Accounting Policies, Changes in

CHAPTER 2
Accounting Estimates and Errors

LEARNING OBJECTIVES
After studying this chapter, you should be able to:
4. Explain the reporting of accounting changes and errors.
5. Describe related equity statements.

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 Accounting Changes LEARNING OBJECTIVE 1
Explain the reporting of
and Errors accounting changes and errors.

Changes in Accounting Principle

 Retrospective adjustment.
 Cumulative effect adjustment to beginning retained earnings.
 Approach preserves comparability across years.
 Examples include:
► Change from FIFO to average-cost.
► Change from the percentage-of-completion to the
completed-contract method.

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 Changes in Accounting Principle

Change in Accounting Principle: Gaubert Inc. decided in March

2019 to change from FIFO to weighted-average inventory pricing.
Gaubert’s income before taxes, using the new weighted-average
method in 2019, is $30,000.
ILLUSTRATION 4.17
Pretax Income Data Calculation of a Change in
Accounting Principle

ILLUSTRATION 4.18
Income Statement
Presentation of a Change
in Accounting Principle
(Based on 30% tax rate)

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 Accounting Changes

Change in Accounting Estimates

 Accounted for in the period of change or the period of
and the future periods if the change affects both.
 Not handled retrospectively.
 Not considered errors.
 Examples include:
► Useful lives and residual values of depreciable assets.
► Uncollectible receivables.
► Inventory obsolescence.

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 Change in Accounting Estimates

Change in Estimate: Arcadia HS, purchased equipment for

$510,000 which was estimated to have a useful life of 10 years
with a residual value of $10,000 at the end of that time.
Depreciation has been recorded for 7 years on a straight-line
basis. In 2019 (year 8), it is determined that the total estimated
life should be 15 years with a residual value of $5,000 at the
end of that time.

Questions:
 Does prior years’ depreciation need to be restated?
 Calculate the depreciation expense for 2019.

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 After
Change in Accounting Estimates 7 years

Equipment cost $510,000 First,

First,establish
establishNBV
NBV
Residual value - 10,000 at
atdate
dateof ofchange
changein
in
Depreciable base 500,000 estimate.
estimate.
Useful life (original) 10 years
Annual depreciation $ 50,000 x 7 years = $350,000

Balance Sheet (Dec. 31, 2018)

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

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 After
Change in Accounting Estimates 7 years

Net book value $160,000 Depreciation

Depreciation
Residual value (new) 5,000 Expense
Expensecalculation
calculation
Depreciable base 155,000 for
for2019.
2019.
Useful life remaining 8 years
Annual depreciation $ 19,375

Journal entry for 2019

Depreciation Expense 19,375

Accumulated Depreciation 19,375

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 Accounting Errors

Corrections of Errors
 Result from:
► mathematical mistakes.
► mistakes in application of accounting principles.
► oversight or misuse of facts.
 Corrections treated as prior period adjustments.
 Adjustment to the beginning balance of retained
earnings.

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 Corrections of Errors

Illustration: In 2019, Tsang Ltd. determined that it incorrectly

overstated its accounts receivable and sales revenue by
NT$100,000 in 2018. In 2019, Tsang makes the following entry
to correct for this error (ignore income taxes).

Retained Earnings 100,000

Accounts Receivable 100,000

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 Accounting Errors
ILLUSTRATION 4.19
Summary Summary of Accounting
Changes and Errors

Type of
Situation
Changes in Accounting Principle
Criteria Change from one generally accepted accounting
principle to another.

Examples Change in the basis of inventory pricing from FIFO to

average-cost.

Placement on Recast prior years’ income statements on the same

Income basis as the newly adopted principle.
Statement

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 Accounting Errors
ILLUSTRATION 4.19
Summary Summary of Accounting
Changes and Errors

Type of
Situation
Changes in Accounting Estimate
Criteria Normal, recurring corrections and adjustments.

Examples Changes in the realizability of receivables and

inventories; changes in estimated lives of equipment,
intangible assets; changes in estimated liability for
warranty costs, income taxes, and salary payments.

Placement on Show change only in the affected accounts (not shown

Income net of tax) and disclose the nature of the change.
Statement

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 Accounting Errors
ILLUSTRATION 4.19
Summary Summary of Accounting
Changes and Errors

Type of
Situation
Corrections of Errors
Criteria Mistake, misuse of facts.

Examples Error in reporting income and expense.

Placement on Restate prior years’ income statements to correct for

Income error.
Statement

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 Related Equity LEARNING OBJECTIVE 2
Describe related equity
Statements statements.

Retained Earnings Statement

Increase Decrease
 Net income  Net loss
 Change in accounting  Dividends
principle  Change in accounting
 Prior period principles
adjustments  Prior period
adjustments

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 Retained Earnings Statement
CHOI LTD.
Statement of Retained Earnings
For the Year Ended December 31, 2019

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, 2019, you
discover a ₩50,000 error (net of tax) that caused 2018 inventory to
be overstated (overstated inventory caused COGS to be lower and
thus net income to be higher in 2018). Would this discovery have
any impact on the reporting of the Statement of Retained Earnings
for 2019?
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 Retained Earnings Statement
CHOI LTD.
Statement of Retained Earnings
For the Year Ended December 31, 2019

Balance, January 1 ₩1,050,000

Prior period adjustment - error correction (50,000)
Balance, January 1 (restated) 1,000,000
Net income 360,000
Dividends (300,000)
Balance, December 31 ₩1,060,000

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 Retained Earnings Statement

Restrictions on Retained Earnings

Disclosed
 In notes to the financial statements.
 As Appropriated Retained Earnings.

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 Related Equity Statements

Comprehensive Income
All changes in equity during a period except those resulting
from investments by owners and distributions to owners.
Includes:
 all revenues and gains, expenses and losses reported in
net income, and
 all gains and losses that bypass net income but affect
equity.

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 Comprehensive Income
Net Income
Income Statement (in thousands)
Other Comprehensive
Sales
Cost of goods sold
$ 285,000
149,000 + Income
Gross profit 136,000
Operating expenses:
 Unrealized gains and
Selling expenses 10,000 losses on non-trading
Administrative expenses 43,000 equity securities.
Total operating expense 53,000  Translation gains and
Income from operations 83,000
Other revenue (expense):
losses on foreign
Interest revenue 17,000 currency.
Interest expense (21,000)  Plus others
Total other (4,000)
Income before taxes 79,000
Income tax expense 24,000 Reported in Equity
Net income $ 55,000

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 Comprehensive Income

Companies must display the components of other

comprehensive income in one of two ways:

1. A single continuous statement (one statement

approach) or

2. two separate, but consecutive statements of net income

and other comprehensive income (two statement
approach).

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 Comprehensive Income

One Statement Approach ILLUSTRATION 4.21

One Statement Format:
Comprehensive Income

Advantage –
does not require
the creation of a
new financial
statement.

Disadvantage -
net income buried
as a subtotal on
the statement.

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 Comprehensive Income

Two Statement Illustration 4-19

Approach

ILLUSTRATION 4.22
Two Statement Format:
Comprehensive Income

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 Related Equity Statements

Statement of Changes in Equity

Required, in addition to a statement of comprehensive
income.
 Generally comprised of
► Share capital—ordinary,
► Share premium—ordinary,
► Retained earnings, and the
► Accumulated balances in other comprehensive
income.

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 Statement of Changes in Equity

Reports the change in each equity account and in total

equity for the period. Includes the following:
1. Accumulated comprehensive income for the period.

2. Contributions (issuances of shares) and distributions

(dividends) to owners.

3. Reconciliation of the carrying amount of each component

of equity from the beginning to the end of the period.

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 Statement of Changes in Equity

ILLUSTRATION 4.23
Statement of Changes in Equity

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 Statement of Changes in Equity

Regardless of the display format used, V. Gill reports the

accumulated other comprehensive income of €90,000 in the
equity section of the statement of financial position as follows.

ILLUSTRATION 4.24
Presentation of Accumulated Other Comprehensive Income in the Statement of Financial Position LO 5
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 GLOBAL ACCOUNTING INSIGHTS

About The Numbers

The terminology used in the IFRS literature is sometimes different than what is
used in U.S. GAAP. For example, here are some of the differences.

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