CHAPTER 21
ACCOUNTING CHANGES AND ERROR ANALYSIS
ASSIGNMENT CHARACTERISTICS TABLE
Item
E21.5
E21.11
P21.3
P21.11
P21.14
P21.18
Description
Accounting for accounting changes
Error correction entries
Change in estimate, policy, and error correction with
tax effect
Accounting changes, with statement of changes in
equity and notes
Error analysis and correcting entries
Accounting changes and ethical considerations
Level of
Difficulty
Simple
Moderate
Moderate
Time
(minutes)
20-25
20-25
30-35
Moderate
20–30
Complex
Moderate
50-60
20–30
EXERCISE 21.5
a. and b.
Accounting treatment under IFRS:
1.
2.
3.
4.
5.
a.
Accounting treatment
P
R
P
NA*
P
6.
7.
8.
9.
10.
P
R
P
P
R
b.
Type of change
Change in estimate
Accounting error correction
Change in estimate
Change in policy
Not an accounting change – selection
of policy for first time.
Change in estimate
Accounting error correction
Change in estimate
Change in estimate
Accounting error correction
*The accounting treatment would be specified in the transitional provisions
of the new source of GAAP. If not specified, then apply retrospectively.
Note that the only two approaches that are permitted for reporting changes
are retrospective and prospective treatment. When new or revised sources
of primary GAAP are adopted, recommendations are usually included that
specify how an entity should handle the transition. These are called
transitional provisions.
Under IFRS, when there is a retrospective change, an opening statement of
financial position must be provided for the earliest comparative period
provided and adjusted basic and fully diluted earnings per share (EPS) must
be reported. Under IFRS, the entity should report information about new
standards that have been issued but are not yet effective and have not yet
been applied. IFRS also requires that the entity disclose information about
measurement uncertainty, including sensitivity of carrying amounts to
changes in assumptions.
c.
Accounting treatment under ASPE (if different than part (a) for IFRS):
For corrections of errors, ASPE assumes that the impact on each specific
prior period is measurable, and therefore only allows full retrospective
restatement. IFRS acknowledges that the full impact of the error may not be
determinable and allows partial retrospective restatement in these
circumstances.
EXERCISE 21.5 (CONTINUED)
c. (continued)
Under ASPE, when there is a retrospective change, there is no requirement to
provide an opening statement of financial position, or to report adjusted basic
and fully diluted earnings per share (EPS). Under ASPE, there is no
requirement to report information about new standards that have been issued
but are not yet effective and have not yet been applied.
There would be no differences to the accounting treatment for the various
items between IFRS and ASPE, however some items have special
considerations worth noting.
(5) IAS 23 requires that interest be capitalized for qualifying assets, whereas
ASPE still permits a choice between capitalization and expense, provided that
the company is consistently applying the policy. Given that this is the first
time the entity has constructed a building for its own purposes, capitalization
of the related interest is not an accounting change, but rather selection of a
policy for the first time.
(9) Under IFRS, if the outcome cannot be reliably measured, recoverable
revenues equal to costs are recognized (sometimes referred to as the zeroprofit method). No gross profit is recorded until the contract is completed and
the gross profit can be reliably measured. IFRS does not allow use of the
completed contract method. Under ASPE, the completed-contract method is
allowed as a default method for long-term contracts where the percentage
complete cannot be reliably measured. Under the completed contract method,
revenue would only be recorded when the contract is completed.
d.
Under IFRS, one of the following two situations is required for a change in an
accounting policy to be acceptable:
1. The change is required by a primary source of GAAP.
2. A voluntary change results in the financial statements presenting
reliable and more relevant information about the effects of the
transactions, events, or conditions on the entity’s financial position,
financial performance, or cash flows.
ASPE provides for further situations where an accounting policy change may
be made without having to meet the “reliable and more relevant” criteria noted
above. It allows the following voluntary changes in policy to be made:
EXERCISE 21.5 (CONTINUED)
d. (continued)
3. Between or among alternative ASPE methods of accounting and
reporting for investments in subsidiary companies, and in companies
where the investor has significant influence or joint control; for
expenditures during the development phase on internally generated
intangible assets; for defined benefit plans; for accounting for income
taxes; and for measuring the equity component of a compound
financial instrument.
These further situations, allowed under ASPE as an acceptable change
in accounting policy, relate to standards where accounting policy
choices have to be made. These changes are treated as voluntary
changes, but they do not have to meet the “reliable and more relevant”
hurdle required of other voluntary changes. Although not specifically
stated in the actual standard, it is assumed that once that choice has
been made, the same policy is followed consistently.
LO 1,3 BT: C Difficulty: S Time: 25 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting
EXERCISE 21.11
a.
1.
Accumulated Depreciation—Machinery .......................
Depreciation Expense ...........................................
Retained Earnings .................................................
Depreciation taken
Depreciation (correct)
1$450,000
2.
3.
4.
15,000
5,000
10,000
2021-2022
2023
*$150,0001
* 140,000*
*$ 10,000*
$75,000
70,000
$ 5,000
X 1/6 X 2
Salaries and Wages Expense ........................................
Retained Earnings .................................................
47,000
Current Tax Expense .....................................................
Retained Earnings .................................................
81,000
47,000
81,000
Goodwill .......................................................................... 225,000
Amortization Expense ...........................................
50,000
Retained Earnings ($50,000 X 3.5 years) .............
175,000
In addition, the company should test goodwill for impairment.
5.
No entry necessary.
6.
Retained Earnings ..........................................................
Loss on Impairment ..............................................
63,000
63,000
EXERCISE 21.11 (CONTINUED)
b.
c.
1.
2.
3.
1.
2.
3.
4.
5.
6.
Error correction
Error correction
Error correction
Error correction
Change in accounting policy
Error correction
Accumulated Depreciation—Machinery .......................
Depreciation Expense ...........................................
Retained Earnings .................................................
Deferred Tax Liability ............................................
15,000
Salaries and Wages Expense ........................................
Retained Earnings .................................................
Income Tax Payable ..............................................
47,000
Current Tax Expense .....................................................
Retained Earnings1................................................
81,000
5,000
7,500
2,500
35,250
11,750
81,000
1Since
the full $81,000 was charged to Retained Earnings, the same amount is
reversed without factoring in the income tax effect.
4.
Goodwill .......................................................................... 225,000
Amortization Expense ...........................................
50,000
Retained Earnings2................................................
131,250
Deferred Tax Liability3...........................................
43,750
2($50,000 X 3.5 years X (1 – 25%))
3($50,000 X 3.5 years) X 25%
In addition, the company should test goodwill for impairment.
5.
No entry necessary.
6.
Retained Earnings ..........................................................
Income Tax Payable .......................................................
Loss on Impairment .............................................
47,250
15,750
63,000
LO 1 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: CPA: cpa-t001 cpa-t006 CM: Reporting and Tax
EXERCISE 21.21
Effect on Net Income
2022
Item
(1)
Overstatement
Understatement
Overstatement
X
X
X
Understatement
X
(3)
(5)
No
Effect
X
(2)
(4)
2023
X
X
X
X
No
Effect
X
LO 1,4 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting
PROBLEM 21.3
a.
(1)
Litigation Expense ..................................................................... 50,000
Litigation Liability ..............................................................
(2)
Loss on
................................................................. 14,850
Allowance for Expected Credit Losses .............................
1($19,800 ÷ 2%) X 1.5% = $14,850
50,000
Impairment1
(3)
Land ......................................................................................... 70,000
Accumulated Depreciation—Equipment2 .................................. 56,000
Depreciation Expense ......................................................
Retained Earnings ............................................................
Equipment ........................................................................
2$70,000 ÷ 5 = $14,000 per year; $14,000 X 4 years = $56,000
14,850
14,000
42,000
70,000
(4)
There would be no adjustment to opening retained earnings for any previous years since
changes in estimate are accounted for prospectively. The books are still open for 2023,
so the depreciation expense for 2023 will be revised for that year only to the straight-line
method.
Accumulated Depreciation—Buildings ...................................... 29,925
Depreciation Expense3 .....................................................
3($63,175 – $33,250)
29,925
Carrying amount of the building at January 1, 2023:
Cost less accumulated depreciation to Dec. 31/22
= $1,400,000 - $70,000 - $66,500 = $1,263,500
Remaining useful life from Jan. 1/23 = 38 years
Correct Depreciation Expense, 2023 (straight-line basis) = $1,263,500 ÷ 38 = $33,250
(5)
Accumulated Depreciation—Equipment ....................................
Depreciation Expense ......................................................
8,000
($75,000 – $5,000) ÷ 5 = $14,000 per year
($75,000 – [$14,000 X 3] – $3,000) ÷ 5 = $6,000
($14,000 – $6,000 = $8,000)
(6)
No entry required. This is an error in classification.
No amounts or items are missing in the financial statements.
8,000
PROBLEM 21.3 (CONTINUED)
b.
Note to Instructor: Corrections to Deferred Income Tax are only necessary when a
retrospective adjustment is being made and where the item involves a temporary
difference between accounting and taxable income. The entry below assumes that the
income tax entry for 2023 income taxes will be made subsequently.
Item 3 is the only entry that would be different from the entries in Part a.
(3)
Land .............................................................................. 70,000
Accumulated Depreciation—Equipment ......................... 56,000
Deferred Tax Liability ($42,000 X 25%) ............................
Depreciation Expense ......................................................
Retained Earnings [$42,000 X (1 – 25%)] ........................
Equipment ........................................................................
c.
10,500
14,000
31,500
70,000
1. This item is an adjustment to the current year financial statements. It is not an
error in a prior year’s financial statements and does not require retrospective
adjustment.
2. This is a change in estimate – prospective treatment.
3. This is an error in a prior year – retrospective treatment.
4. This is a change in estimate – prospective treatment, but requiring a change in
the current year as adjustments have already been recorded.
5. This is a change in estimate – prospective treatment, but requiring a change in
the current year as adjustments have already been recorded.
6. This is a SFP change in classification. No journal entry and no adjustment to
opening retained earnings are required. However, comparative financial
information will need to be restated to properly reflect the change in classification.
A note indicating the nature of the adjustment would be included.
LO 1 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting
PROBLEM 21.11
a. and b.
1.
Uncollectible accounts receivable. This is a change in accounting estimate, not
a correction of an error, since it was not known in 2021 that Michael would go
bankrupt. Restatement of prior periods is not required.
2.
This is a change in an accounting estimate. Restatement of opening retained
earnings is not required.
3.
This is a new method for a new class of assets. No change is involved.
4.
Adoption of the revaluation method is a voluntary change in an accounting
policy, as required by IAS 16 for property, plant, and equipment. IAS 8
paragraph 17 indicates that the initial application of the revaluation model is
dealt within IAS 16, not IAS 8. As a result, IAS 16 allows prospective treatment
since it would be difficult to go back and determine fair values at previous
dates. Consequently, for this specific change, the entity can apply this change
prospectively and retrospective application is not required. However, the
company is still required to disclose why it believes that the revaluation model
is reliable and more relevant than the cost model. This change in policy is
applied prospectively. Therefore, there would be a restatement of the opening
balances at January 1, 2023. The entry required at January 1, 2023, would be
the following:
Land ($900,000 – $750,000) ............................... 150,000
Deferred Tax Liability ($150,000 X 30%) 45,000
Revaluation Surplus (OCI) .....................
5.
105,000
As this is a correction of an error, the change must be applied retrospectively.
Because FV-OCI investments affect other comprehensive income, a
restatement of the AOCI (not retained earnings) in equity is required. The
journal entry would be as follows:
Deferred Tax Liability ($200,000 X 30%) ....................
Accumulated OCI .......................................................
FV-OCI Investments.....................................
60,000
140,000
200,000
PROBLEM 21.11 (CONTINUED)
c.
Contents of the statement of changes in equity for 2023 would be the following:
Share
Capital
Balance - January 1,
2022
$1,000,000
Comprehensive
income – as restated
Retained
Earnings
Accumulated
OCI
Revaluation
Surplus
Total
$2,500,000
$650,000
$4,150,000
910,000
335,000 *
1,245,000
Balance – December
31, 2022 as restated
1,000,000
3,410,000
985,000
5,395,000
Balance – January 1,
2023 as restated
1,000,000
3,410,000
985,000
5,395,000
1,350,000
150,000
$105,000
1,605,000
$4,760,000
$1,135,000
105,000
$7,000,000
Comprehensive
income 2023
Balance December
31, 2023
$1,000,000
*Comprehensive income for 2022 is restated for the overstatement in the fair value of the
FV-OCI investment: $475,000 – $140,000 = $335,000
PROBLEM 21.11 (CONTINUED)
d.
For the error correction for item 5, the company needs to report the impact of the
change on 2022’s comprehensive income and restate the opening balances of 2023
for the investment, the related deferred tax liability, and the AOCI in equity.
Disclosures should be made that enable users of the financial statements to
understand the effect of any changes on the financial statements so that the
statements remain comparable to those of other years and of other entities. IFRS
also requires reporting of the nature of the error, the effect of the correction on both
basic and fully diluted earnings per share for each prior period presented, and an
opening statement of financial position for the earliest period presented.
For item 1, which is a change in estimate, disclosure is required if it is material for
the current period. In this case, it might be argued that the amount is material and
requires disclosure of the amount and its impact on the current earnings. IFRS also
requires reporting of the nature and amount of any change that is expected to affect
future periods, unless it is impracticable to estimate its effect.
For item 2, the change in an estimate impacts both the current and future earnings
and therefore the nature and amount of the change on the current year needs to be
disclosed. If the future impact can be estimated then this should also be disclosed.
If this is impracticable to estimate, this fact is disclosed. The accounting policy note
would also disclose use of the straight-line method of depreciation.
For item 3, this is a new transaction so the accounting policy is being applied on
this transaction for the first time. This is required to be disclosed in the summary of
significant accounting policies.
For item 4, the note disclosure for this change in policy would state that it is being
applied prospectively, so there is no impact on prior years, and the changes are
made to the opening balances at January 1, 2023. The company would also have
to explain why it believes that the revaluation model is reliable and more relevant
than the cost model. There would also be a note in the summary of significant
accounting policies describing the revaluation model. Finally, the note on the land
requires disclosure of the effective date of the revaluation, whether an independent
valuator was used, the methods and assumptions used to determine the fair value
and the level applied in the fair value hierarchy, the carrying amount of the land that
would have been recognized under the cost model, and the revaluation surplus and
changes to it during the year.
Finally, under IFRS, the entity should report information about new standards that
have been issued but are not yet effective and have not yet been applied. IFRS
also requires that the entity disclose information about measurement uncertainty,
including sensitivity of carrying amounts to changes in assumptions.
LO 1,4 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting
PROBLEM 21.14
a.
JACOBSEN CORPORATION
Adjusting Journal Entries
December 31, 2023
1.
2.
3.
4.
Allowance for Expected Credit Losses1 ...................
Loss on Impairment ........................................
To reflect reduction in loss experience rate.
1$1,000,000 X (2% – 1½%)
5,000*
5,000
Investment Income or Loss2 ..................................... 13,000
FV-NI Investments .......................................
To reduce trading securities to fair value.
2$78,000 – $65,000
Retained Earnings ...................................................
Cost of Goods Sold .................................................
Inventory.........................................................
To adjust for overstatements in opening and closing
Inventories.
13,000
8,900
4,700
Equipment ............................................................... 30,000
Depreciation Expense ............................................. 2,500
([$30,000 – $5,000] ÷ 10)
Retained Earnings ..........................................
($30,000 – $2,500)
Accumulated Depreciation—
Equipment3 .................................................
To correct posting of equipment purchase
as expense in 2022.
3$2,500 X 2
Accumulated Depreciation—Equipment .................. 17,500
Equipment ......................................................
Gain on Disposal of Equipment ......................
To correct the recording of the disposal of equipment.
13,600
27,500
5,000
14,700
2,800
PROBLEM 21.14 (CONTINUED)
a. (continued)
5.
6.
b.
Prepaid Insurance ...................................................
Insurance Expense ($4,700 ÷ 4) .............................
Retained Earnings4.........................................
4($4,700 – $1,175)
To adjust for nonrecognition of prepaid expense
in 2022.
2,350
1,175
3,525
No entry is required. The items will be properly reclassified as part of the
financial statement preparation.
JACOBSEN CORPORATION
Computation of Corrected Net Income
For the Years Ended December 31, 2023 and 2022
2023
Reported income
Change in accounts receivable loss
experience rate from 2% to 1½%
Loss on FV-NI investments
Ending inventories overstated:
December 31, 2022
December 31, 2023
Misposting of equipment purchase
Decrease in operating expenses—2022
Incr. in depreciation expenses—2023
Misposting of proceeds of equipment sold
Recognition of prepaid insurance
Corrected net income
$220,000
2022
$195,000
5,000
(13,000)
—
8,900
(13,600)
(8,900)
27,500
(2,500)
2,800
(1,175)
$206,425
3,525
$217,125
PROBLEM 21.14 (CONTINUED)
c.
JACOBSEN CORPORATION
Calculation of Corrected Retained Earnings
At January 1, 2023
Retained earnings, January 1,
Change in accounts receivable loss
experience rate from 2% to 1½%
Loss on FV-NI investments
Ending inventories overstated:
December 31, 2022
Misposting of equipment purchase
Decrease in operating expenses—2022
Recognition of prepaid insurance
Retained earnings, January 1, restated
$247,000
—
—
(8,900)
27,500
3,525
$269,125
LO 1,4 BT: AP Difficulty: C Time: 60 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting
PROBLEM 21.18
Memorandum to:
From:
Subject:
Ali Reiners, Controller
Accountant
Accounting treatment of various issues at Luftsa Corp.
Here are my recommendations on the various issues you have brought to my attention.
If you have further questions or wish to discuss these issues, please do not hesitate to
contact me.
1.
This situation is an adoption of a new accounting policy. In previous years, the
loyalty points award program was immaterial. Now however, the item has become
material and the appropriate accounting policy is to identify the performance
obligations related to the loyalty points award program, allocate and defer a portion
of revenue to the performance obligations, and recognize the related revenue when
(or as) Luftsa satisfies the performance obligations. The accounting policy can be
applied prospectively starting January 1, 2023. Note disclosure is appropriate to
describe this new policy and its impact on the current and future periods, if
practicable to estimate.
2.
In this situation, the company is changing its policies to use components for
depreciation and the revaluation model. Luftsa has determined that it was not
practicable to determine the impact of depreciation on components on prior years
since the information was not available, so the policy change cannot be applied
retrospectively.
Additionally, the revaluation model may be implemented
prospectively even though it is also a change in policy. IAS 8 paragraph 17 indicates
that the initial application of the revaluation model is dealt with in IAS 16, not IAS 8.
As a result, IAS 16 allows prospective treatment since it would be difficult to go back
and determine fair values at previous dates.
The note disclosure would state why the company
believes
that
these
policies provide reliable and more relevant information. The company would also be
required
to note the impact on the opening balances as the company adopts
the revaluation model for the assets at January 1, 2023 – that is the change to the
assets, deferred taxes, and the revaluation surplus. Finally, the company should
also disclose the impact on the depreciation and taxes for the current period with
the adoption of these two new policies.
3.
This situation is considered a correction of an error. The general rule is that careful
estimates that later prove to be incorrect should be considered changes in
estimates. Where the estimate was obviously computed incorrectly because of lack
of expertise or in bad faith, the adjustment should be considered an error. Changes
due to error should employ the retrospective approach by:
PROBLEM 21.18 (CONTINUED)
3. (continued)
a.
b.
Restating, via a prior period adjustment, the beginning balance of retained
earnings for the statements of the current period.
Correcting all prior period statements presented in comparative financial
statements. The amount of the error related to periods prior to the earliest
year’s statement presented for comparative purposes should be included as
an adjustment to the beginning balance of retained earnings of that earliest
year’s statement. In addition, an opening balance sheet must be presented for
the earliest comparative period.
There are ethical issues involved in this situation. These involve the honesty and
integrity of Rosentiel’s financial reporting practices versus the corporation’s and the
division controller’s profit motives. Understating inventory obsolescence would
overstate the division’s net income. Such a practice distorts Rosentiel’s operating
results and misleads users of the financial statements. This practice is unethical and
must be reported to Luftsa’s Board of Directors. In addition, the result of these
practices is that
excess bonuses may have been paid to the divisional
controller, at the expense of other divisional controllers whose results would not
have looked favourable in comparison.
4.
No adjustment is necessary— depreciation methods may be chosen that best
reflect the pattern of use for any assets.
5.
This situation is considered a change in estimate because new events have
occurred that call for a change in estimate. The accounting change is made
prospectively. Note disclosure would describe the impact of the change on the
current earnings, and any impact that is practicable to estimate for the future.
6.
Even though this situation looks like a change in estimate, the facts of the case
indicate that the estimates were not revised based on better information, but rather
revised incorrectly due to bad faith by the divisional manager. This situation is
considered a correction of an error. The accounting treatment would be the same
as discussed in point 3.
As well, there are ethical issues involved in this situation that relate to the honesty
and integrity of Harper’s financial reporting practices and the divisional manager’s
profit motives. Shortening the life of assets from 10 to 6 years may be evidence that
depreciation expense during the first five years were understated. Such a practice
distorts Harper’s operating results and misleads users of Harper’s (and ultimately
Luftsa's) financial statements. If this practice is intentional, it is unethical. In addition,
the result of these practices is that excess bonuses may have been paid to the
divisional manager. This situation should be reported to the highest levels of
management within Luftsa (the Board of Directors).
LO 1,2 BT: C Difficulty: M Time: 30 min. AACSB: Ethics and Communication CPA: CPA: cpa-t001 cpa-e001 Reporting and Ethics