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CHAPTER 22

ACCOUNTING CHANGES AND ERROR ANALYSIS


TRUE-FALSEConceptual
Ans e!
F T F T F T T T F T F F T F T T F F T T

No"
1. 2. 3. 4. . !. $. &. (. 1). 11. 12. 13. 14. 1 . 1!. 1$. 1&. 1(. 2).

Desc!#pt#on
Change in accounting estimate. Errors in financial statements. Adoption of a new principle. Retrospective application of accounting principle. Reporting cumulative effect of change in principle. "isclosure re#uirements for a change in principle. %ndirect effect of an accounting change. Retrospective application impracticalit'. Reporting changes in accounting estimates. Change in principle vs. change in estimate. Accounting for change in depreciation method. Accounting for change in reporting entities. E*ample of a change in reporting entities. Accounting error vs. change in estimate. Accounting for corrections of errors. +ew principle created ,' FA-. standard. .alance sheet errors. "efinition of counter,alancing errors. Accounting for counter,alancing errors. Correcting entries for noncounter,alancing errors.

$ULTIPLE CHOICEConceptual
Ans e!
, , c d a c c d , c a , , c d c c

No"
21. 22. 23. 24. 2 . 2!. 2$. 2&. 2(. 3). 31. 32. 33. 34. 3 . 3!. 3$.

Desc!#pt#on
Accounting changes and consistenc' concept. %dentif' changes in accounting principle. %dentif' a non/retrospective change. %dentif' a change in accounting principle. Entr' to record a change in depreciation methods. "isclosures re#uired for a change in depreciation methods. Change from percentage/of/completion to completed/contracts. "isclosures re#uired for a change from 0%F1 to F%F1. Change from F%F1 to 0%F1. Change in accounting estimate. Change in accounting estimate. %dentif' a change in accounting estimate. Change in accounting estimate. %dentif' a change in accounting estimate. %dentif' a change in reporting entit'. Retroactive reporting a change in reporting entit'. %dentif' a correction of an error.

22 - 2 ,

Test %an& 'o! Inte!(e)#ate Account#n*+ T el't, E)#t#on 3&. %dentification of counter,alancing errors.

$ULTIPLE CHOICEConceptual -cont".


Ans e!
c c

No"
3(. 4).

Desc!#pt#on
%mpact of failure to record purchase and count ending inventor'. %mpact of failure to record purchase and count ending inventor'.

$ULTIPLE CHOICECo(putat#onal
Ans e!
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No"
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Desc!#pt#on
Calculate effect of a change in depreciation method. Calculate effect of a change in depreciation method. Calculate net income with change in accounting principle with ta* effects. Calculate effect of accounting change. Calculate depreciation e*pense after change in accounting principle. Calculate cumulative effect of a change on retained earnings. Calculate effect of a change on retained earnings. Compute depreciation e*pense after a change in depreciation methods. Calculate cumulative effect of a change in inventor' methods. Calculate net income after a change to 0%F1 method. Calculate net income with change from F%F1 to 0%F1. Calculate depreciation after a change in estimate. Calculate net income with change in an accounting estimate. "etermine depreciation e*pense after a change in estimated life. Compute effect of errors on income ,efore ta*es. Compute effect of errors on retained earnings. Calculate effect of errors on net income. Calculate effect of errors on wor2ing capital. Calculate effect of errors on retained earnings. Effect of errors on income and retained earnings. Calculate effect of errors on net income. Calculate effect of errors on retained earnings. Calculate effect of errors on wor2ing capital. "etermine cumulative effect of error on income statement. "etermine the understatement of retained earnings. Calculate effect of error on net income. Compute effect of error on retained earnings.

$ULTIPLE CHOICECPA A)apte)


Ans e!
, c a a , d , c a

No"
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Desc!#pt#on
%dentif' a change in accounting principle. Cumulative effect of a change from weighted/average to 0%F1. Reporting a change to F%F1 from 0%F1. .alance of accumulated depreciation after a change in estimate. "etermine carr'ing value of a patent with a change in estimate. Reporting ro'alt' income when amount reali3ed differs from estimate. "epreciation e*pense to ,e recorded following an error. %mpact of failure to accrue insurance costs. Retained earnings ,alance with multiple errors.

Accounting Changes and Error Anal'sis

22 - 2

E/ERCISES
Ite(
E22/$$ E22/$& E22/$( E22/&) E22/&1 E22/&2 E22/&3 E22/&4 E22/&

Desc!#pt#on
4atching accounting changes to situations. 5ow changes or corrections are recogni3ed. 4atching disclosures to situations. Change in accounting principle. Change in estimate6 change in entit'6 corrections of errors. Changes in depreciation methods6 estimates. +oncounter,alancing error. Effects of errors. Effects of errors.

PRO%LE$S
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722/&! 722/&$ 722/&&

Desc!#pt#on
Accounting for changes and error corrections. Corrections of errors. Error corrections and ad8ustments.

CHAPTER LEARNING O%0ECTI1ES


1. 2. 3. 4. . !. $. &. (. %dentif' the t'pes of accounting changes. "escri,e the accounting for changes in accounting principles. 9nderstand how to account for retrospective accounting changes. 9nderstand how to account for impractica,le changes. "escri,e the accounting for changes in estimates. %dentif' changes in a reporting entit'. "escri,e the accounting for correction of errors. %dentif' economic motives for changing accounting methods. Anal'3e the effect of errors.

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Test %an& 'o! Inte!(e)#ate Account#n*+ T el't, E)#t#on

SU$$ARY OF LEARNING O%0ECTI1ES %Y 3UESTIONS


Item 1. 3. 4. . !. $. &. 2$. (. 1). 11. 12. 14. 1 . 1!. 1$. 1&. 1(. 2). +ote: Type TF TF TF TF TF TF TF 4C TF TF TF TF TF TF TF TF TF TF TF Item 2. 22. 23. 2!. 41. 42. 2&. 2(. 3). 31. 32. 13. 3$. . !. 3&. 3(. 4). $. Type TF 4C 4C 4C 4C 4C 4C 4C 4C 4C 4C TF 4C 4C 4C 4C 4C 4C 4C Item 21. 24. 2 . 43. 44. 4 . ). 1. 33. 34. 2. 3 . $4. $$. $&. &. (. !). !1. Type Item Type Item Type Item Type Item Type Lea!n#n* O45ect#6e 7 4C Lea!n#n* O45ect#6e 2 4C !&. 4C $&. 4C $$. E Lea!n#n* O45ect#6e 2 4C 4!. 4C 4(. 4C 4$. 4C !(. 4C 4&. 4C $&. Lea!n#n* O45ect#6e 8 4C $). 4C $(. 4C $&. E &). Lea!n#n* O45ect#6e 9 4C 3. 4C $2. 4C 4. 4C $3. 4C $1. 4C $$. Lea!n#n* O45ect#6e : 4C 3!. 4C $$. Lea!n#n* O45ect#6e ; 4C $(. E &!. E &1. E &$. E &3. E &&. Lea!n#n* O45ect#6e < 4C !2. 4C !!. 4C !3. 4C !$. 4C !4. 4C $ . 4C ! . 4C $!.

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TF ; True/False 4C ; 4ultiple Choice E ; E*ercise 7 ; 7ro,lem

Accounting Changes and Error Anal'sis

22 - 9

TRUE-FALSEConceptual
1. 2. 3. 4. A change in accounting principle is a change that occurs as the result of new information or additional e*perience. Errors in financial statements result from mathematical mista2es or oversight or misuse of facts that e*isted when preparing the financial statements. Adoption of a new principle in recognition of events that have occurred for the first time or that were previousl' immaterial is treated as an accounting change. Retrospective application refers to the application of a different accounting principle to recast previousl' issued financial statements<as if the new principle had alwa's ,een used. =hen a compan' changes an accounting principle6 it should report the change ,' reporting the cumulative effect of the change in the current 'ear>s income statement. 1ne of the disclosure re#uirements for a change in accounting principle is to show the cumulative effect of the change on retained earnings as of the ,eginning of the earliest period presented. An indirect effect of an accounting change is an' change to current or future cash flows of a compan' that result from ma2ing a change in accounting principle that is applied retrospectivel'. Retrospective application is considered impractica,le if a compan' cannot determine the prior period effects using ever' reasona,le effort to do so. Companies report changes in accounting estimates retrospectivel'. =hen it is impossi,le to determine whether a change in principle or change in estimate has occurred6 the change is considered a change in estimate. Companies account for a change in depreciation methods as a change in accounting principle. =hen companies ma2e changes that result in different reporting entities6 the change is reported prospectivel'. Changing the cost or e#uit' method of accounting for investments is an e*ample of a change in reporting entit'. Accounting errors include changes in estimates that occur ,ecause a compan' ac#uires more e*perience6 or as it o,tains additional information. Companies record corrections of errors from prior periods as an ad8ustment to the ,eginning ,alance of retained earnings in the current period. %f an FA-. standard creates a new principle6 e*presses preference for6 or re8ects a specific accounting principle6 the change is considered clearl' accepta,le.

. !.

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&. (. 1). 11. 12. 13. 14. 1 . 1!.

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Test %an& 'o! Inte!(e)#ate Account#n*+ T el't, E)#t#on .alance sheet errors affect onl' the presentation of an asset or lia,ilit' account. Counter,alancing errors are those that will ,e offset and that ta2e longer than two periods to correct themselves. For counter,alancing errors6 restatement of comparative financial statements is necessar' even if a correcting entr' is not re#uired. Companies must ma2e correcting entries for noncounter,alancing errors6 even if the' have closed the prior 'ear>s ,oo2s.

T!ue-False Ans e!sConceptual


Ite( 1. 2. 3. 4. . Ans" F T F T F Ite( !. $. &. (. 1). Ans" T T T F T Ite( 11. 12. 13. 14. 1 . Ans" F F T F T Ite( 1!. 1$. 1&. 1(. 2). Ans" T F F T T

$ULTIPLE CHOICEConceptual
21. Accounting changes are often made and the monetar' impact is reflected in the financial statements of a compan' even though6 in theor'6 this ma' ,e a violation of the accounting concept of a. materialit'. ,. consistenc'. c. conservatism. d. o,8ectivit'. =hich of the following is not treated as a change in accounting principle? a. A change from 0%F1 to F%F1 for inventor' valuation ,. A change to a different method of depreciation for plant assets c. A change from full/cost to successful efforts in the e*tractive industr' d. A change from completed/contract to percentage/of/completion =hich of the following is not a retrospective/t'pe accounting change? a. Completed/contract method to the percentage/of/completion method for long/term contracts ,. 0%F1 method to the F%F1 method for inventor' valuation c. -um/of/the/'ears@/digits method to the straight/line method d. AFull costA method to another method in the e*tractive industr' =hich of the following is accounted for as a change in accounting principle? a. A change in the estimated useful life of plant assets. ,. A change from the cash ,asis of accounting to the accrual ,asis of accounting. c. A change from e*pensing immaterial e*penditures to deferring and amorti3ing them as the' ,ecome material. d. A change in inventor' valuation from average cost to F%F1.

22.

23.

24.

Accounting Changes and Error Anal'sis 2 .

22 - ;

A compan' changes from straight/line to an accelerated method of calculating depreciation6 which will ,e similar to the method used for ta* purposes. The entr' to record this change should include a a. credit to Accumulated "epreciation. ,. de,it to Retained Earnings in the amount of the difference on prior 'ears. c. de,it to "eferred Ta* Asset. d. credit to "eferred Ta* 0ia,ilit'. =hich of the following disclosures is re#uired for a change from sum/of/the/'ears/digits to straight/line? a. The cumulative effect on prior 'ears6 net of ta*6 in the current retained earnings statement ,. Restatement of prior 'ears> income statements c. Recomputation of current and future 'ears> depreciation d. All of these are re#uired. A compan' changes from percentage/of/completion to completed/contract6 which is the method used for ta* purposes. The entr' to record this change should include a a. de,it to Construction in 7rocess. ,. de,it to 0oss on 0ong/term Contracts in the amount of the difference on prior 'ears6 net of ta*. c. de,it to Retained Earnings in the amount of the difference on prior 'ears6 net of ta*. d. credit to "eferred Ta* 0ia,ilit'. =hich of the following disclosures is re#uired for a change from 0%F1 to F%F1? a. The cumulative effect on prior 'ears6 net of ta*6 in the current retained earnings statement ,. The 8ustification for the change c. Restated prior 'ear income statements d. All of these are re#uired. -tone Compan' changed its method of pricing inventories from F%F1 to 0%F1. =hat t'pe of accounting change does this represent? a. A change in accounting estimate for which the financial statements for prior periods included for comparative purposes should ,e presented as previousl' reported. ,. A change in accounting principle for which the financial statements for prior periods included for comparative purposes should ,e presented as previousl' reported. c. A change in accounting estimate for which the financial statements for prior periods included for comparative purposes should ,e restated. d. A change in accounting principle for which the financial statements for prior periods included for comparative purposes should ,e restated. =hich t'pe of accounting change should alwa's ,e accounted for in current and future periods? a. Change in accounting principle ,. Change in reporting entit' c. Change in accounting estimate d. Correction of an error

2!.

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22 - = 31.

Test %an& 'o! Inte!(e)#ate Account#n*+ T el't, E)#t#on =hich of the following is BareC the proper time periodBsC to record the effects of a change in accounting estimate? a. Current period and prospectivel' ,. Current period and retrospectivel' c. Retrospectivel' onl' d. Current period onl' =hen a compan' decides to switch from the dou,le/declining ,alance method to the straight/line method6 this change should ,e handled as a a. change in accounting principle. ,. change in accounting estimate. c. prior period ad8ustment. d. correction of an error. The estimated life of a ,uilding that has ,een depreciated 3) 'ears of an originall' estimated life of ) 'ears has ,een revised to a remaining life of 1) 'ears. .ased on this information6 the accountant should a. continue to depreciate the ,uilding over the original )/'ear life. ,. depreciate the remaining ,oo2 value over the remaining life of the asset. c. ad8ust accumulated depreciation to its appropriate ,alance6 through net income6 ,ased on a 4)/'ear life6 and then depreciate the ad8usted ,oo2 value as though the estimated life had alwa's ,een 4) 'ears. d. ad8ust accumulated depreciation to its appropriate ,alance through retained earnings6 ,ased on a 4)/'ear life6 and then depreciate the ad8usted ,oo2 value as though the estimated life had alwa's ,een 4) 'ears. =hich of the following statements is correct? a. Changes in accounting principle are alwa's handled in the current or prospective period. ,. 7rior statements should ,e restated for changes in accounting estimates. c. A change from e*pensing certain costs to capitali3ing these costs due to a change in the period ,enefited6 should ,e handled as a change in accounting estimate. d. Correction of an error related to a prior period should ,e considered as an ad8ustment to current 'ear net income. =hich of the following descri,es a change in reporting entit'? a. A compan' ac#uires a su,sidiar' that is to ,e accounted for as a purchase. ,. A manufacturing compan' e*pands its mar2et from regional to nationwide. c. A compan' divests itself of a European ,ranch sales office. d. Changing the companies included in com,ined financial statements. 7resenting consolidated financial statements this 'ear when statements of individual companies were presented last 'ear is a. a correction of an error. ,. an accounting change that should ,e reported prospectivel'. c. an accounting change that should ,e reported ,' restating the financial statements of all prior periods presented. d. not an accounting change.

32.

33.

34.

3 .

3!.

Accounting Changes and Error Anal'sis 3$.

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An e*ample of a correction of an error in previousl' issued financial statements is a change a. from the F%F1 method of inventor' valuation to the 0%F1 method. ,. in the service life of plant assets6 ,ased on changes in the economic environment. c. from the cash ,asis of accounting to the accrual ,asis of accounting. d. in the ta* assessment related to a prior period. Counter,alancing errors do not include a. errors that correct themselves in two 'ears. ,. errors that correct themselves in three 'ears. c. an understatement of purchases. d. an overstatement of unearned revenue. A compan' using a perpetual inventor' s'stem neglected to record a purchase of merchandise on account at 'ear end. This merchandise was omitted from the 'ear/end ph'sical count. 5ow will these errors affect assets6 lia,ilities6 and stoc2holders@ e#uit' at 'ear end and net income for the 'ear? a. ,. c. d. Assets +o effect +o effect 9nderstate 9nderstate 0ia,ilities 9nderstate 1verstate 9nderstate +o effect -toc2holders@ E#uit' 1verstate 9nderstate +o effect 9nderstate +et %ncome 1verstate. 9nderstate. +o effect. 9nderstate.

3&.

3(.

4).

%f6 at the end of a period6 a compan' erroneousl' e*cluded some goods from its ending inventor' and also erroneousl' did not record the purchase of these goods in its accounting records6 these errors would cause a. the ending inventor' and retained earnings to ,e understated. ,. the ending inventor'6 cost of goods sold6 and retained earnings to ,e understated. c. no effect on net income6 wor2ing capital6 and retained earnings. d. cost of goods sold and net income to ,e understated.

$ult#ple C,o#ce Ans e!sConceptual


Ite( Ans" Ite( Ans" Ite( Ans" Ite( Ans" Ite( Ans" Ite( Ans" Ite( Ans"

21. 22. 23.

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24. 2 . 2!.

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c a ,

33. 34. 3 .

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3(. 4).

c c

22 - 7> Test %an& 'o! Inte!(e)#ate Account#n*+ T el't, E)#t#on

$ULTIPLE CHOICECo(putat#onal
41. 1n Danuar' 16 2)) 6 0'nn Corporation ac#uired e#uipment at a cost of E!))6))). 0'nn adopted the dou,le/declining ,alance method of depreciation for this e#uipment and had ,een recording depreciation over an estimated life of eight 'ears6 with no residual value. At the ,eginning of 2))&6 a decision was made to change to the straight/line method of depreciation for this e#uipment. Assuming a 3)F ta* rate6 the cumulative effect of this accounting change on ,eginning retained earnings6 net of ta*6 is a. E1216&$ . ,. E). c. E$&6$ ). d. E$$61)(. 1n Danuar' 16 2)) 6 Fole' Corporation ac#uired machiner' at a cost of E2 )6))). Fole' adopted the dou,le/declining ,alance method of depreciation for this machiner' and had ,een recording depreciation over an estimated useful life of ten 'ears6 with no residual value. At the ,eginning of 2))&6 a decision was made to change to the straight/line method of depreciation for the machiner'. The depreciation e*pense to ,e recorded for the machiner' in 2))& is Bround to the nearest dollarC a. E2 6!)). ,. E1&62&!. c. E226& $. d. E2 6))). 1n Danuar' 16 2)) 6 .aden Co.6 purchased a machine Bits onl' deprecia,le assetC for E3))6))). The machine has a five/'ear life6 and no salvage value. -um/of/the/'ears@/ digits depreciation has ,een used for financial statement reporting and the elective straight/line method for income ta* reporting. Effective Danuar' 16 2))&6 for financial statement reporting6 .aden decided to change to the straight/line method for depreciation of the machine. Assume that .aden can 8ustif' the change. .aden@s income ,efore depreciation6 ,efore income ta*es6 and ,efore the cumulative effect of the accounting change Bif an'C6 for the 'ear ended "ecem,er 316 2))&6 is E2 )6))). The income ta* rate for 2))&6 as well as for the 'ears 2)) /2))$6 is 3)F. =hat amount should .aden report as net income for the 'ear ended "ecem,er 316 2))&? a. E!)6))) ,. E(16))) c. E1 46))) d. E1$ 6))) 9se the following information for #uestions 44 and 4 . =aeglein Corporation purchased machiner' on Danuar' 16 2))! for E!3)6))). The compan' used the straight/line method and no salvage value to depreciate the asset for the first two 'ears of its estimated si*/'ear life. %n 2))&6 =aeglein changed to the sum/of/the/'ears>/digits depreciation method for this asset. The following facts pertain: 2))! 2))$ -traight/line E1) 6))) E1) 6))) -um/of/the/'ears>/digits 1&)6))) 1 )6)))

42.

43.

Accounting Changes and Error Anal'sis 44.

22 - 77

=aeglein is su,8ect to a 4)F ta* rate. The cumulative effect of this accounting change on ,eginning retained earnings is a. E13 6))). ,. E12)6))). c. E$26))). d. E). The amount that =aeglein should report for depreciation e*pense on its 2))& income statement is a. E1!&6))). ,. E1) 6))). c. E$ 6))). d. none of the a,ove. "uring 2))&6 a construction compan' changed from the completed/contract method to the percentage/of/completion method for accounting purposes ,ut not for ta* purposes. Gross profit figures under ,oth methods for the past three 'ears appear ,elow: 2))! 2))$ 2))& Completed/Contract E 4$ 6))) !2 6))) $))6))) E16&))6))) 7ercentage/of/Completion E &))6))) ( )6))) 16) )6))) E26&))6)))

4 .

4!.

Assuming an income ta* rate of 4)F for all 'ears6 the affect of this accounting change on prior periods should ,e reported ,' a credit of a. E!))6))) on the 2))& income statement. ,. E3()6))) on the 2))& income statement. c. E!))6))) on the 2))& retained earnings statement. d. E3()6))) on the 2))& retained earnings statement. 9se the following information for #uestions 4$ and 4&. 1n Danuar' 16 2)) 6 =int3 Corporation ac#uired machiner' at a cost of E!))6))). =int3 adopted the straight/line method of depreciation for this machine and had ,een recording depreciation over an estimated life of ten 'ears6 with no residual value. At the ,eginning of 2))&6 a decision was made to change to the dou,le/declining ,alance method of depreciation for this machine. 4$. Assuming a 3)F ta* rate6 the cumulative effect of this accounting change on ,eginning retained earnings6 is a. E!$62)). ,. E). c. E$&6(!). d. E1126&)). The amount that =int3 should record as depreciation e*pense for 2))& is a. E!)6))). ,. E&46))). c. E12)6))). d. none of the a,ove.

4&.

22 - 72 Test %an& 'o! Inte!(e)#ate Account#n*+ T el't, E)#t#on 4(. 1n "ecem,er 316 2))& Hean Compan' changed its method of accounting for inventor' from weighted average cost method to the F%F1 method. This change caused the 2))& ,eginning inventor' to increase ,' E42)6))). The cumulative effect of this accounting change to ,e reported for the 'ear ended 12I31I)&6 assuming a 4)F ta* rate6 is a. E42)6))). ,. E2 26))). c. E1!&6))). d. E). Eaton Compan' ,egan operations on Danuar' 16 2))$6 and uses the F%F1 method in costing its raw material inventor'. 4anagement is contemplating a change to the 0%F1 method and is interested in determining what effect such a change will have on net income. Accordingl'6 the following information has ,een developed: Final %nventor' F%F1 0%F1 +et %ncome Bcomputed under the F%F1 methodC 2))$ E!4)6))) !)6))) (&)6))) 2))& E $126))) !3!6))) 16)&)6)))

).

.ased on the a,ove information6 a change to the 0%F1 method in 2))& would result in net income for 2))& of a. E1612)6))). ,. E16)&)6))). c. E16))46))). d. E16)))6))). 1. 5annah Compan' ,egan operations on Danuar' 16 2))$6 and uses the F%F1 method in costing its raw material inventor'. 4anagement is contemplating a change to the 0%F1 method and is interested in determining what effect such a change will have on net income. Accordingl'6 the following information has ,een developed: Final %nventor' 2))$ 2))& F%F1 E32)6))) E3!)6))) 0%F1 24)6))) 3))6))) +et %ncome Bcomputed under the F%F1 methodC ))6))) !))6))) .ased upon the a,ove information6 a change to the 0%F1 method in 2))& would result in net income for 2))& of a. E 4)6))). ,. E!))6))). c. E!2)6))). d. E!!)6))). 2. E#uipment was purchased at the ,eginning of 2)) for E2)46))). At the time of its purchase6 the e#uipment was estimated to have a useful life of si* 'ears and a salvage value of E246))). The e#uipment was depreciated using the straight/line method of depreciation through 2))&. At the ,eginning of 2))&6 the estimate of useful life was revised to a total life of eight 'ears and the e*pected salvage value was changed to E1 6))). The amount to ,e recorded for depreciation for 2))&6 reflecting these changes in estimates6 is a. E1263$ . ,. E1(6&)). c. E226&)). d. E236!2 .

Accounting Changes and Error Anal'sis 9se the following information for #uestions 3 and 4.

22 - 72

Care' Compan' purchased a machine on Danuar' 16 2)) 6 for E3))6))). At the date of ac#uisition6 the machine had an estimated useful life of si* 'ears with no salvage. The machine is ,eing depreciated on a straight/line ,asis. 1n Danuar' 16 2))&6 Care' determined6 as a result of additional information6 that the machine had an estimated useful life of eight 'ears from the date of ac#uisition with no salvage. An accounting change was made in 2))& to reflect this additional information. 3. Assume that the direct effects of this change are limited to the effect on depreciation and the related ta* provision6 and that the income ta* rate was 3)F in 2)) 6 2))!6 2))$6 and 2))&. =hat should ,e reported in Care'@s income statement for the 'ear ended "ecem,er 316 2))&6 as the cumulative effect on prior 'ears of changing the estimated useful life of the machine? a. E) ,. E2)6))) c. E3)6))) d. E1) 6))) =hat is the amount of depreciation e*pense on this machine that should ,e charged in Care'@s income statement for the 'ear ended "ecem,er 316 2))&? a. E3)6))) ,. E3$6 )) c. E!)6))) d. E$ 6))) and !.

4.

9se the following information for #uestions

=ashington %nc. is a calendar/'ear corporation. %ts financial statements for the 'ears ended 12I31I)& and 12I31I)( contained the following errors: Ending inventor' "epreciation e*pense . 2))& E1 6))) overstatement !6))) understatement 2))( E246))) understatement 126))) overstatement

Assume that the 2))& errors were not corrected and that no errors occurred in 2))$. .' what amount will 2))& income ,efore income ta*es ,e overstated or understated? a. E216))) overstatement ,. E(6))) overstatement c. E216))) understatement d. E(6))) understatement Assume that no correcting entries were made at 12I31I)&6 or 12I31I)(. %gnoring income ta*es6 ,' how much will retained earnings at 12I31I)( ,e overstated or understated? a. E246))) overstatement ,. E216))) overstatement c. E3)6))) understatement d. E(6))) understatement

!.

22 - 78 Test %an& 'o! Inte!(e)#ate Account#n*+ T el't, E)#t#on 9se the following information for #uestions $ through (. Rensing Compan'@s "ecem,er 31 'ear/end financial statements contained the following errors: "ec. 316 2))$ "ec. 316 2))& Ending inventor' E$6 )) understated E116))) overstated "epreciation e*pense 26))) understated An insurance premium of E1&6))) was prepaid in 2))$ covering the 'ears 2))$6 2))&6 and 2))(. The prepa'ment was recorded with a de,it to insurance e*pense. %n addition6 on "ecem,er 316 2))&6 full' depreciated machiner' was sold for E(6 )) cash6 ,ut the sale was not recorded until 2))(. There were no other errors during 2))& or 2))( and no corrections have ,een made for an' of the errors. %gnore income ta* considerations. $. =hat is the total net effect of the errors on Rensing@s 2))& net income? a. +et income understated ,' E146 )). ,. +et income overstated ,' E$6 )). c. +et income overstated ,' E136))). d. +et income overstated ,' E1 6))). =hat is the total net effect of the errors on the amount of Rensing@s wor2ing capital at "ecem,er 316 2))&? a. =or2ing capital overstated ,' E 6))) ,. =or2ing capital overstated ,' E16 )) c. =or2ing capital understated ,' E46 )) d. =or2ing capital understated ,' E126))) =hat is the total effect of the errors on the ,alance of Rensing@s retained earnings at "ecem,er 316 2))&? a. Retained earnings understated ,' E1)6))) ,. Retained earnings understated ,' E46 )) c. Retained earnings understated ,' E26 )) d. Retained earnings overstated ,' E36 )) Accrued salaries pa'a,le of E 16))) were not recorded at "ecem,er 316 2))$. 1ffice supplies on hand of E246))) at "ecem,er 316 2))& were erroneousl' treated as e*pense instead of supplies inventor'. +either of these errors was discovered nor corrected. The effect of these two errors would cause a. 2))& net income to ,e understated E$ 6))) and "ecem,er 316 2))& retained earnings to ,e understated E246))). ,. 2))$ net income and "ecem,er 316 2))$ retained earnings to ,e understated E 16))) each. c. 2))$ net income to ,e overstated E2$6))) and 2))& net income to ,e understated E246))). d. 2))& net income and "ecem,er 316 2))& retained earnings to ,e understated E246))) each.

&.

(.

!).

Accounting Changes and Error Anal'sis 9se the following information for #uestions !1 through !3.

22 - 79

Friend Co. ,egan operations on Danuar' 16 2))$. Financial statements for 2))$ and 2))& con/ tained the following errors: "ec. 316 2))$ "ec. 316 2))& Ending inventor' E1326))) too high E1 !6))) too low "epreciation e*pense &46))) too high < %nsurance e*pense !)6))) too low !)6))) too high 7repaid insurance !)6))) too high < %n addition6 on "ecem,er 316 2))& full' depreciated e#uipment was sold for E2&6&))6 ,ut the sale was not recorded until 2))(. +o corrections have ,een made for an' of the errors. %gnore income ta* considerations. !1. The total effect of the errors on Friend@s 2))& net income is a. understated ,' E3$!6&)). ,. understated ,' E2446&)). c. overstated ,' E11 62)). d. overstated ,' E1((62)). The total effect of the errors on the ,alance of Friend@s retained earnings at "ecem,er 316 2))& is understated ,' a. E32&6&)). ,. E2!&6&)). c. E1&46&)). d. E13!6&)). The total effect of the errors on the amount of Friend@s wor2ing capital at "ecem,er 316 2))& is understated ,' a. E4))6&)). ,. E31!6&)). c. E1&46&)). d. E1246&)).

!2.

!3.

9se the following information for #uestions !4 and ! . Rice Co. purchased machiner' that cost E&1)6))) on Danuar' 46 2))!. The entire cost was recorded as an e*pense. The machiner' has a nine/'ear life and a E 46))) residual value. The error was discovered on "ecem,er 2)6 2))&. %gnore income ta* considerations. !4. Rice@s income statement for the 'ear ended "ecem,er 316 2))&6 should show the cumulative effect of this error in the amount of a. E$2!6))). ,. E!426))). c. E &6))). d. E). .efore the correction was made6 and ,efore the ,oo2s were closed on "ecem,er 316 2))&6 retained earnings was understated ,' a. E&1)6))). ,. E$2!6))). c. E!426))). d. E &6))).

! .

22 - 7: Test %an& 'o! Inte!(e)#ate Account#n*+ T el't, E)#t#on 9se the following information for #uestions !! and !$. 5and' Compan' purchased e#uipment that cost E$ )6))) on Danuar' 16 2))!. The entire cost was recorded as an e*pense. The e#uipment had a nine/'ear life and a E3)6))) residual value. 5and' uses the straight/line method to account for depreciation e*pense. The error was discovered on "ecem,er 1)6 2))&. 5and' is su,8ect to a 4) F ta* rate. !!. 5and'>s net income for the 'ear ended "ecem,er 316 2))!6 was understated ,' a. E4)26))). ,. E4 )6))). c. E!$)6))). d. E$ )6))). .efore the correction was made and ,efore the ,oo2s were closed on "ecem,er 316 2))&6 retained earnings was understated ,' a. E3326))). ,. E33!6))). c. E3 46))). d. E4 )6))).

!$.

$ult#ple C,o#ce Ans e!sCo(putat#onal


Ite( Ans" Ite( Ans" Ite( Ans" Ite( Ans" Ite( Ans" Ite( Ans" Ite( Ans"

41. 42. 43. 44.

, , c d

4 . 4!. 4$. 4&.

a d , c

4(. ). 1. 2.

, c a ,

3. 4. . !.

a a a c

$. &. (. !).

d c c a

!1. !2. !3. !4.

a , c d

! . !!. !$.

c a c

$ULTIPLE CHOICECPA A)apte)


!&. =hich of the following should ,e reported as a prior period ad8ustment? Change in Change from Estimated 0ives 9naccepted 7rinciple of "eprecia,le Assets to Accepted 7rinciple a. Jes Jes ,. +o Jes c. Jes +o d. +o +o 1n "ecem,er 316 2))&6 Ellworth6 %nc. appropriatel' changed its inventor' valuation method to F%F1 cost from weighted/average cost for financial statement and income ta* purposes. The change will result in a E16 ))6))) increase in the ,eginning inventor' at Danuar' 16 2))&. Assume a 3)F income ta* rate. The cumulative effect of this accounting change on ,eginning retained earnings is a. E). ,. E4 )6))). c. E16) )6))). d. E16 ))6))).

!(.

Accounting Changes and Error Anal'sis $).

22 - 7;

1n Danuar' 16 2))&6 .osco Corp. changed its inventor' method to F%F1 from 0%F1 for ,oth financial and income ta* reporting purposes. The change resulted in an E&))6))) increase in the Danuar' 16 2))& inventor'. Assume that the income ta* rate for all 'ears is 3)F. The cumulative effect of the accounting change should ,e reported ,' .osco in its 2))& a. retained earnings statement as a E !)6))) addition to the ,eginning ,alance. ,. income statement as a E !)6))) cumulative effect of accounting change. c. retained earnings statement as an E&))6))) addition to the ,eginning ,alance. d. income statement as an E&))6))) cumulative effect of accounting change. 1n Danuar' 16 2)) 6 "ent Co. purchased a machine for E$(26))) and depreciated it ,' the straight/line method using an estimated useful life of eight 'ears with no salvage value. 1n Danuar' 16 2))&6 "ent determined that the machine had a useful life of si* 'ears from the date of ac#uisition and will have a salvage value of E$26))). An accounting change was made in 2))& to reflect these additional data. The accumulated depreciation for this machine should have a ,alance at "ecem,er 316 2))& of a. E43&6))). ,. E4!26))). c. E4&)6))). d. E 2&6))). 1n Danuar' 16 2)) 6 +eer Co. purchased a patent for E ( 6))). The patent is ,eing amorti3ed over its remaining legal life of 1 'ears e*piring on Danuar' 16 2)2). "uring 2))&6 +eer determined that the economic ,enefits of the patent would not last longer than ten 'ears from the date of ac#uisition. =hat amount should ,e reported in the ,alance sheet for the patent6 net of accumulated amorti3ation6 at "ecem,er 316 2))&? a. E3 $6))) ,. E4)&6))) c. E42)6))) d. E43!63$ "uring 2))$6 a te*t,oo2 written ,' Givens Co. personnel was sold to Grand 7u,lishing6 %nc.6 for ro'alties of 1)F on sales. Ro'alties are receiva,le semiannuall' on 4arch 316 for sales in Dul' through "ecem,er of the prior 'ear6 and on -eptem,er 3)6 for sales in Danuar' through Dune of the same 'ear.

$1.

$2.

$3.

Ro'alt' income of E1)&6))) was accrued at 12I31I)$ for the period Dul'/"ecem,er 2))$. Ro'alt' income of E12)6))) was received on 3I31I)&6 and E1 !6))) on (I3)I)&. Givens learned from Grand that sales su,8ect to ro'alt' were estimated at E16!2)6))) for the last half of 2))&. %n its income statement for 2))&6 Givens should report ro'alt' income at a. E2$!6))). ,. E2&&6))). c. E31&6))). d. E33)6))). $4. 1n Danuar' 16 2))$6 Gregg Corp. ac#uired a machine at a cost of E ))6))). %t is to ,e depreciated on the straight/line method over a five/'ear period with no residual value. .ecause of a ,oo22eeping error6 no depreciation was recogni3ed in Gregg@s 2))$ financial statements. The oversight was discovered during the preparation of Gregg@s 2))& financial statements. "epreciation e*pense on this machine for 2))& should ,e

22 - 7= Test %an& 'o! Inte!(e)#ate Account#n*+ T el't, E)#t#on a. ,. c. d. $ . E). E1))6))). E12 6))). E2))6))).

1n "ecem,er 316 2))&6 special insurance costs6 incurred ,ut unpaid6 were not recorded. %f these insurance costs were related to wor2 in process6 what is the effect of the omission on accrued lia,ilities and retained earnings in the "ecem,er 316 2))& ,alance sheet? a. ,. c. d. Accrued 0ia,ilities +o effect +o effect 9nderstated 9nderstated Retained Earnings +o effect 1verstated +o effect 1verstated

$!.

Earl'6 %nc. is a calendar/'ear corporation whose financial statements for 2))$ and 2))& included errors as follows: Jear 2))$ 2))& Ending %nventor' E1!26))) overstated 46))) understated "epreciation E*pense E13 6))) overstated 4 6))) understated

Assume that purchases were recorded correctl' and that no correcting entries were made at "ecem,er 316 2))$6 or at "ecem,er 316 2))&. %gnoring income ta*es6 ,' how much should Earl'@s retained earnings ,e retroactivel' ad8usted at Danuar' 16 2))(? a. E1446))) increase ,. E3!6))) increase c. E1&6))) decrease d. E(6))) increase

$ult#ple C,o#ce Ans e!sCPA A)apte)


Ite( Ans" Ite( Ans" Ite( Ans" Ite( Ans" Ite( Ans"

!&. !(.

, c

$). $1.

a a

$2. $3.

, d

$4. $ .

, c

$!.

DERI1ATIONS Co(putat#onal
No" Ans e!
41. 42. 43. , , c

De!#6at#on
E)6 +o cumulative effectK handle prospectivel'. E2 )6))) L MBE2 )6))) N .2C O BE2))6))) N .2C O BE1!)6))) N .2CP ; E12&6))) E12&6))) $ ; E1&62&!. MB I1 O 4I1 O 3I1 C N E3))6)))P ; E24)6))) BA"C BE3))6))) L E24)6)))C ; E!)6))) B.QC ME2 )6))) L BE!)6))) R 2CP N B1 L .3C ; E1 46))). E)6 +o cumulative effectK handle prospectivel'.

44.

Accounting Changes and Error Anal'sis

22 - 7<

DERI1ATIONS Co(putat#onal -cont".


No" Ans e!
4 . 4!. 4$. 4&. 4(. ). 1. 2. 3. 4. . !. $. &. (. !). !1. !2. !3. !4. ! . c d , c , c a , a a a c d c c a a , c d c

De!#6at#on
ME!3)6))) L BE1) 6))) O E1) 6)))CP ; E42)6))). E42)6))) 4I1) ; E1!&6))). MBE&))6))) O E( )6)))C L BE4$ 6))) O E!2 6)))CP N B1 L .4)C ; E3()6))). E)6 +o cumulative effectK handle prospectivel'. SBE!))6))) L MBE!))6))) R 1)C N 3PT R $ N 2 ; E12)6))). E42)6))) N B1 L .4)C ; E2 26))). E16)&)6))) L BE$126))) L E!3!6)))C ; E16))46))). E!))6))) L BE3!)6))) L E3))6)))C ; E 4)6))). E2)46))) L SMBE2)46))) L E246)))C R !P N 3T ; E1146))) BE1146))) L E1 6)))C R B& L 3C ; E1(6&)). E)6 no cumulative effect6 handle prospectivel' Bchange in estimateC. BE3))6))) R !C N 3 ; E1 )6))) E1 )6))) R ; E3)6))). E1 6))) O E!6))) ; E216))) overstatement. E246))) O E!6))) ; E3)6))) understatement. E$6 )) BoC O E116))) BoC O E!6))) BoC L E(6 )) BuC ; E1 6))) BoC. E116))) BoC L E!6))) BuC L E(6 )) BuC ; E46 )) BuC. E26))) BoC O E116))) BoC L E!6))) BuC L E(6 )) BuC ; E26 )) BuC. 2))& +% ; E1$6))) BuC O E&6))) BuC ; E2 6))) BuC. 2))& RE ; E&6))) BuC MThe 2))$ E1$6))) BoC is offset ,' 2))& E1$6))) BuCP. E1326))) BuC O E1 !6))) BuC O E!)6))) BuC O E2&6&)) BuC ; E3$!6&)) BuC. E1 !6))) BuC O E&46))) BuC L E!)6))) BoC O E!)6))) BuC O E2&6&)) BuC ; E2!&6&)) BuC. E1 !6))) BuC O E2&6&)) BuC ; E1&46&)) BuC. CE ; E)6 correction of error. E&1)6))) L E&1)6))) L E 46))) MB<<<<<<<<< C N 2 P ; E!426))) (

22 - 2> Test %an& 'o! Inte!(e)#ate Account#n*+ T el't, E)#t#on

DERI1ATIONS Co(putat#onal -cont".


No" Ans e!
!!. !$. a c

De!#6at#on
BE$ )6))) L MBE$ )6))) L E3)6)))C R (PC N B1 L .4)C ; E4)26))). E$ )6))) L MBE$ )6))) L E3)6)))C R ( N 2P ; E ()6))). E ()6))) N B1 L .4)C ; E3 46))).

DERI1ATIONS CPA A)apte)


No" Ans e!
!&. !(. $). $1. $2. $3. $4. $ . $!. , c a a , d , c a

De!#6at#on
Conceptual. E16 ))6))) N B1 L .3C ; E16) )6))). E&))6))) N B1 L .3C ; E !)6))). E$(26))) N 3I& ; E2($6))) E2($6))) O MBE$(26))) L E2($6))) L E$26)))C N 1I3P ; E43&6))). E ( 6))) N 3I1 ; E11(6))) E ( 6))) L E11(6))) L MBE ( 6))) L E11(6)))C N 1I$P ; E4)&6))). BE12)6))) L E1)&6)))C O E1 !6))) O BE16!2)6))) N .1)C ; E33)6))). E ))6))) R Conceptual. E 46))) BuC O E13 6))) BuC L E4 6))) BoC ; E1446))) BuC. ; E1))6))).

Accounting Changes and Error Anal'sis

22 - 27

E/ERCISES
E?" 22-;;<4atching accounting changes to situations. The four t'pes of accounting changes6 including error correction6 are: Code a. Change in accounting principle. ,. Change in accounting estimate. c. Change in reporting entit'. d. Error correction. Inst!uct#ons Following are a series of situations. Jou are to enter a code letter to the left to indicate the t'pe of change. UUUUUU 1. UUUUUU 2. UUUUUU 3. UUUUUU 4. UUUUUU . Change from presenting nonconsolidated to consolidated financial statements. Change due to charging a new asset directl' to an e*pense account. Change from e*pensing to capitali3ing certain costs6 due to a change in periods ,enefited. Change from F%F1 to 0%F1 inventor' procedures. Change due to failure to recogni3e an accrued BuncollectedC revenue. Change in amorti3ation period for an intangi,le asset. Changing the companies included in com,ined financial statements. Change in the loss rate on warrant' costs. Change due to failure to recogni3e and accrue income. Change in residual value of a deprecia,le plant asset. Change from an unaccepta,le to an accepta,le accounting principle. Change in ,oth estimate and accepta,le accounting principles. Change due to failure to recogni3e a prepaid asset. Change from straight/line to sum/of/the/'ears@/digits method of depreciation. Change in life of a deprecia,le plant asset. Change from one accepta,le principle to another accepta,le principle. Change due to understatement of inventor'. Change in e*pected recover' of an account receiva,le.

UUUUUU !. UUUUUU $. UUUUUU &. UUUUUU (. UUUUUU 1). UUUUUU 11. UUUUUU 12. UUUUUU 13. UUUUUU 14. UUUUUU 1 . UUUUUU 1!. UUUUUU 1$. UUUUUU 1&.

Solut#on 22-;; 1. c 2. d 3. , 4. a . d !. , $. c &. , (. d 1). , 11. d 12. , 13. d 14. , 1 . , 1!. a 1$. d 1&. ,

22 - 22 Test %an& 'o! Inte!(e)#ate Account#n*+ T el't, E)#t#on E?" 22-;=<5ow changes or corrections are recogni3ed. For each of the following items6 indicate the t'pe of accounting change and how each is recogni3ed in the accounting records in the current 'ear. BaC B,C BcC BdC BeC BfC BgC Change from straight/line method of depreciation to sum/of/the/'ears@/digits Change from the cash ,asis to accrual ,asis of accounting Change from F%F1 to 0%F1 method for inventor' valuation purposes Change from presentation of statements of individual companies to presentation of consolidated statements Change due to failure to record depreciation in a previous period Change in the reali3a,ilit' of certain receiva,les Change from 0%F1 to F%F1 method for inventor' valuation purposes

Solut#on 22-;= BaC B,C BcC BdC BeC BfC BgC Change in accounting estimateK currentl' and prospectivel'. Correction of an errorK restatement of financial statements of all prior periods presentedK ad8ustment of ,eginning retained earnings of the current period. Change in accounting principleK no restatementK ,ase inventor' is the opening inventor' of the period of change. Change in accounting entit'K retrospective restatement of financial statements of all prior periods presentedK ad8ustment of ,eginning retained earnings of the current period. Correction of an errorK restatement of financial statements of the period affectedK prior period ad8ustmentK ad8ustment of ,eginning retained earnings of the first period after the error. Change in accounting estimateK currentl' and prospectivel'. Change in accounting principleK retrospective restatement of all affected prior financial statementsK ad8ustment of ,eginning retained earnings of the current period.

Accounting Changes and Error Anal'sis E?" 22-;<<4atching disclosures to situations.

22 - 22

%n the ,lan2 to the left of each #uestion6 fill in the letter from the following list which ,est descri,es the presentation of the item on the financial statements of Gorden Corporation for 2))&. a. ,. c. d. UUUUU UUUUU 1. 2. Change in estimate 7rior period ad8ustment Bnot due to change in principleC Retrospective t'pe accounting change with note disclosure +one of the a,ove %n 2))&6 the compan' changed its method of recogni3ing income from the completed/contract method to the percentage/of/completion method. At the end of 2))&6 an audit revealed that the corporation@s allowance for dou,tful accounts was too large and should ,e reduced to 2F. =hen the audit was made in 2))$6 the allowance seemed appropriate. "epreciation on a truc26 ac#uired in 2)) 6 was understated ,ecause the service life had ,een overestimated. The understatement had ,een made in order to show higher net income in 2))! and 2))$. The compan' switched from a 0%F1 to a F%F1 inventor' valuation method during the current 'ear. %n the current 'ear6 the compan' decides to change from e*pensing certain costs to capitali3ing these costs6 due to a change in the period ,enefited. "uring 2))&6 a long/term ,ond with a carr'ing value of E36!))6))) was retired at a cost of E461))6))). After negotiations with the %R-6 income ta*es for 2))! were esta,lished at E426()). The' were originall' estimated to ,e E2&6!)). %n 2))&6 the compan' incurred interest e*pense of E2(6))) on a 2)/'ear ,ond issue. %n computing the depreciation in 2))! for e#uipment6 an error was made which overstated income in that 'ear E$ 6))). The error was discovered in 2))&. %n 2))&6 the compan' changed its method of depreciating plant assets from the dou,le/declining ,alance method to the straight/line method.

UUUUU

3.

UUUUU UUUUU UUUUU UUUUU UUUUU UUUUU

4. . !. $. &. (.

UUUUU 1).

Solut#on 22-;< 1. 2. c a 3. 4. , c . !. a d $. &. a d (. 1). , a

22 - 28 Test %an& 'o! Inte!(e)#ate Account#n*+ T el't, E)#t#on E?" 22-=><Change in accounting principle. %n 2))&6 4a*well Corporation changed its method of inventor' pricing from 0%F1 to F%F1. +et income computed on a 0%F1 as compared to a F%F1 ,asis for the four 'ears involved is: B%gnore income ta*es.C 0%F1 F%F1 2)) E$&62)) E&36$)) 2))! &46 )) &&61)) 2))$ &$6))) (164)) 2))& (26 )) (46$)) Inst!uct#ons BaC %ndicate the net income that would ,e shown on comparative financial statements issued at 12I31I)& for each of the four 'ears6 assuming that the compan' changed to the F%F1 method in 2))&. B,C Assume that the compan' had switched from the average cost method to the F%F1 method with net income on an average cost ,asis for the four 'ears as follows: 2)) 6 E&)64))K 2))!6 E&!612)K 2))$6 E()63))K and 2))&6 E(36!)). %ndicate the net income that would ,e shown on comparative financial statements issued at 12I31I)& for each of the four 'ears under these conditions. Assuming that the compan' switched from the F%F1 to the 0%F1 method6 what would ,e the net income reported on comparative financial statements issued at 12I31I)& for 2)) 6 2))!6 and 2))$?

BcC

Solut#on 22-=> BaC B,C BcC 2)) 6 E&36$))K 2))!6 E&&61))K 2))$6 E(164))K 2))&6 E(46$))6 BRetrospective restatementC. 2)) 6 E&36$))K 2))!6 E&&61))K 2))&6 E(164))K 2))&6 E(46$))6 BRetrospective restatementC. 2)) 6 E&36$))K 2))!6 E&&61))K 2))$6 E(164)).

E?" 22-=7<Change in estimate6 change in entit'6 correction of errors. "iscuss the accounting procedures for and illustrate the following: BaC Change in estimate B,C Change in entit' BcC Correction of an error

Solut#on 22-=7 BaC Accounting estimates will change as new events occur6 as more e*perience is ac#uired6 or new information is o,tained. E*amples of changes in estimate are: BaC collecti,ilit' of receiva,les6 B,C inventor' o,solescence6 BcC estimated lives or residual values6 and BdC warrant' costs. Changes in estimates are handled prospectivel'K that is6 in current and future periods. +o restatement of previous financial statements is made.

Accounting Changes and Error Anal'sis Solut#on 22-=7 Bcont.C B,C

22 - 29

A change in accounting entit' results in financial statements of a different entit'. E*amples of changes in entit' are: BaC consolidated statements replacing individual statements6 B,C different su,sidiaries in the group for which consolidated statements are presented6 BcC different companies included in com,ined financial statements6 and BdC a pooling of interests. The financial statements of all prior periods presented should ,e restated to show the financial information for the new reporting entit' for all periods. E*amples of accounting errors are: BaC a change from an accounting principle that is not generall' accepted to an accounting principle that is accepted6 B,C mathematical mista2es6 BcC changes in estimates that occur ,ecause the estimates are not made in good faith6 BdC an oversight6 BeC a misuse of facts6 and BfC misclassification of an asset as an e*pense or vice versa. Corrections of errors are recorded in the 'ear discovered6 are treated as prior period ad8ustments6 and the ,eginning ,alance of retained earnings is ad8usted. 7rior financial statements are restated.

BcC

E?" 22-=2<Changes in depreciation methods6 estimates. 1n Danuar' 16 2))36 -auder Compan' purchased a ,uilding and machiner' that have the following useful lives6 salvage value6 and costs. .uilding6 2 /'ear estimated useful life6 E46)))6))) cost6 E4))6))) salvage value 4achiner'6 1)/'ear estimated useful life6 E ))6))) cost6 no salvage value The ,uilding has ,een depreciated under the straight/line method through 2))$. %n 2))&6 the compan' decided to switch to the dou,le/declining ,alance method of depreciation for the ,uilding. -auder also decided to change the total useful life of the machiner' to & 'ears6 with a salvage value of E2 6))) at the end of that time. The machiner' is depreciated using the straight/ line method. Inst!uct#ons BaC 7repare the 8ournal entr' necessar' to record the depreciation e*pense on the ,uilding in 2))&. B,C Compute depreciation e*pense on the machiner' for 2))&.

Solut#on 22-=2 Computation of 2))& depreciation e*pense on the ,uilding: Cost of ,uilding Accumulated depreciation MBE46)))6))) L E4))6)))C R 2 P N .oo2 value6 1I1I)& E46)))6))) 'ears $2)6))) E362&)6)))

2))& "epreciation e*pense: E362&)6))) N 1)F ; E32&6))) "epreciation E*pense..................................................................... Accumulated "epreciation<.uilding...................................... 32&6))) 32&6)))

22 - 2: Test %an& 'o! Inte!(e)#ate Account#n*+ T el't, E)#t#on Solut#on 22-=2 Bcont.C Computation of 2))& depreciation e*pense on machiner': Cost of machiner' Accumulated depreciation MBE ))6))) L E)C R 1)P N 'ears .oo2 value6 1I1I)& E ))6))) 2 )6))) E2 )6)))

2))& "epreciation e*pense: BE2 )6))) L E2 6)))C R B& L C ; E22 6))) R 3 ; E$ 6)))

E?" 22-=2<+oncounter,alancing error. -tevens Co. ,ought a machine on Danuar' 16 2))! for E&$ 6))). %t had a E$ 6))) estimated residual value and a ten/'ear life. An e*pense account was de,ited on the purchase date. -tevens uses straight/line depreciation. This was discovered in 2))&. Inst!uct#ons 7repare the entr' or entries related to the machine for 2))&.

Solut#on 22-=2 4achine................................................................................................ Retained Earnings..................................................................... Accumulated "epreciation B2 N E&)6)))C................................... "epreciation E*pense........................................................................... Accumulated "epreciation......................................................... &$ 6))) $1 6))) 1!)6))) &)6))) &)6)))

E?" 22-=8<Effects of errors. -how how the following independent errors will affect net income on the %ncome -tatement and the stoc2holders@ e#uit' section of the .alance -heet using the s'm,ol O BplusC for overstated6 L BminusC for understated6 and ) B3eroC for no effect. 2))& 2))( %ncome .alance %ncome .alance -tatement -heet -tatement -heet 1. Ending inventor' in 2))& overstated. 2. Failed to accrue 2))& interest reve/ nue. 3. A capital e*penditure for factor' e#uipment Buseful life6 'earsC was erroneousl' charged to maintenance e*pense in 2))&.

Accounting Changes and Error Anal'sis E?" 22-=8 Bcont.C 2))& %ncome -tatement 4. Failed to count office supplies on hand at 12I31I)&. Cash e*penditures have ,een charged to an office supplies e*pense account during the 'ear 2))&. . Failed to accrue 2))& wages. !. Ending inventor' in 2))& understated. $. 1verstated 2))& depreciation penseK 2))( e*pense correct. e*/ .alance -heet %ncome -tatement 2))(

22 - 2;

.alance -heet

Solut#on 22-=8 2))& %ncome -tatement 1. Ending inventor' in 2))& overstated. 2. Failed to accrue 2))& interest reve/ nue. 3. A capital e*penditure for factor' e#uipment Buseful life6 'earsC was erroneousl' charged to maintenance e*pense in 2))&. 4. Failed to count office supplies on hand at 12I31I)&. Cash e*penditures have ,een charged to 1ffice -upplies E*pense during the 'ear 2))&. . Failed to accrue 2))& wages. !. Ending inventor' in 2))& understated. $. 1verstated 2))& depreciation e*/ penseK 2))( e*pense correct O L .alance -heet O L 2))( %ncome .alance -tatement -heet L O ) )

L O L L

L O L L

O L O )

) ) ) L

22 - 2= Test %an& 'o! Inte!(e)#ate Account#n*+ T el't, E)#t#on E?" 22-=9<Effects of errors. Redman Co. ,egan operations on Danuar' 16 2))$. Financial statements for 2))$ and 2))& contained the following errors: "ec. 316 2))$ "ec. 316 2))& Ending inventor' E()6))) too high E1146))) too high "epreciation e*pense 4&6))) too low < Accumulated depreciation 4&6))) too low 4&6))) too low %nsurance e*pense 426))) too high 426))) too low 7repaid insurance 3!6))) too low %n addition6 on "ecem,er 2!6 2))& full' depreciated e#uipment was sold for E &6)))6 ,ut the sale was not recorded until 2))(. +o corrections have ,een made for an' of the errors. Inst!uct#ons %gnoring income ta*es6 show 'our calculation of the total effect of the errors on 2))& net income.

Solut#on 22-=9 2))$ ending inventor' 2))& ending inventor' %nsurance e*pense 9nrecorded gain 1verstatement of 2))& income E B()6)))C 1146))) 426))) B &6)))C E &6)))

+ote: The error in depreciation e*pense has no effect on 2))& income. The error in prepaid insurance is related to the error in insurance e*pense.

PRO%LE$S
P!" 22-=:<Accounting for changes and error corrections. 7ac2 Compan'@s net incomes for the past three 'ears are presented ,elow: 2))( 2))& 2))$ E4&)6))) E4 )6))) E3!)6))) "uring the 2))( 'ear/end audit6 the following items come to 'our attention: 1. 7ac2 ,ought a truc2 on Danuar' 16 2))! for E1(!6))) with a E1!6))) estimated salvage value and a si*/'ear life. The compan' de,ited an e*pense account and credited cash on the purchase date for the entire cost of the asset. B-traight/line methodC 2. "uring 2))(6 7ac2 changed from the straight/line method of depreciating its cement plant to the dou,le/declining ,alance method. The following computations present depreciation on ,oth ,ases: 2))( 2))& 2))$ -traight/line 3!6))) 3!6))) 3!6))) "ou,le/declining 4!6)&) $6!)) $26)))

Accounting Changes and Error Anal'sis P!" 22-=: Bcont.C

22 - 2<

The net income for 2))( was computed using the dou,le/declining ,alance method6 on the Danuar' 16 2))( ,oo2 value6 over the useful life remaining at that time. The depreciation recorded in 2))( was E$26))). 3. 7ac26 in reviewing its provision for uncollecti,les during 2))(6 has determined that 1F is the appropriate amount of ,ad de,t e*pense to ,e charged to operations. The compan' had used 1I2 of 1F as its rate in 2))& and 2))( when the e*pense had ,een E1&6))) and E126)))6 respectivel'. The compan' recorded ,ad de,t e*pense under the new rate for 2))(. The compan' would have recorded E!6))) less of ,ad de,t e*pense on "ecem,er 316 2))( under the old rate. Inst!uct#ons BaC 7repare in general 8ournal form the entr' necessar' to correct the ,oo2s for the transaction in part 1 of this pro,lem6 assuming that the ,oo2s have not ,een closed for the current 'ear. B,C BcC Compute the net income to ,e reported each 'ear 2))$ through 2))(. Assume that the ,eginning retained earnings ,alance Bunad8ustedC for 2))$ was E162!)6))). At what ad8usted amount should this ,eginning retained earnings ,alance for 2))$ ,e stated6 assuming that comparative financial statements were prepared? Assume that the ,eginning retained earnings ,alance Bunad8ustedC for 2))( is E16&))6))) and that non/comparative financial statements are prepared. At what ad8usted amount should this ,eginning retained earnings ,alance ,e stated?

BdC

Solut#on 22-=: BaC E#uipment.................................................................................... "epreciation E*pense.................................................................. Accumulated "epreciation B4 'ears6 )!/)(C...................... Retained Earnings............................................................ 2))$: E3!)6))) L E3)6))) ; E33)6))). 2))&: E4 )6))) L E3)6))) ; E42)6))). 2))(: E4&)6))) L E3)6))) ; E4 )6))). Retained earnings Bunad8ustedC Correction of 2))! error BE1(!6))) L E3)6)))C Retained earnings Bad8ustedC Retained earnings Bunad8ustedC Correction of error BE1(!6))) L E()6)))C Retained earnings Bad8ustedC E162!)6))) 1!!6))) E1642!6))) E16&))6))) 1)!6))) E16()!6))) 1(!6))) 3)6))) 12)6))) 1)!6)))

B,C

BcC

BdC

22 - 2> Test %an& 'o! Inte!(e)#ate Account#n*+ T el't, E)#t#on P!" 22-=;<Correction of errors. 9nruh Compan' reported net incomes for a three/'ear period as follows: 2))!6 E1&!6)))K 2))$6 E1&(6)))K 2))&6 E1&)6))). %n reviewing the accounts in 2))( after the ,oo2s for the prior 'ear have ,een closed6 'ou find that the following errors have ,een made in summari3ing activities: 2))! 2))$ 2))& 1verstatement of ending inventor' E426))) E 16))) E246))) 9nderstatement of accrued advertising e*pense !6!)) 126))) $62)) Inst!uct#ons BaC "etermine corrected net incomes for 2))!6 2))$6 and 2))&. B,C Give the entr' to ,ring the ,oo2s of the compan' up to date in 2))(6 assuming that the ,oo2s have ,een closed for 2))&.

Solut#on 22-=; BaC 2))! +et income Bunad8ustedC E1&!6))) 1verstatement of ending inventor'<2))! B426)))C 1verstatement of ending inventor'<2))$ 1verstatement of ending inventor'<2))& 9nderstatement of accrued advertising e*pense<2))! B!6!))C 9nderstatement of accrued advertising e*pense<2))$ 9nderstatement of accrued advertising e*pense<2))& +et income BcorrectedC E13$64)) 2))$ 2))& E1&(6))) E1&)6))) 426))) B 16)))C 16))) B246)))C !6!)) B126)))C 126))) B$62))C E1$46!)) E2116&)) 3162)) $62)) 246)))

B,C Retained Earnings......................................................................... Advertising E*pense............................................................ %nventor'..............................................................................

P!" 22-==<Error corrections and ad8ustments. The controller for Grant Corporation is concerned a,out certain ,usiness transactions that the compan' e*perienced during 2))&. The controller6 after discussing these matters with various individuals6 has come to 'ou for advice. The transactions at issue are presented ,elow. 1. The compan' has decided to switch from the direct write/off method in accounting for ,ad de,t e*pense to the percentage/of/sales approach. Assume that Grant Corporation has recogni3ed ,ad de,t e*pense as the receiva,les have actuall' ,ecome uncollecti,le in the following wa': 2))$ 2))& From 2))$ sales 316&)) 126))) From 2))& sales 4 6))) The controller estimates that an additional E! 64)) will ,e charged off in 2))(: E1164)) applica,le to 2))$ sales and E 46))) to 2))& sales.

Accounting Changes and Error Anal'sis P!" 22-== Bcont.C

22 - 27

2. %nventor' has ,een shipped on consignment. These transactions have ,een recorded as ordinar' sales and ,illed as such on account. At "ecem,er 316 2))&6 inventor' ,illed and in the hands of consignees amounted to E4))6))). The percentage mar2up on selling price is 2)F. Assume that consigned inventor' is sold the following 'ear. The compan' uses the perpetual inventor' s'stem. 3. "uring the current 'ear6 the compan' sold E!))6))) of goods on the installment ,asis. The cost of sales associated with these goods sold is E42)6))). The compan' inadvertentl' handled these sales and related costs as part of the regular sales transactions. Cash of E1$26)))6 including a down pa'ment of E!)6)))6 was collected on these installment sales during the current 'ear. "ue to #uestiona,le collecti,ilit'6 the installment method was considered appropriate. Inst!uct#ons BaC Assume that Grant Corporation reported net income of E16)))6))) for 2))&. 7resent a schedule showing the corrected net income after reviewing the a,ove transactions. B,C 7repare the 8ournal entries necessar' at "ecem,er 316 2))&6 assuming that the ,oo2s have ,een closed.

Solut#on 22-== BaC Reported net income 1. Additional charge for ,ad de,ts 2))$ de,ts written off in 2))& 2))& de,ts to ,e written off in 2))( 2. Consignment<B2)F N E4))6)))C 3. Gross profit< Recogni3ed -hould ,e B3)F N E1$26)))C Corrected net income B,C 1&)6))) B 16!))C ! 64)) ! 64)) 32)6))) &)6))) 4))6))) 12&64)) 12&64)) E16)))6))) E 126))) B 46)))C B426)))C B&)6)))C B12&64))C E$4(6!))

1. Retained Earnings.................................................................. Allowance for "ou,tful Accounts................................. 2. Consignment 1ut B%nventor'C.................................................. Retained Earnings.................................................................. Accounts Receiva,le................................................... 3. Retained Earnings.................................................................. "eferred Gross 7rofit..................................................