Mgmt 351 Study

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Accounting Changes and Error Analysis

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Accounting Changes and Error Analysis

Accounting Changes

Error Analysis

Changes in accounting policy
Changes in accounting estimate

Balance sheet errors
Income statement errors Balance sheet and income statement effects

Change in reporting entity
Correction of errors Summary Motivations for change of method 22-2

Comprehensive example
Preparation of statements with error corrections

Changes in Accounting Principle
Change from one accepted accounting policy to another. Examples include:  

Average cost to LIFO. Completed-contract to percentage-of-completion.

Adoption of a new policy in recognition of events that have occurred for the first time or that were previously immaterial is not an accounting change.

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Changes in Accounting Principle
Retrospective Accounting Change Approach
Company reporting the change
1) Adjusts its financial statements for each prior period

presented to the same basis as the new accounting principle. 2) Adjusts the carrying amounts of assets and liabilities as of the beginning of the first year presented, plus the opening balance of retained earnings.

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Changes in Accounting Principle
E22-1 (Change in Principle—Long-Term Contracts): Cherokee

Construction Company changed from the completed-contract to the percentage-of-completion method of accounting for long-term construction contracts during 2012. For tax purposes, the company

employs the completed-contract method and will continue this approach in the future. (Hint: Adjust all tax consequences through the Deferred Tax Liability account.)

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Changes in Accounting Principle
E22-1 (Change in policy—Long-Term Contracts):

Instructions: (assume a tax rate of 35%) (b) What entry(ies) are necessary to adjust the accounting records for the change in accounting principle? (a) What is the amount of net income and retained earnings that would be reported in 2012? Assume beginning retained earnings for 2011 to be $100,000. 22-8

Changes in Accounting Estimate
Examples of Estimates
1. Uncollectible receivables. 2. Inventory obsolescence.

3. Useful lives and salvage values of assets.
4. Periods benefited by deferred costs. 5. Liabilities for warranty costs and income taxes. 6. Recoverable mineral reserves. 7. Change in depreciation methods.

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Changes in Accounting Estimate
Prospective Reporting
Changes in accounting estimates are reported prospectively. Account for changes in estimates in 1. the period of change if the change affects that period only, or 2. the period of change and future periods if the change affects both. FASB views changes in estimates as normal recurring corrections and adjustments and prohibits retrospective treatment.

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Change in Estimate Example
Illustration: Arcadia High School purchased equipment for $510,000 which was estimated to have a useful life of 10 years with a salvage value of $10,000 at the end of that time. Depreciation has been recorded for 7 years on a straight-line basis. In 2012 (year 8), it is determined that the total estimated life should be 15 years with a salvage value of $5,000 at the end of that time. Required: 

What is the journal entry to correct prior years’ depreciation expense? Calculate depreciation expense for 2012.

No Entry Required



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Changes in Accounting Estimate
Disclosures
Companies need not disclose changes in accounting estimate made as part of normal operations, such as bad debt allowances or inventory obsolescence, unless such changes are material.

However, for a change in estimate that affects several periods (such as a change in the service lives of depreciable assets), companies should disclose the effect on income from continuing

operations and related per-share amounts of the current period.

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Correction of Errors
Types of Accounting Errors:
1. A change from an accounting principle...
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