Chapter 7
Notes (Part 1)
I.
Accounting Policies, Changes in Estimates and Errors
PROBLEM 1: TRUE OR FALSE
1. FALSE
6.
2. FALSE
7.
3. TRUE
8.
4. FALSE
9.
5. TRUE
10.
11.
FALSE
FALSE
FALSE
TRUE
FALSE
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
1
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.
Deferred tax liability
98,000
42,000
16. Solutions:
Requirement (a):
20x1
Under (Over) statement of ending inventory 20x1
Under (Over) statement of ending inventory 20x2
Depreciation understatement - 20x1
Depreciation understatement - 20x2
Failure to accrue salaries at year end - 20x1
Failure to accrue salaries at year end - 20x2
Effect on profit or loss - (Over) Under
statement
10,000
20x2
(10,000)
(4,000)
(4,000)
(8,000)
(2,000)
(6,000)
8,000
(12,000)
(24,000)
Requirement (b):
Effect on 12/31/x2 retained earnings = (2,000) + (24,000) = (26,000)
17. Solutions:
Requirement (a):
20x1
4,000
Ending inventory - 20x1
Ending inventory - 20x2
Depreciation
Insurance premium (3,600 x 2/3)
Insurance premium (3,600 / 3)
20x2
(4,000)
(3,600)
(800)
2,400
(1,200)
2
Gain on sale
Effect on profit or loss - (Over) Under
statement
6,400
5,600
(2,400)
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 ........................
Accumulated Depreciation ..................
16,150
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
3
*SYD denominator = Life x [(Life + 1) ÷ 2] = 10 x (11 ÷ 2) = 55
Depreciation 20x4 = 50,909 ÷ 7 = 7,273
Adjusted net
income
350,000
450,000
300,000
Year
20x1
20x2
20x3
20x4 (670K 7,273)
5.
662,727
Solutions:
Requirement (a):
Bad Debt Expense (163,000 x 2%)
Allowance for Bad Debts
3,260
3,260
Requirement (b):
Allowance for bad debts
Writeoffs:
20x1
20x2
20x3
20x4
End.
6.
1,200
2,850
3,222
3,720
2,978
2,610
3,690
4,410
3,260
Estimated bad
debts:
20x1
20x2
20x3
20x4
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):
4
Inventory ....................................
40,000
Retained Earnings (1/1/x2) ..........................
8.
40,000
Solutions:
Requirement (a):
Asset inappropriately charged as expense
(120K + 50K)
Unrecorded depreciation [(120K + 50K) - 20K] ÷ 5
yrs.
Effect on profit or loss - (Over) Under statement
20x1
170,00
0
(30,000
)
140,00
0
20x2
(30,000)
(30,000)
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)
Retained earnings – beg.
60,000
140,000
ii. books already closed
Machinery (150K + 20K)
170,000
Accumulated depreciation (30K x 2)
Retained earnings
60,000
110,000
9. Solution:
(a)
No journal entry is required. The error has already counterbalanced.
(b)
Sales .......................................
4,000
Retained Earnings .........................
(c)
Insurance Expense ...........................
Retained Earnings ...........................
Prepaid Insurance .........................
4,000
2,880
1,920
4,800
(d)
Interest Revenue ............................ 240
Retained Earnings .........................
5
240
(e)
Depreciation Expense .......................
3,920
Retained Earnings ..........................
3,920
Accumulated Depreciation--Equipment ......
7,840
10. Solution:
20x0
40,000
(2,900
Unadjusted profit (loss)
Accrued expenses
)
20x1
(15,000)
20x2
35,000
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
Unearned revenue
(4,250
)
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
6
2.
D
Solution:
Historical cost
Divide by: Original estimate of useful life
Original annual depreciation
Multiply by: (20x6 to 20x8)
Accumulated depreciation - Dec. 31, 20x8
264,000
Historical cost
264,000
Accumulated depreciation - Dec. 31, 20x8
Carrying amount - Dec. 31, 20x8
(99,000)
165,000
Less: New estimate of residual value
(24,000)
New depreciable amount
Divide by: Revised estimate of useful life (6 - 3)
Revised annual depreciation
141,000
Accumulated depreciation - Dec. 31, 20x8
Depreciation - 20x9
Accumulated depreciation - Dec. 31, 20x9
8
33,000
3
99,000
3
47,000
99,000
47,000
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
7
8.
B The best answer is “retrospective application” because the
transaction is a change in accounting policy.
9.
D
Solution:
Unadjusted profit
Unrealized loss on decline in fair value of investments in
FVOCI
Adjustment to profits of prior years for errors in
depreciation (net of ₱3,750 tax effect)
Adjusted profit
74,100
5,400
7,500
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.
2.
3.
4.
5.
6.
7.
8.
9.
10.
ADJUSTING
ADJUSTING
NON-ADJUSTING
ADJUSTING
ADJUSTING
NON-ADJUSTING
NON-ADJUSTING
ADJUSTING
NON-ADJUSTING
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.
8
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.
9
PROBLEM 8: EXERCISES
1. Solution:
Unadjusted profit
(a) Impairment loss
(c) Additional write-down of inventory (120K - 100K)
Adjusted profit
2.
1,000,000
(100,000)
(20,000)
880,000
Solution:
Unadjusted profit
2,000,000
(c) Impairment loss
Adjusted profit
(500,000)
3.
1,500,000
Solutions:
Current
assets
Noncurrent
assets
Unadjusted
balances
3,000,000
(300,000)
(a)
(b)
(e)
Adjusted
balances
2,700,000
4. Solutions:
7,000,000
300,000
Liabilitie
s
4,000,00
0
500,000
160,000
7,460,000
4,500,00
0
Equity
Profit
6,000,000 2,000,000
(500,000)
160,000
5,660,000
(500,000)
160,000
1,660,00
0
Requirement (a):
McMaster, Inc.
Statement of financial position
As of December 31, 2001 and 2000
ASSETS
2001
Current assets
Cash and cash equivalents
Trade and other receivables
Held for trading securities
Inventories
Total current assets
Noncurrent assets:
Property, plant and equipment (1)
TOTAL ASSETS
10
2000
₱550,000
874,000
156,000
820,000
2,400,000
₱300,000
720,000
770,000
1,790,000
384,000
192,000
₱2,784,000
₱1,982,000
LIABILITIES & EQUITY
Current liabilities:
Trade and other payables
Note payable
Total current liabilities
₱340,000
100,000
440,000
₱194,000
194,000
Noncurrent liabilities:
Note payable
500,000
600,000
TOTAL LIABILITIES
940,000
794,000
420,000
260,000
1,164,000
1,844,000
420,000
260,000
508,000
1,188,000
₱2,784,000
₱1,982,000
Common stock, ₱10 par
Additional paid-in capital
Retained earnings (2)
TOTAL EQUITY
TOTAL LIABILITIES & EQUITY
(1)
(620,000 – 300,000 + (80,000 x 4/5) = 384,000
(2)
Retained earnings, unadjusted
(b) Overstatement of ending inventory
(c) Asset charged as expense (80K x
4/5)
(d) Contingent liability
Retained earnings, adjusted
930,000
(30,000)
64,000
200,000
1,164,000
Requirement (b):
McMaster, Inc.
Statements of profit or loss
For the years ended December 31, 2001 and 2001
ASSETS
Net sales
Cost of sales (1.510M + 30K overstatement of
EI)
Gross profit
Selling costs
Administrative expenses (984K - 295K + 80K)
Depreciation [58K + (80K/5)]
11
2001
3,160,000
(1,540,000)
1,620,000
(295,000)
(609,000)
(74,000)
2000
2,500,000
(1,380,000
)
1,120,000
(219,000)
(511,000)
(36,000)
Unrealized gain on held for trading securities
Profit for the year
14,000
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
.
12
13