Chapter 7

Notes (Part 1)

I. Accounting Policies, Changes in Estimates and Errors

PROBLEM 1: TRUE OR FALSE

1. FALSE 6. FALSE
2. FALSE 7. FALSE
3. TRUE 8. FALSE
4. FALSE 9. TRUE
5. TRUE 10. FALSE
11. TRUE

PROBLEM 2: FOR CLASSROOM DISCUSSION

1. C

2. B

3. D

4. C

5. D

6. B

7. C

8. C

9. A

10. E

11. D

12. C

13. C

Explanation: PAS 8 requires an entity to account for a change in accounting

policy in accordance with the transitional provision of the related standard. In
the absence of a transitional provision, the entity shall account for the change

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in accounting policy by retrospective application. If retrospective application is
impracticable, PAS 8 allows a change in accounting policy to be accounted
for by prospective application.

14. Solutions:
Requirement (a):
1st step: CA on 1/1/x5: (600,000 x 6/10) = 360,000;
2nd step: 360,000 ÷ 3 yrs. = 120,000 amortization expense in 20x5

Requirement (b):
CA on 1/1/x5 360,000 – 120,000 = 240,000 CA on 12/31/x5

15. Solutions:
Requirement (a):
140,000 increase in beginning inventory x 70% = 98,000

Requirement (b):
Inventory – beg. 140,000
Retained earnings – beg. 98,000
Deferred tax liability 42,000

16. Solutions:

Requirement (a):
  20x1 20x2
Under (Over) statement of ending inventory -
10,000
20x1 (10,000)
Under (Over) statement of ending inventory -
(4,000)
20x2
Depreciation understatement - 20x1 (4,000) -
Depreciation understatement - 20x2 (6,000)
Failure to accrue salaries at year end - 20x1 (8,000) 8,000
Failure to accrue salaries at year end - 20x2 (12,000)
Effect on profit or loss - (Over) Under
(2,000) (24,000)
statement

Requirement (b):
Effect on 12/31/x2 retained earnings = (2,000) + (24,000) = (26,000)

17. Solutions:

Requirement (a):
  20x1 20x2
Ending inventory - 20x1 4,000 (4,000)
Ending inventory - 20x2 (3,600)
Depreciation (800)
Insurance premium (3,600 x 2/3) 2,400
Insurance premium (3,600 / 3) (1,200)
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Gain on sale 6,400
Effect on profit or loss - (Over) Under
5,600 (2,400)
statement

Requirement (b):
Effect on 12/31/x2 retained earnings = 5,600 + (2,400) = (3,200)

PROBLEM 3: EXERCISES

1. Solutions:

Requirement (a):
CA on 1/1/x4: (600,000 x 75% x 75% x 75%) = ₱253,125
Depreciation 20x4: (253,125 – 150,000) ÷ 5 = 20,625

DDB rate = 2/Life = 2/8 = 25%; (100% - 25% = 75%)

Requirement (b):
CA on 1/1/x4 253,125 – 20,625 depreciation = 232,500 CA on 12/31/x4

Requirement (c):
(600,000 historical cost – 232,500 CA on 12/31/x4) = 367,500 accumulated
depreciation 12/31/x4

2. Solution:
CA on 1/1/x4: (46,000 - 2,000) x 7/10 + 2,000 = 32,800
Depreciation 20x4 = (32,800 – 500) ÷ 2 = 16,150

Depreciation Expense ........................ 16,150

Accumulated Depreciation .................. 16,150

3. Solution:
Historical cost: 124,000;
Accumulated depreciation - 1/1/x4: (124,000 - 12,000) x [(8+7+6) / 36*] =
65,333;
CA on 1/1/x4: (124,000 – 65,333) = 58,667

*SYD denominator = Life x [(Life + 1) ÷ 2] = 8 x (9 ÷ 2) = 36

Depreciation 20x4 = (58,667 – 12,000) ÷ 5 = 9,333

Depreciation Expense ......................... 9,333

Accumulated Depreciation ................... 9,333

4. Solution:
Historical cost: 100,000;
Accumulated depreciation - 1/1/x4: 100,000 x [(10+9+8) / 55*] = 49,090;
CA on 1/1/x4: (100,000 – 49,090) = 50,909

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*SYD denominator = Life x [(Life + 1) ÷ 2] = 10 x (11 ÷ 2) = 55

Depreciation 20x4 = 50,909 ÷ 7 = 7,273

Adjusted net
Year
income
20x1 350,000
20x2 450,000
20x3 300,000
20x4 (670K -
662,727
7,273)

5. Solutions:

Requirement (a):

Bad Debt Expense (163,000 x 2%) 3,260

Allowance for Bad Debts 3,260

Requirement (b):
Allowance for bad debts
Write- Estimated bad
offs: debts:
20x1 1,200 2,610 20x1
20x2 2,850 3,690 20x2
20x3 3,222 4,410 20x3
20x4 3,720 3,260 20x4
End. 2,978

6. Solutions:

Requirement (a):
The change is an error (not a change in accounting policy or estimate)
because it is a change from an unacceptable principle to an acceptable
principle. The change shall be accounted for by retrospective restatement.

Requirement (b):
Retained Earnings – beg. ........................... 22,000
Allowance for Doubtful Accounts ........... 22,000

7. Solutions:

Requirement (a):
The beginning balance of retained earnings (Jan. 1, 20x2) shall be increased
by ₱40,000 (400,000 – 360,000).

Requirement (b):

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Inventory .................................... 40,000
Retained Earnings (1/1/x2) .......................... 40,000

8. Solutions:

Requirement (a):
  20x1 20x2
Asset inappropriately charged as expense 170,00
(120K + 50K) 0 -
Unrecorded depreciation [(120K + 50K) - 20K] ÷ 5 (30,000
yrs. ) (30,000)
140,00
(30,000)
Effect on profit or loss - (Over) Under statement 0

Requirement (b):
Effect on 12/31/x2 retained earnings = 140,000 + (30,000) = 110,000 under

Requirement (c):

i. books still open

Machinery (150K + 20K) 170,000

Depreciation expense 30,000
Accumulated depreciation (30K x 2) 60,000
Retained earnings – beg. 140,000

ii. books already closed

Machinery (150K + 20K) 170,000

Accumulated depreciation (30K x 2) 60,000
Retained earnings 110,000

9. Solution:
(a)
No journal entry is required. The error has already counterbalanced.

(b)
Sales ....................................... 4,000
Retained Earnings ......................... 4,000

(c)
Insurance Expense ........................... 2,880
Retained Earnings ........................... 1,920
Prepaid Insurance ......................... 4,800

(d)
Interest Revenue ............................ 240
Retained Earnings ......................... 240

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(e)
Depreciation Expense ....................... 3,920
Retained Earnings .......................... 3,920
Accumulated Depreciation--Equipment ...... 7,840

10. Solution:
  20x0 20x1 20x2
Unadjusted profit (loss) 40,000 (15,000) 35,000
(2,900
Accrued expenses
) 2,900
(3,000) 3,000
(3,400
)
Prepaid expenses 2,000 (2,000)
2,800
(2,800)
1,500
Accrued revenue 2,750 (2,750)
2,500
(2,500)
2,700
(4,250
Unearned revenue
) 4,250
(4,500) 4,500
(4,100
)
Adjusted profit (loss) 37,600 (14,800) 33,900

PROBLEM 4: MULTIPLE CHOICE – THEORY

1. C 6. C
2. A 7. D
3. B 8. B
4. D 9. D
5. D 10. A

PROBLEM 5: MULTIPLE CHOICE – COMPUTATIONAL

1. B

Solution:
Carrying amt. on Dec. 31, 20x6: (100K – 10K) x 6/10 + 10K = 64,000
Carrying amt. on Dec. 31, 20x7: (64K – 4K) x 3/4 + 4K = 49,000

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2. D

Solution:

Historical cost 264,000

Divide by: Original estimate of useful life 8
Original annual depreciation 33,000
Multiply by: (20x6 to 20x8) 3
Accumulated depreciation - Dec. 31, 20x8 99,000

Historical cost 264,000

Accumulated depreciation - Dec. 31, 20x8 (99,000)

Carrying amount - Dec. 31, 20x8 165,000

Less: New estimate of residual value (24,000)

New depreciable amount 141,000

Divide by: Revised estimate of useful life (6 - 3) 3
Revised annual depreciation 47,000

Accumulated depreciation - Dec. 31, 20x8 99,000

Depreciation - 20x9 47,000
Accumulated depreciation - Dec. 31, 20x9 146,000

3. D The change is a change in accounting estimate that is accounted for

prospectively. Therefore, no cumulative effect shall be computed.

4. D No deferred tax liability arises because the change did not give rise to
any difference in the tax base and the carrying amount of the asset.

5. C (700,000 x 70% net of tax rate) = 490,000

6. A from 83,000 FIFO balance as of Dec. 31, 20x6 to 78,000

Weighted average = 5,000 decrease

7. C Jan. 1, 20x1 balances: (77,000 – 71,000) x 70% = 4,200

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8. B The best answer is “retrospective application” because the
transaction is a change in accounting policy.

9. D

Solution:
Unadjusted profit 74,100
Unrealized loss on decline in fair value of investments in
FVOCI 5,400
Adjustment to profits of prior years for errors in
depreciation (net of ₱3,750 tax effect) 7,500
Adjusted profit 87,000

10. B Amortization expense = (100,000 ÷ 5) = 20,000;

Retained earnings = (20,000 x 2 yrs. from 20x3 to 20x4) = 40,000

II. Events After the Reporting Period

PROBLEM 6: IDENTIFICATION
1. ADJUSTING
2. ADJUSTING
3. NON-ADJUSTING
4. ADJUSTING
5. ADJUSTING
6. NON-ADJUSTING
7. NON-ADJUSTING
8. ADJUSTING
9. NON-ADJUSTING
10. NON-ADJUSTING

PROBLEM 7: FOR CLASSROOM DISCUSSION

1. D The application of a letter of guarantee is not an obligating event. An

obligating event would be the application and granting of loan. Moreover,
the application of a letter of guarantee need not be disclosed by the
grantee (ABC Ltd.). However, the guarantor (not ABC Ltd.) may disclose
the guarantee if it is deemed a significant commitment.

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2. C Before a liability is recognized, all of the following conditions must first
be met:
a. The item meets the definition of a liability (i.e., present obligation
arising from past events);
b. Probable outflow of resources embodying economic benefits; and
c. The outflow can be measured reliably.

If not all the conditions are met, no liability is recognized. However, the entity
may disclose a contingent liability if the outflow is deemed reasonably
possible.

In the problem above, the fact that a lawsuit is filed cannot be presumed that
the outflow is probable.

3. B

4. D Only a disclosure shall be made because there is no present obligation

as of the end of the reporting period, i.e., the fire happened subsequent
to year-end.

5. C Changes in fair values, market prices and exchange rates after the
end of the reporting period are non-adjusting events.

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PROBLEM 8: EXERCISES
1. Solution:
Unadjusted profit 1,000,000
(a) Impairment loss (100,000)
(c) Additional write-down of inventory (120K - 100K) (20,000)
Adjusted profit 880,000

2. Solution:

Unadjusted profit 2,000,000

(c) Impairment loss (500,000)

Adjusted profit 1,500,000

3. Solutions:

Current Noncurrent Liabilitie

  assets assets s Equity Profit
Unadjusted 4,000,00
balances 3,000,000 7,000,000 0 6,000,000 2,000,000
(a) (300,000) 300,000
(b) 500,000 (500,000) (500,000)
(e) 160,000 160,000 160,000
Adjusted 4,500,00 1,660,00
balances 2,700,000 7,460,000 0 5,660,000 0
4. Solutions:

Requirement (a):

McMaster, Inc.
Statement of financial position
As of December 31, 2001 and 2000

ASSETS 2001 2000

Current assets
Cash and cash equivalents ₱550,000 ₱300,000
Trade and other receivables 874,000 720,000
Held for trading securities 156,000 -
Inventories 820,000 770,000
Total current assets 2,400,000 1,790,000

Noncurrent assets:
Property, plant and equipment (1) 384,000 192,000

TOTAL ASSETS ₱2,784,000 ₱1,982,000

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LIABILITIES & EQUITY
Current liabilities:
Trade and other payables ₱340,000 ₱194,000
Note payable 100,000 -
Total current liabilities 440,000 194,000

Noncurrent liabilities:
Note payable 500,000 600,000

TOTAL LIABILITIES 940,000 794,000

Common stock, ₱10 par 420,000 420,000

Additional paid-in capital 260,000 260,000
Retained earnings (2) 1,164,000 508,000
TOTAL EQUITY 1,844,000 1,188,000

TOTAL LIABILITIES & EQUITY ₱2,784,000 ₱1,982,000

(1)
(620,000 – 300,000 + (80,000 x 4/5) = 384,000

(2)

Retained earnings, unadjusted 930,000

(b) Overstatement of ending inventory (30,000)
(c) Asset charged as expense (80K x
4/5) 64,000
(d) Contingent liability 200,000
Retained earnings, adjusted 1,164,000

Requirement (b):
McMaster, Inc.
Statements of profit or loss
For the years ended December 31, 2001 and 2001

ASSETS 2001 2000

Net sales 3,160,000 2,500,000
Cost of sales (1.510M + 30K overstatement of (1,380,000
(1,540,000)
EI) )
Gross profit 1,620,000 1,120,000
Selling costs (295,000) (219,000)
Administrative expenses (984K - 295K + 80K) (609,000) (511,000)
Depreciation [58K + (80K/5)] (74,000) (36,000)

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Unrealized gain on held for trading securities 14,000
Profit for the year 656,000 354,000

Requirement (c):

 Summary of significant accounting policies.

A description of accounting principles and methods used in recognizing
revenues and allocating asset costs to current and future periods.
Specifically, McMaster should disclose accounting policies relating to
measurement of financial assets, inventories, and depreciable assets
and any other policies that would influence the decisions of users.

 Information regarding loss contingency.

A description of the pending legal action, including information and data
to assist users in evaluating the risk of potential loss. Based on the
opinion of McMaster's counsel, the estimated loss of ₱200,000 should
not be reported in the financial statements, but the contingency should
be described in a note, since the incurrence of a loss is "reasonably
possible."

 Information regarding the bankruptcy of a major customer.

This type of subsequent event does not affect the amounts reported in
the financial statements, because the casualty giving rise to the
bankruptcy occurred after McMaster's balance sheet date.

 Additional information to support totals in financial statements.

For example, McMaster might present additional detail for trade and
other receivables, property, plant and equipment, and trade and other
payables.

PROBLEM 9: MULTIPLE CHOICE – THEORY

1 6. A
B
.
2 7. B
A
.
3 8. D
A
.
4 9. C
B
.
5 10. D
A
.

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