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Chapter 20

Accounting Changes and

EXERCISES
Error Corrections
Exercise 20-1
A change in depreciation method is considered a change in accounting estimate
resulting from a change in accounting principle. In other words, a change in the
depreciation method is similar to changing the economic useful life of a depreciable
asset, and therefore the two events should be reported the same way. Accordingly,
Bearing reports the change prospectively; previous financial statements are not revised.
Instead, the company simply employs the straight-line method from then on. The
undepreciated cost remaining at the time of the change would be depreciated straightline over the remaining useful life.
Assets cost
Accumulated depreciation to date (calculated below)
Undepreciated cost, Jan. 1, 2011
Estimated residual value
To be depreciated over remaining 7 years
Annual straight-line depreciation 2011-2017

$105,000
(48,600)
$ 56,400
(6,000)
$ 50,400
7 years
$ 7,200

Calculation of SYD depreciation


(10+9+8) x [$105,000 6,000]) = $48,600
55
Adjusting entry (2011 depreciation):
Depreciation expense (calculated above).............................................. 7,200
Accumulated depreciation.............................................................
7,200

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2011


20-1

Exercise 20-2
Requirement 1
To record the change:
Retained earnings ............................................................................................ 24,600
Inventory ($96,000 71,400).................................................
24,600
Requirement 2
Emerson applies the average cost method retrospectively; that is, to all prior
periods as if it always had used that method. In other words, all financial statement
amounts for individual periods that are included for comparison with the current
financial statements are revised for period-specific effects of the change.
Then, the cumulative effects of the new method on periods prior to those presented
are reflected in the reported balances of the assets and liabilities affected as of the
beginning of the first period reported and a corresponding adjustment is made to the
opening balance of retained earnings for that period. Lets say Emerson reports 20112009 comparative statements of shareholders equity. The $24,600 adjustment above
is due to differences prior to the 2011 change. The portion of that amount due to
differences prior to 2009 is subtracted from the opening balance of retained earnings
for 2009.
The effect of the change on each line item affected should be disclosed for each
period reported as well as any adjustment for periods prior to those reported. Also, the
nature of and justification for the change should be described in the disclosure notes.

The McGraw-Hill Companies, Inc., 2011


20-2

Intermediate Accounting, 6e

Exercise 20-3
Requirement 1
Accrued liability and expense
Warranty expense (4% x $720,000)............................................................
Estimated warranty liability ...............................................

28,800

Actual expenditures (summary entry)


Estimated warranty liability ...................................................
Cash, wages payable, parts and supplies, etc. ....................

17,600

28,800

17,600

Requirement 2
Actual expenditures (summary entry)
Estimated warranty liability ($15,000 4,600)..........................
Loss on product warranty (4% 3%] x $500,000)......................
Cash, wages payable, parts and supplies, etc. ....................

10,400
5,000
15,400*

*(4% x $500,000) $4,600 = $10,400

PROBLEMS
Problem 20-1
a. This is a change in estimate.

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2011


20-3

No entry is needed to record the change


2011 adjusting entry:
Warranty expense (3% x $800,000)........................................
.................................... Estimated warranty liability
...................................................................... 24,000

24,000

A disclosure note should describe the effect of a change in estimate on income


before extraordinary items, net income, and related per-share amounts for the current
period.
b. This is a change in estimate.

No entry is needed to record the change


2011 adjusting entry:
Depreciation expense (determined below) ................. 180,000
...................................... Accumulated depreciation
.................................................................... 180,000

Calculation of annual depreciation after the estimate change:


$4,000,000
Cost
$100,000
Old depreciation ($4,000,000 40 years)
x 3 yrs
(300,000)
Depreciation to date (2008-2010)
$ 3,700,000
Undepreciated cost
(2,800,000)
New estimated salvage value
$ 900,000
To be depreciated
5
Estimated remaining life (5 years: 2011-2015)
$ 180,000
New annual depreciation
The McGraw-Hill Companies, Inc., 2011
20-4

Intermediate Accounting, 6e

A disclosure note should describe the effect of a change in estimate on income


before extraordinary items, net income, and related per-share amounts for the current
period.

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2011


20-5

Problem 20-1 (continued)


c. This is a change in accounting principle that usually is reported prospectively.
No entry is needed to record the change.

When a company changes to the LIFO inventory method from another inventory
method, accounting records usually are insufficient to determine the cumulative income
effect of the change necessary to retrospectively revise accounts. So, a company
changing to LIFO usually reports the beginning inventory in the year the LIFO method
is adopted ($13 million in this case) as the base year inventory for all future LIFO
calculations. The disclosure required is a footnote to the financial statements
describing the nature of and justification for the change as well as an explanation as to
why the retrospective application was impracticable.

The McGraw-Hill Companies, Inc., 2011


20-6

Intermediate Accounting, 6e

Problem 20-5 (continued)


d. This is a change in accounting estimate resulting from a change in accounting
principle.
No entry is needed to record the change
2011 adjusting entry:
Depreciation expense (determined below) ..................
.......................................Accumulated depreciation
......................................................................72,000

72,000

A change in depreciation method is considered a change in accounting estimate


resulting from a change in accounting principle. Accordingly, DD reports the change
prospectively; previous financial statements are not revised. Instead, the company
simply employs the straight-line method from now on. The undepreciated cost
remaining at the time of the change is depreciated straight-line over the remaining
useful life.
($ in 000s)

Assets cost
Accumulated depreciation to date (calculated below)
Undepreciated cost, Jan. 1, 2011
Estimated residual value
To be depreciated over remaining 7 years
Annual straight-line depreciation 2011-2013

$990
(486)
$504
(0)
$504
7
$ 72

years

Calculation of SYD depreciation:


(10+9+8) x $990,000) = $486,000
55

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2011


20-7

Problem 20-1 (concluded)


e. This is a change in estimate.

To revise the liability on the basis of the new estimate:


Loss litigation.............................................................. 5,000,000
................................................. Liability litigation ($45 million 40 million)
........................................................................................
........................................................................5,000,000

A disclosure note should describe the effect of a change in estimate on income


before extraordinary items, net income, and related per-share amounts for the current
period.
f. This is a change in accounting principle accounted for prospectively.
Because the change will be effective only for assets placed in service after the date
of change, the change doesnt affect assets depreciated in prior periods. The nature of
and justification for the change should be described in the disclosure notes. Also, the
effect of the change on the current periods financial statements should be disclosed.

The McGraw-Hill Companies, Inc., 2011


20-8

Intermediate Accounting, 6e

Problem 20-2
a. To correct the error:
Equipment (cost)......................................................................
Accumulated depreciation ([$9,000 5] x 2 years))...................
Retained earnings ($9,000 [$1,800 x 2 years)).....................................

9,000
3,600
5,400

2011 adjusting entry:

Depreciation expense ($9,000 5) ...........................................


Accumulated depreciation.................................................

1,800
1,800

b. To reverse erroneous entry:


Cash ......................................................................................
Office supplies .................................................................

51,000
51,000

To record correct entry:


Storage boxes .......................................................................
Cash ..................................................................................

51,000
51,000

c. To correct the error:


Inventory ............................................................................................................
Retained earnings ....................................................................................

112,000
112,000

d. To correct the error:

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2011


20-9

Retained earnings ([$10 x 4,000 shares] $4,000)......................


Paid-in capital excess of par...........................................

36,000
36,000

Note: A small stock dividend (<25%) requires that the market value of the additional shares be
capitalized..

e. To correct the error:


Retained earnings (overstatement of 2010 income)............................
Interest expense (overstatement of 2011 interest) ...................

120,000
120,000

2011 adjusting entry:

Interest expense (4/6 x $180,000).............................................

120,000

Interest payable (4/6 x $180,000)..........................................

120,000

f. To correct the error:


Prepaid insurance ($216,000 3 yrs x 2 years: 2011-2012) .........
Retained earnings ($216,000 [$216,000 3 years]) ............

144,000
144,000

2011 adjusting entry:

Insurance expense ($216,000 3 years) ...............................................


Prepaid insurance .............................................................

The McGraw-Hill Companies, Inc., 2011


20-10

72,000
72,000

Intermediate Accounting, 6e