements. In addition, a change from straight-line to accelerated depreciation made at the beginning of 20X2 resulted in a cumulative effect of $30,000 on Foy’s retained earnings. Both the $50,000 and the $30,000 are net of related income taxes. What amount should Foy report as prior-period adjustments in 20X2?

$80,000

$30,000

$0

$50,000

A

$50,000

FASB ASC 250-10-45-22 notes, “Any error in the financial statements of a prior period discovered after the financial statements are issued or are available to be issued (as discussed in Section 855-10-25) shall be reported as an error correction, by restating the prior-period financial statements.”

Foy Corp.’s failure to accrue $50,000 of warranty cost in 20X1 is an error which should be reported in 20X2 as a prior-period adjustment. (The change in depreciation is a change in accounting principle, shown on the income statement.)

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18
Q
  • At December 31, 20X2, Off-Line Co. changed its method of accounting for demo costs from writing off the costs over two years to expensing the costs immediately
  • . Off-Line made the change in recognition of an increasing number of demos placed with customers that did not result in sales. Off-Line had deferred demo costs of $500,000 at December 31, 20X1, $300,000 of which were to be written off in 20X2 and the remainder in 20X3.
  • Off-Line’s income tax rate is 30%. In its 20X2 income statement, what amount should Off-Line report as cumulative effect of change in accounting principle?

$500,000

$200,000

$140,000

$0

A

$0

FASB ASC 250-10-45-5 mandates that voluntary changes in accounting principle be recognized using the retrospective approach, in which the cumulative effect is reported as an adjustment of the beginning-of-year retained earnings of the earliest year presented. Thus, the cumulative effect of Off-Line’s change in accounting principle would not be included in its 20X2 income statement.

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19
Q

Which of the following accounting changes should be given retrospective treatment when preparing the financial statements?

A change in the useful life of a property, plant, and equipment asset

A change in the depreciation method used for a tangible asset

A change in the percentage used to estimate the amount of uncollectible accounts

A change in the method used to account for long-term contracts

A

A change in the method used to account for long-term contracts

A change in accounting principle is given retrospective treatment when reported in the financial statements. This means that all periods presented need to reflect the new accounting principle. A change in accounting estimate is given prospective treatment, meaning that all changes are reported in current and future periods, but no prior periods are restated.

Of the four answer choice items, only the change in the method used to account for long-term contracts qualifies as a change in accounting principle. Thus, it is the only one of the four that will be treated retrospectively. While a change in depreciation methods is a change in accounting principle, it is treated as a change in accounting estimate.

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20
Q

Which of the following describes the appropriate reporting treatment for a change in accounting estimate?

In the period of change and future periods if the change affects both

By restating amounts reported in financial statements of prior periods

By reporting pro forma amounts for prior periods

In the period of change with no future consideration

A

In the period of change and future periods if the change affects both

Changes in accounting estimates are handled on a prospective basis—in the current year and future years. There is no retroactive application. An explanation and justification must be disclosed in the notes.

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21
Q

In Year 6, Spirit, Inc., determined that the 12-year estimated useful life of a machine purchased for $48,000 in January of Year 1 should be extended by three years. The machine is being depreciated using the straight-line method and has no salvage value. What amount of depreciation expense should Spirit report in its financial statements for the year ending December 31, Year 6?

$4,200

$4,800

$2,800

$3,200

A

$2,800

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22
Q

Matt Co. included a foreign subsidiary in its current consolidated financial statements. The subsidiary was acquired six years ago and was excluded from previous consolidations. The change was caused by the elimination of foreign exchange controls. Including the subsidiary in the consolidated financial statements results in accounting change that should be reported:

currently and prospectively.

currently with footnote disclosure of pro forma effects of retroactive application.

by footnote disclosure only.

by retrospective application to the financial statements of all prior periods presented.

A

by retrospective application to the financial statements of all prior periods presented.

A change in accounting entity is reported under the retrospective approach. All financial statements presented must be restated to reflect the new accounting entity.

23
Q

Which of the following items requires a prior-period adjustment to retained earnings?

Unrealized holding gains on available-for-sale debt securities were not recorded.

Prior service cost on the defined benefit pension plan was not recorded for the current year.

Equity method revenue (a material amount) was not recorded for investments for the current year.

A fixed asset purchased two years ago was incorrectly expensed.

A

A fixed asset purchased two years ago was incorrectly expensed.

  • Prior-period adjustments to retained earnings are only reported for errors in prior-year financial statements that resulted in an incorrect balance in retained earnings at the beginning of the year.
  • These adjustments are not required for errors that affect the current year because these errors do not affect prior-year balances, and current-year income should be corrected if current-year errors are detected before the financial statements are published.
  • Prior-year errors in reporting other comprehensive income do not affect the beginning balance of retained earnings. Rather, they result in erroneous balances in accumulated other comprehensive income.
24
Q

Cody Corporation planned to depreciate a $383,000 asset over seven years, using the straight-line method with a salvage value of $19,000. At the beginning of the third year, it was determined that the asset would only last two more years. What amount should Cody report as the asset’s carrying value at the end of year 3, after depreciation for the year had been recorded?

$149,000

$279,000

$260,000

$130,000

A

$149,000

Cody should carry the asset at $149,000 at December 31, year 3:

Original cost $383,000
Salvage value (19,000)
Depreciable basis 364,000
Depreciation Years 1-2 ($52,000* x 2 yrs.) (104,000)
Depreciable basis at beginning of Year 3 260,000

Year 3 depreciation ($260,000 ÷ 2) 130,000

Carrying value at end of year 3: $383,000 − $104,000 − $130,000 = $149,000

* Depreciable bases: $364,000 ÷ 7 years = $52,000

25
Q

On January 1, 20X3, Warren Co. purchased a $600,000 machine with a 5-year useful life and no salvage value. The machine was depreciated by an accelerated method for book and tax purposes. The machine’s carrying amount was $240,000 on December 31, 20X4. On January 1, 20X5, Warren changed to the straight-line method for financial statement purposes. Warren can justify the change. How much depreciation expense for this asset should Warren’s report in its 20X5 income statement?

$120,000

$240,000

$100,000

$80,000

A

$80,000

Depreciation expense is computed prospectively, using the revised carrying value and the remaining estimated useful life of 3 years (5 years original less 2 years recorded): $240,000 ÷ 3 years = $80,000 depreciation expense.

26
Q

Cuthbert Industrials, Inc., prepares 3-year comparative financial statements. In Year 3, Cuthbert discovered an error in the previously issued financial statements for Year 1. The error affects the financial statements that were issued in Years 1 and 2. How should the company report the error?

  1. 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.
  2. The financial statements for Years 1 and 2 should not be restated; financial statements for Year 3 should disclose the fact that the error was made in prior years.
  3. The financial statements for Years 1 and 2 should not 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.
  4. The financial statements for Years 1 and 2 should be restated; an offsetting adjustment to the cumulative effect of the error should be made to the comprehensive income in the Year 3 financial statements.
A

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.

A correction of an accounting error must be reported by restating the financial statements for all prior years. The carrying amounts for assets, liabilities, and beginning retained earnings must be restated for the earliest year presented in the financial statements presented in the year the error is discovered.

27
Q

On January 1, 20X1, Warren Co. purchased a $600,000 machine with a 5-year useful life and no salvage value. The machine was depreciated by an accelerated method for book and tax purposes. The machine’s carrying amount was $240,000 on December 31, 20X2. On January 1, 20X3, Warren changed to the straight-line method for financial statement purposes. Warren can justify the change. Warren’s income tax rate is 30%.

In its 20X3 financial statements, how should Warren report this accounting change?

By including the cumulative effect of the change in 20X3 net income

By including the cumulative effect of the change as an adjustment to retained earnings

By including the cumulative effect in other comprehensive income

Prospectively

A

Prospectively

  1. Under FASB ASC 250-10-45-18, changes in depreciation methods are to be accounted for prospectively as changes in accounting estimates.
  2. Accordingly, the carrying amount at January 1, 20X3, should be depreciated over the estimated remaining life of the machinery under the straight-line method.
  3. Thus, the machine’s $240,000 carrying amount at December 31, 20X2, should be depreciated over the estimated remaining life of the machinery under the straight-line depreciation method.
28
Q

On January 2, Year 4, Raft Corp. discovered that it had incorrectly expensed a $210,000 machine purchased on January 2, Year 1. Raft estimated the machine’s original useful life to be 10 years and its salvage value at $10,000. Raft uses the straight-line method of depreciation and is subject to a 30% tax rate. In its December 31, Year 4, financial statements, what amount should Raft report as an adjustment to the opening balance of retained earnings of the earliest year presented? (Assume that only one year is presented.)

$102,900

$105,000

$168,000

$165,900

A

$105,000

Depreciation of $20,000 should have been recognized in Years 1–4, as well as each of the remaining six years of the asset’s life after Year 4. However, no depreciation was recorded in any of the years up to Year 4. Rather, an expense of $210,000 was recognized in Year 1.

29
Q

How should the effect of a change in accounting estimate be accounted for?

In the period of change and future periods if the change affects both

As a prior-period adjustment to beginning retained earnings

By reporting pro forma amounts for prior periods

By restating amounts reported in financial statements of prior periods

A

In the period of change and future periods if the change affects both

FASB ASC 250-10-45-17 indicates that reported amounts should not be restated for changes in accounting estimates. Instead, “the effect of a change in accounting estimate should be accounted for in (a) the period of change if the change affects that period only or (b) the period of change and future periods if the change affects both.”

30
Q

Which of the following examples would require restatement of prior years’ financial statements?

  1. A calculation change of warranty obligations based on updated claim information for the prior year
  2. An intangible asset with a remaining estimated amortization period of two years, which is determined to be obsolete
  3. A change from the income tax basis of accounting to the accrual basis
  4. An insurance premium that was due in the prior year but that lapsed because the policy was not paid
A

A change from the income tax basis of accounting to the accrual basis

The FASB requires that changes in accounting principle use the retrospective approach, whereby all prior years’ financial statements presented should be restated and the cumulative effect of the change should be reported in the retained earnings statement (or in the statement of changes in stockholders’ equity) as an adjustment of the beginning-of-period balance of retained earnings of the earliest year presented.

Changes in estimate are handled on a prospective basis—in the current year and future years; there is no retroactive application.

The only answer choice which is a change in principle requiring restatement is a change from the income tax basis of accounting to the accrual basis.

31
Q

In which of the following situations should a company report a prior-period adjustment?

The correction of a mathematical error in the calculation of prior years’ depreciation

A change in the estimated useful lives of fixed assets purchased in prior years

The scrapping of an asset prior to the end of its expected useful life

A switch from the straight-line to double-declining-balance method of depreciation

A

The correction of a mathematical error in the calculation of prior years’ depreciation

  1. The correction of an error in prior year financial statements requires restatement of the financial statements. A prior-period adjustment to beginning retained earnings is required to correct the retained earnings for the error.
  2. Changes in estimates and changes in depreciation methods are accounted for prospectively.
32
Q

When there is a change in the reporting entity, how should the change be reported in the financial statements?

Note disclosures only

Currently, including note disclosures

Retrospectively, including note disclosures, and application to all prior-period financial statements presented

Prospectively, including note disclosures

A

Retrospectively, including note disclosures, and application to all prior-period financial statements presented

  1. With a change in reporting entity, all prior years’ financial statements must be reported as if the change happened before the financial statements were presented.
  2. The cumulative effect of the change is an adjustment to beginning retained earnings for the first year presented. This treatment is the retrospective approach.
33
Q

The cumulative effect of a change in accounting principle should be recorded separately as a component of income after continuing operations, when the change is from the:

issuance of a new FASB Statement (SFAS) that requires the use of the new method and specifies that the change be recognized by including cumulative effect (net of income taxes) in net income.

completed-contract method of accounting for long-term construction-type contracts to the percentage-of-completion method.

presentation of statements of individual companies to their inclusion in consolidated statements.

cash basis of accounting for vacation pay to the accrual basis.

A

issuance of a new FASB Statement (SFAS) that requires the use of the new method and specifies that the change be recognized by including cumulative effect (net of income taxes) in net income.

  • FASB ASC 250-10-45-5 mandates that voluntary changes in accounting principle be recognized using the retrospective approach, in which the cumulative effect is reported as an adjustment of the beginning-of-year retained earnings of the earliest year presented.
  • The only exception is when the FASB issues a new pronouncement and mandates in that pronouncement that a change in accounting principle made to comply with that pronouncement should be made by including the cumulative effect in net income of the year of change.
34
Q

Althouse Co. discovered that equipment purchased on January 2 for $150,000 was incorrectly expensed at the time. The equipment should have been depreciated over five years with no salvage value. What amount, if any, should be adjusted to Althouse’s depreciation expense at January 2, the beginning of the third year, when the error was discovered?

$0

$150,000

$60,000

$30,000

A

$0

  • Depreciation expense would not be adjusted at the beginning of the year. Accumulated depreciation would be adjusted at the beginning of the first year presented in the financial statements.
  • Retained earnings would be also be restated at the beginning of the first year presented in the financial statement. Depreciation expense of $30,000 will be reported at the end of the third year.
  • The FASB uses the term “restatement” to refer to the method to report a correction of the error. “Restatement” is essentially the same as the “retrospective” method.
35
Q

Miller Co. discovered that in the prior year, it failed to report $40,000 of depreciation related to a newly constructed building. The depreciation was computed correctly for tax purposes. The tax rate for the current year was 40%. What was the impact of the error on Miller’s financial statements for the prior year?

Understatement of net income of $24,000

Understatement of accumulated depreciation of $24,000

Understatement of accumulated depreciation of $40,000

Understatement of depreciation expense of $24,000

A

Understatement of accumulated depreciation of $40,000

Failure to report depreciation expense would understate depreciation expense and accumulated depreciation by the amount of the depreciation expense not reported. If no other errors were made, income would be overstated by the net of tax amount ($24,000).

36
Q

Which of the following items requires a prior-period adjustment to retained earnings?

Revenue of $5 million that should have been deferred was recorded in the previous year as earned.

The prior year’s foreign currency translation gain of $2 million was never recorded.

Purchases of inventory this year were overstated by $5 million.

Investments in equity securities were improperly valued last year by $20 million.

A

Revenue of $5 million that should have been deferred was recorded in the previous year as earned.

  1. Prior-period adjustments to retained earnings are only reported for errors in prior-year financial statements that resulted in an incorrect balance in retained earnings at the beginning of the year.
  2. These adjustments are not required for errors that affect the current year because these errors do not affect prior-year balances, and current-year income should be corrected if current-year errors are detected before the financial statements are published.
  3. Prior-year errors in reporting other comprehensive income do not affect the beginning balance of retained earnings. Rather, they result in erroneous balances in accumulated other comprehensive income.
37
Q

Which of the following statements is correct as it relates to changes in accounting estimates?

  1. It is easier to differentiate between a change in accounting estimate and a change in accounting principle than it is to differentiate between a change in accounting estimate and a correction of an error.
  2. Whenever it is impossible to determine whether a change in an estimate or a change in accounting principle occurred, the change should be considered a change in principle.
  3. 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.
  4. Most changes in accounting estimates are accounted for retrospectively.
A

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.

  • The effect of the change in accounting principle, or the method of applying it, may be inseparable from the effect of the change in accounting estimate.
  • Changes of that type often are related to the continuing process of obtaining additional information and revising estimates and, therefore, shall be considered changes in estimates for purposes of applying this Subtopic.” (Emphasis added)
38
Q

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 __

A

estimate.

39
Q

Foster Company reported a retained earnings balance of $402,000 on December 31, 20X4. In May 20X5, Foster discovered that merchandise costing $95,000 had been erroneously included in inventory in its 20X4 financial statements. Foster has a 25% tax rate. What amount should Foster report as adjusted beginning retained earnings in its statement of retained earnings at December 31, 20X5?

$330,750

$473,750

$425,750

$402,000

A

$330,750

40
Q

Nect Corporation reported a retained earnings balance of $330,000 at December 31 of the previous year. In August of the current year, Nect determined that insurance premiums of $51,000 for the 2-year period beginning January 1 of the previous year had been paid and fully expensed in that year. Nect has a 40% income tax rate. What amount should Nect report as adjusted beginning retained earnings in its current-year statement of retained earnings?

$330,000

$345,300

$360,600

$319,800

A

$345,300

Income was understated in the previous year because the full insurance premium was recorded as expense, leading to an understatement in beginning retained earnings the next year. The beginning retained earnings balance should reflect the after-tax effect of only half of the insurance premium because the premium covered two years. Nect should report adjusted beginning retained earnings of $345,300:

Beg ret. earn as originally reported $330,000
Overstated exp of ($51,000/2) – Tax of 40% ($10,200) 15,300
Corrected beg ret. earn. $345,300

41
Q

The correction of an error in the financial statements of a prior period should be reported:

net of applicable income taxes, in the current retained earnings statement after net income but before dividends.

as a prior-period adjustment by restating the prior-period financial statements.

net of applicable income taxes, in the current income statement after income from continuing operations and after extraordinary items.

net of applicable income taxes, in the current income statement after income from continuing operations and before extraordinary items.

A

as a prior-period adjustment by restating the prior-period financial statements.

Errors in prior-period financial statements result in the restatement of all financial statements for any prior periods reported.

The concept of “extraordinary” items has been eliminated from GAAP; the presentation for items that are unusual in nature or occur infrequently will be expanded to include items that are both unusual in nature and infrequently occurring.

42
Q

Which of the following would be treated retrospectively in the financial statements starting with the earliest period presented?

  1. A change in the name of the account used to record selling expenses
  2. A change in the amount salvage value for a tangible, fixed asset
  3. A change in the estimation method for the value of compensated absences
  4. A change in the composition of the companies included in the consolidated financial statements
A

A change in the composition of the companies included in the consolidated financial statements

  • A change in accounting entity is given retrospective treatment when reported in the financial statements. This means that all periods presented need to reflect the new accounting entity.
  • A change in accounting estimate is given prospective treatment, meaning that all changes are reported in current and future periods, but no prior periods are restated.
  • Of the four answer choice items, only the change in the composition of the companies included in the consolidated financial statements qualifies as a change in accounting principle. Thus, it is the only one of the four that will be treated retrospectively.
43
Q
A

retrospectively as an adjustment of the beginning-of-period balance of retained earnings of the earliest year presented.

FASB ASC 250-10-45-5 mandates that voluntary changes in accounting principle be recognized using the retrospective approach, in which the cumulative effect is reported as an adjustment of the beginning-of-year retained earnings of the earliest year presented.

The only exception is when the FASB issues a new pronouncement and mandates in that pronouncement that a change in accounting principle made to comply with that pronouncement should be made by including the cumulative effect in net income of the year of change.

44
Q

Which of the following statements is correct regarding accounting changes that result in financial statements that are, in effect, the statements of a different reporting entity?

  1. Cumulative-effect adjustments should be reported as separate items on the financial statements pertaining to the year of change.
  2. No restatements or adjustments are required if the changes involve consolidated methods of accounting for subsidiaries.
  3. No restatements or adjustments are required if the changes involve the cost or equity methods of accounting for investments.
  4. The financial statements of all prior periods presented should be restated.
A

The financial statements of all prior periods presented should be restated.

FASB ASC 250-10-50-6 provides that accounting changes involving a change in reporting entity should be reported by restating the financial statements of all prior periods.

45
Q

Belle Co. determined after 4 years that the estimated useful life of its labeling machine should be 10 years rather than 12 years. The machine originally cost $46,000 and had an estimated salvage value of $1,000. Belle uses straight-line depreciation. What amount should Belle report as depreciation expense for the current year?

$3,200

$4,500

$5,000

$3,750

A

$5,000

46
Q

Which of the following accounting changes should be given retrospective treatment when preparing the financial statements?

A change in the amount of expected repairs warranty repairs

A change in the settlement rate used in computing pension expense

A change in the useful life of a finite life intangible asset

A change from the weighted-average method to the FIFO method of inventory costing

A

A change from the weighted-average method to the FIFO method of inventory costing

  • A change in accounting principle is given retrospective treatment when reported in the financial statements. This means that all periods presented need to reflect the new accounting principle
  • . A change in accounting estimate is given prospective treatment, meaning that all changes are reported in current and future periods, but no prior periods are restated.
  • Of the four answer choices, only the change from weighted average to FIFO for inventory costing qualifies as a change in accounting principle.
47
Q

Lore Co. changed from the cash basis of accounting to the accrual basis of accounting during 20X1. The cumulative effect of this change should be reported in Lore’s 20X1 financial statements as a:

prior-period adjustment resulting from the correction of an error.

component of other comprehensive income.

component of accumulated other comprehensive income.

prior-period adjustment resulting from the change in accounting principle.

A

prior-period adjustment resulting from the correction of an error.

A change from cash-basis accounting (non-GAAP) to accrual-basis accounting (GAAP) would be considered a correction of an error.

Lore Co. should report the cumulative effect of the change from cash-basis to accrual-basis accounting as a prior-period adjustment.

48
Q

On January 1, 20X2, to better reflect the variable use of its only machine, Holly, Inc., elected to change its method of depreciation from the straight-line method to the units of production method.

The original cost of the machine on January 2, 20X0, was $50,000, and its estimated life was 10 years. Holly estimates that the machine’s remaining total life is 50,000 machine hours as of January 1, 20X2.

Machine hours usage was 8,500 during 20X1 and 3,500 during 20X0.

Holly’s income tax rate is 30%. Holly should report the accounting change in its 20X2 financial statements as:

  1. an adjustment to beginning retained earnings of $1,400.
  2. a cumulative effect of a change in accounting principle of $1,400 in its income statement.
  3. prospectively.
  4. an adjustment to beginning retained earnings of $2,000.
A

prospectively.

FASB ASC 250-10-45-5 requires that changes in depreciation methods be accounted for prospectively. Accordingly, the carrying amount (book value) of the machine at January 1, 20X2, should be depreciated over the remaining life of the machine.

  • At January 1, 20X2, the carrying amount is $40,000 (i.e., $50,000 acquisition cost less $10,000 accumulated depreciation), which should be depreciated over the remaining 50,000 machine hours at a rate of $.80 per machine hour (i.e., $40,000 ÷ 50,000 hours = $.80).
  • The depreciation amount to be recognized in 20X2 is the number of machine hours used in 20X2 × $.80.
49
Q
  • On January 1, Year 1, Newport Corp. purchased a machine for $100,000. The machine was depreciated using the straight-line method over a 10-year period with no residual value.
  • Because of a bookkeeping error, no depreciation was recognized in Newport’s Year 1 financial statements, resulting in a $10,000 overstatement of the book value of the machine on December 31, Year 1.
  • The oversight was discovered during the preparation of Newport’s Year 2 financial statements. What amount should Newport report for depreciation expense on the machine in the Year 2 financial statements?

$10,000

$20,000

$11,000

$9,000

A

$10,000

The correct amount of depreciation for all 10 years is $100,000 ÷ 10 = $10,000. The correction of the error for Year 1 would not affect the amount of depreciation expense for Year 2.

50
Q

How should a company report its decision to change from a cash basis of accounting to accrual basis of accounting?

As a component of other comprehensive income

Prospectively, with no amounts restated and no cumulative adjustment

As a change in accounting principle, requiring the cumulative effect of the change (net of tax) to be reported in the income statement

As a correction of an error (net of tax), by adjusting the beginning balance of retained earnings

A

As a correction of an error (net of tax), by adjusting the beginning balance of retained earnings

  • A change from an accounting principle that is not generally accepted to one that is generally accepted is a correction of an error. The cash basis is not generally accepted.
  • Consequently, the change to accrual basis is a correction of an error. A correction of an error in prior years’ financial statements is reported in the year of correction by restating all prior years affected by the error.
  • The cumulative effect of the error on periods prior to those presented must be reflected in the carrying amounts of the assets and liabilities as of the beginning of the earliest year presented.
51
Q

The cash basis method of accounting is not an allowable method under GAAP unless there is no material difference from the accrual method.

However, cash-basis financial statements are sometimes provided for investors or creditors.

A

true to both

52
Q
A

$0

FASB ASC 250-10-45-5 mandates that voluntary changes in accounting principle be recognized using the retrospective approach, in which the cumulative effect is reported as an adjustment of the beginning-of-year retained earnings of the earliest year presented.

The only exception is when the FASB issues a new pronouncement and mandates in that pronouncement that a change in accounting principle made to comply with that pronouncement should be made by including the cumulative effect in net income of the year of change.

53
Q
  • Milt Co. began operations on January 1, Year 1. On January 1, Year 3, Milt changed its inventory method from LIFO to FIFO for both financial and income tax reporting.
  • If FIFO had been used in prior years, Milt’s inventories would have been higher by $60,000 and $40,000 at December 31, Year 3 and Year 2, respec­tively. Milt has a 30% income tax rate.

What amount should Milt report as the cumulative effect of this accounting change in its income statement for the year ended December 31, Year 3?

$28,000

$0

$42,000

$14,000

A

$0

The cumulative effect of a change in an accounting method is reflected in retained earnings, not net income.

54
Q
  • In year 1, a company purchased equipment that cost $70,000. The equipment has a useful life of 7 years and no salvage value. The company used the straight-line method to depreciate the equipment and reported $10,000 of depreciation expense in years 1 and 2.
  • At the beginning of year 3, the company determines that the equipment will last for only 3 more years (5 years total) and changes the depreciable life of the asset accordingly.

What amount of depreciation expense should the company report in year 3?

$16,667

$22,000

$14,000

$10,000

A

$16,667