CHAPTER 8

MFRS 108 CHANGES IN ACCOUNTING

POLICIES, ESTIMATIONS AND
CORRECTION OF ERRORS

Intermediate Accounting
IFRS Edition
Kieso, Weygandt, and Warfield

22-1
 Learning
Learning Objectives
Objectives

1. Identify the two types of accounting changes.

2. Describe the accounting for changes in accounting policies.
3. Understand how to account for retrospective accounting changes.
4. Understand how to account for impracticable changes.
5. Describe the accounting for changes in estimates.
6. Describe the accounting for correction of errors.
7. Identify economic motives for changing accounting policies.
8. Analyze the effect of errors.

22-2
 Accounting
Accounting Changes
Changes and
and Error
Error Analysis
Analysis

Accounting Changes Error Analysis

Changes in accounting Statement of financial

policy position errors
Changes in accounting Income statement errors
estimate Statement of financial
Correction of errors position and income
Summary statement effects

Motivations for change of Comprehensive example

policy Preparation of statements
with error corrections

22-3
 Accounting
Accounting Changes
Changes

Accounting Alternatives:
 Diminish the comparability of financial information.
 Obscure useful historical trend data.

Types of Accounting Changes:

1. Change in Accounting Policy.
2. Changes in Accounting Estimate.

Errors are not considered an accounting change.

22-4 LO 1 Identify the two types of accounting changes.

 Changes in Accounting Policy
Accounting policies define as ‘specific principles’ bases,
conventions, rules and practices applied by an entity in preparing
and presenting financial statements.

An entity is only allowed to change its accounting policy under

one of the following two circumstances:
Initial application of a standard or interpretation

The change is required by a standard or an interpretation.

Voluntary change

The change results in the financial statements providing

reliable and more relevant information about the effects of
transactions, other events or conditions on the entity’s financial
position, financial performance or cash flows.

22-5
 Changes
Changes in
in Accounting
Accounting Policy
Policy

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.

22-6 LO 2 Describe the accounting for changes in accounting policies.

 Changes
Changes in
in Accounting
Accounting Policy
Policy

Three approaches for reporting changes:

1) Currently.

2) Retrospectively.

3) Prospectively (in the future).

IASB requires use of the retrospective approach.

Rationale - Users can then better compare results from one period to
the next.

22-7 LO 2 Describe the accounting for changes in accounting policies.

 Changes
Changes in
in Accounting
Accounting Policy
Policy

Retrospective Accounting Change Approach

IFRS permits a change in policy if:
1) It is required by IFRS; or

2) It results in the financial statements providing more

reliable and relevant information.

22-8 LO 3 Understand how to account for retrospective accounting changes.

 Changes
Changes in
in Accounting
Accounting Policy
Policy

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
policy.

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.

22-9 LO 3 Understand how to account for retrospective accounting changes.

 Changes
Changes in
in Accounting
Accounting Policy
Policy

Retrospective Accounting Change: Long-Term Contracts

Illustration: Denson Company has accounted for its income from

long-term construction contracts using the cost-recovery (zero-
profit) method. In 2011, the company changed to the percentage-
of-completion method. Management believes this approach
provides a more appropriate measure of the income earned. For
tax purposes, the company uses the cost-recovery method and
plans to continue doing so in the future. (Assume a 40 percent
enacted tax rate.)

22-10 LO 3 Understand how to account for retrospective accounting changes.

 Changes
Changes in
in Accounting
Accounting Policy
Policy
Illustration 22-1

22-11 LO 3 Understand how to account for retrospective accounting changes.

 Method
1. Get the Difference Pre- Income B/4 Tax
before 2011and year 2011 under two method
2. Difference amount x tax rate 40%
3. Journal entries beginning 2011
Dr CIP 220,000 Cr Deferred tax 88,000 Cr
Retained earnings

22-12
 Changes
Changes in
in Accounting
Accounting Policy
Policy

Data for Retrospective Change

Illustration 22-2

Journal entry Construction in Process 220,000

beginning of Deferred Tax Liability 88,000
2010
Retained Earnings 132,000

22-13
LO 3 Understand how to account for retrospective accounting changes.
 Changes
Changes in
in Accounting
Accounting Policy
Policy

Reporting a Change in policy

Major disclosure requirements are as follows.
1. Nature of the change in accounting policy;
2. Reasons why applying the new accounting policy provides reliable
and more relevant information;
3. For the current period and each prior period presented, to the
extent practicable, the amount of the adjustment:
1. For each financial statement line (Tutorial 2) item
affected; and
2. Basic and diluted earnings per share.
4. Amount of the adjustment relating to periods before those
presented, to the extent practicable.
22-14
LO 3 Understand how to account for retrospective accounting changes.
 Changes
Changes in
in Accounting
Accounting Policy
Policy

Reporting a Change in policy Illustration 22-3

22-15
LO 3
 Changes
Changes in
in Accounting
Accounting Policy
Policy

Retained Earnings Adjustment

Retained earnings balance is €1,360,000 at the beginning of 2009.
Illustration 22-4

Before Change

22-16
LO 3 Understand how to account for retrospective accounting changes.
 Changes
Changes in
in Accounting
Accounting Policy
Policy

Retained Earnings Adjustment

Illustration 22-5
After Change

22-17
LO 3 Understand how to account for retrospective accounting changes.
 Retained Earnings After Retrospective
Application
 Eg 2011 and 2010 Financial Statements
 2010
2011 2010
Closing 2009 RE (OLD Policy)
Or Opening RE 2010 (OLD
Policy)
Add / Less (Diff of Net Income
Btw Old and New Policy)
New Policy RE of 2010
(Closing)
Net Income (New
Policy)
Closing Retained
Earnings
22-18 (New Policy)
 Changes
Changes in
in Accounting
Accounting Policy
Policy

Direct and Indirect Effects of Changes

 Direct Effects - IASB takes the position that companies
should retrospectively apply the direct effects of a
change in accounting policy.

 Indirect Effect is any change to current or future cash

flows of a company that result from making a change in
accounting policy that is applied retrospectively.

22-19 LO 3 Understand how to account for retrospective accounting changes.

 Changes
Changes in
in Accounting
Accounting Policy
Policy

Impracticability
Companies should not use retrospective application if one of the
following conditions exists:

1. Company cannot determine the effects of the retrospective

application.

2. Retrospective application requires assumptions about

management’s intent in a prior period.

3. Retrospective application requires significant estimates

that the company cannot develop.

22-20 LO 4 Understand how to account for impracticable changes.

 Changes in Estimates
 Many items in the financial statements are estimated.
Estimation involves judgment based on the most recent
available information that is reliable. These estimates may have
to be revised due to changes business activities.

 Revision of an estimate is called changes in estimates.

 Accounting estimates will change as new events occur, as

more experience is acquired, or new information is obtained.
Changes in estimates are handled prospectively; that is, in
current and future periods. No restatement of previous
financial statement is made.

22-21
 Changes
Changes in
in Accounting
Accounting Estimate
Estimate

Examples of Estimates
1. Bad debts.
2. Inventory obsolescence.
3. Useful lives and residual 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.
8. Fair value of financial assets or financial liabilities.

22-22 LO 5 Describe the accounting for changes in estimates.

 Changes
Changes in
in Accounting
Accounting Estimate
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.

IASB views changes in estimates as normal recurring corrections

and adjustments and prohibits retrospective treatment.

22-23 LO 5 Describe the accounting for changes in estimates.

 Prospective Reporting

 Companies should not adjust previously

reported results for changes in estimates.

22-24
 Change
Change in
in Estimate
Estimate Example
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 2010 (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 No Entry
prior years’ depreciation expense? Required

 Calculate depreciation expense for 2010.

22-25 LO 5 Describe the accounting for changes in estimates.

 Change
Change in
in Estimate
Estimate Example
Example After 7 years

Equipment cost $510,000 First,

First,establish
establishNBV
NBV
Salvage value - 10,000 at
atdate
dateofofchange
changeinin
Depreciable base 500,000 estimate.
estimate.
Useful life (original) 10 years
Annual depreciation $ 50,000 x 7 years = $350,000

Balance Sheet (Dec. 31, 2009)

Fixed Assets:
Equipment $510,000
Accumulated depreciation 350,000
Net book value (NBV) $160,000

22-26 LO 5 Describe the accounting for changes in estimates.

 Change
Change in
in Estimate
Estimate Example
Example
Net book value $160,000 Second,
Second,calculate
calculate
Salvage value (if any) 5,000 depreciation
depreciationexpense
expense
Depreciable base 155,000 for
for2010.
2010.
Useful life (15-7 yrs) 8 years
Annual depreciation $ 19,375

Journal entry for 2010

Depreciation expense 19,375

Accumulated depreciation 19,375

22-27 LO 5 Describe the accounting for changes in estimates.

 Changes
Changes in
in Accounting
Accounting Estimate
Estimate

Disclosures
Companies should disclose the nature and amount of a
change in an accounting estimate that has an effect in the
current period or is expected to have an effect in future periods.

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.

22-28 LO 5 Describe the accounting for changes in estimates.

 Errors
 FRS 108 defines prior period errors as ‘omissions
from, and misstatements in the entity’s financial
statements for one or more prior periods arising
from a failure to use, or misuse of, reliable
information. A prior period error has to be corrected
by retrospective restatement.
 Types of errors
1. Mathematical mistakes
2. Misclassification of expenses
3. Misuse of facts
4. An oversight
5. Any changes in accounting policy against GAAP

22-29
 Correction
Correction of
of Errors
Errors

Types of Accounting Errors:

1. A change from an accounting policy that is not generally
accepted to an accounting policy that is acceptable.
2. Mathematical mistakes.
3. Changes in estimates that occur because a company did
not prepare the estimates in good faith.
4. Failure to accrue or defer certain expenses or revenues.
5. Misuse of facts.
6. Incorrect classification of a cost as an expense instead of
an asset, and vice versa.
22-30 LO 6 Describe the accounting for correction of errors.
 Correction
Correction of
of Errors
Errors (Important
(Important)) ***
***

 All material errors must be corrected.

 Record corrections of errors from prior periods as an
adjustment to the beginning balance of retained
earnings in the current period.
 Such corrections are called prior period adjustments.
 For comparative statements, a company should
restate the prior statements affected, to correct for
the error.

22-31 LO 6 Describe the accounting for correction of errors.

 Correction
Correction of
of Errors
Errors

Comparative Statements
Company should
1. make adjustments to correct the amounts for all affected
accounts reported in the statements for all periods
reported.
2. restate the data to the correct basis for each year
presented.
3. show any catch-up adjustment as a prior period
adjustment to retained earnings for the earliest period it
reported.

22-32 LO 6 Describe the accounting for correction of errors.

 Correction
Correction of
of Errors
Errors
Woods, Inc.
Statement of Retained Earnings
For the Year Ended December 31, 2010

Balance, January 1 $ 1,050,000

Net income 360,000
Dividends (300,000)
Balance, December 31 $ 1,110,000

Before issuing the report for the year ended December 31, 2010, you discover
a $62,500 error that caused the 2009 inventory to be overstated (overstated
inventory caused COGS to be lower and thus net income to be higher in
2009). Would this discovery have any impact on the reporting of the
Statement of Retained Earnings for 2010? Assume a 20% tax rate.

22-33 LO 6 Describe the accounting for correction of errors.

 Correction
Correction of
of Errors
Errors
Woods, Inc.
Statement of Retained Earnings
For the Year Ended December 31, 2010

Balance, January 1, as previously reported $ 1,050,000

Prior period adjustment, net of tax (50,000)
Balance, January 1, as restated 1,000,000
Net income 360,000
Dividends (300,000)
Balance, December 31 $ 1,060,000

22-34 LO 6 Describe the accounting for correction of errors.

 Retained Earnings (RE) – Error in year
2009
2010 2009
RE 2009 Closing (Before
Error Adj)
Less : Add Error
Retained earnings (RE) RE 2009 Opening (2008
Closing 2009 RE Closing)
(After adjustment)
Net Income Net Income
(After Adj error)
(Dividend) (Dividend)
Retained Earnings Retained earning Closing
2010 (Closing) 2009
(After adjustment)

22-35
 Summary
Summary of
of Accounting
Accounting Changes
Changes and
and Errors
Errors
Illustration 22-23

22-36
LO 6
 Error
Error Analysis
Analysis Example
Example
E22-19 (Error Analysis; Correcting Entries): A partial trial balance of
Dickinson Corporation is as follows on December 31, 2010.

Dr. Cr.
Supplies on hand $ 2,500
Accured salaries and wages $ 1,500
Interest receivable 5,100
Prepaid insurance 90,000
Unearned rent 0
Accured interest payable 15,000

Instructions: (a) Assuming that the books have not been closed, what are
the adjusting entries necessary at December 31, 2010?

22-37 LO 8 Analyze the effect of errors.

 Error
Error Analysis
Analysis Example
Example
(a) Assuming that the books have not been closed, what are the
adjusting entries necessary at December 31, 2010?

1. A physical count of supplies on hand on December 31, 2010, totaled

$1,100.

Supplies expense 1,400

Supplies on hand 1,400

2. Accrued salaries and wages on December 31, 2010, amounted to

$4,400.

Salaries and wages expense 2,900

Accured salaries and wages 2,900

22-38 LO 8 Analyze the effect of errors.

 Error
Error Analysis
Analysis Example
Example
(a) Assuming that the books have not been closed, what are the
adjusting entries necessary at December 31, 2010?

3. Accrued interest on investments amounts to $4,350 on December 31,

2010.

Interest revenue 750

Interest receivable 750

4. The unexpired portions of the insurance policies totaled $65,000 as

of December 31, 2010.

Insurance expense 25,000

Prepaid insurance 25,000

22-39 LO 8 Analyze the effect of errors.

 Error
Error Analysis
Analysis Example
Example
(a) Assuming that the books have not been closed, what are the
adjusting entries necessary at December 31, 2010?

5. $24,000 was received on January 1, 2010 for the rent of a building for
both 2010 and 2011. The entire amount was credited to rental
income.
Retained earnings 12,000
Unearned rent 12,000

6. Depreciation for the year was erroneously recorded as $5,000 rather

than the correct figure of $50,000.

Depreciation expense 45,000

Accumulated depreciation 45,000
22-40 LO 8 Analyze the effect of errors.
 Error
Error Analysis
Analysis Example
Example
E22-19 (Error Analysis; Correcting Entries) A partial trial balance of
Dickinson Corporation is as follows on December 31, 2010.

Dr. Cr.
Supplies on hand $ 2,500
Accured salaries and wages $ 1,500
Interest receivable 5,100
Prepaid insurance 90,000
Unearned rent 0
Accured interest payable 15,000

Instructions: (b) Assuming that the books have been closed, what are
the adjusting entries necessary at December 31, 2010?

22-41 LO 8 Analyze the effect of errors.

 Error
Error Analysis
Analysis Example
Example
(b) Assuming that the books have been closed, what are the adjusting
entries necessary at December 31, 2010?

1. A physical count of supplies on hand on December 31, 2010, totaled

$1,400.
Retained earnings 1,400
Supplies on hand 1,400

2. Accrued salaries and wages on December 31, 2010, amounted to

$4,400.

Retained earnings 2,900

Accured salaries and wages 2,900

22-42 LO 8 Analyze the effect of errors.

 Error
Error Analysis
Analysis Example
Example
(b) Assuming that the books have been closed, what are the adjusting
entries necessary at December 31, 2010?

3. Accrued interest on investments amounts to $4,350 on December 31,

2010.
Retained earnings 750
Interest receivable 750

4. The unexpired portions of the insurance policies totaled $65,000 as

of December 31, 2010.

Retained earnings 25,000

Prepaid insurance 25,000

22-43 LO 8 Analyze the effect of errors.

 Error
Error Analysis
Analysis Example
Example
(b) Assuming that the books have been closed, what are the
adjusting entries necessary at December 31, 2010?

5. $24,000 was received on January 1, 2010 for the rent of a

building for both 2010 and 2011. The entire amount was credited
to rental income.
Retained earnings 12,000
Unearned rent 12,000

6. Depreciation for the year was erroneously recorded as $5,000

rather than the correct figure of $50,000.
Retained earnings 45,000
Accumulated depreciation 45,000

22-44 LO 8 Analyze the effect of errors.

 FRS 108
Accounting
Policies,
Changes in
Accounting
Estimates and
Errors

22-45