Chapter
20
Accounting Changes and Error Corrections
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
LO20-1 Differentiate among the three types of accounting changes and distinguish between the
retrospective and prospective approaches to accounting for and reporting accounting
changes.
LO20-2 Describe how changes in accounting principle typically are reported.
LO20-3 Explain how and why some changes in accounting principle are reported
prospectively.
LO20-4 Explain how and why changes in estimates are reported prospectively
LO20-5 Describe the situations that constitute a change in reporting entity.
LO20-6 Understand and apply the four-step process of correcting and reporting errors,
regardless of the type of error or the timing of its discovery.
LO20-7 Discuss the primary differences between U.S. GAAP and IFRS with respect to
accounting changes and error correction
CHAPTER HIGHLIGHTS
PART A: ACCOUNTING CHANGES
Types of Accounting Changes
For accounting purposes, we identify three types of accounting changes:
 Changes in principle.
 Changes in estimates.
 Changes in reporting entity.
Accounting changes can be accounted for:
 Retrospectively (prior years revised)
 Prospectively (only current and future years affected)
The choice depends on the type of change.
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Accounting Changes and Error Correction
Changes in Accounting Principle
Although consistency and comparability are desirable, changing from one accounting method to
another method sometimes is appropriate. This is called a change in accounting principle.
GENERAL APPROACH
We report most voluntary changes in accounting principles retrospectively. This means reporting all
previous period’s financial statements as if the new method had been used in all prior periods.
Illustration
In 2014, the Arizona Company changed its method of valuing inventory from the average
cost method to the FIFO method. At December 31, 2013, Arizona’s inventories were $35
million (average cost). Arizona’s accounting records indicated that the inventories would
have totaled $45 million on that date if determined on a FIFO basis. Arizona’s tax rate is
40%.
1. Revise Comparative Financial Statements. For each year reported in the comparative
statements, Arizona Company revises those statements to appear as if the newly adopted
accounting method (FIFO) had been applied all along.
2. Adjust Accounts for the Change. In addition to reporting revised amounts in the
comparative financial statements, Arizona Company must also adjust the book balances of
affected accounts. This is accomplished by creating a journal entry to change those
balances from their current amounts (from using Average) to what those balances would
have been using the newly adopted method (FIFO). Differences in cost of goods sold and
income are reflected in retained earnings, as are the income tax effects of changes in
income. Thus, the journal entry updates inventory, retained earnings, and the income tax
liability for revisions resulting from differences in the Average and FIFO methods prior
to the switch, pre-2013.
The journal entry to record the adjustment:
Inventory ($45 million – $35 million) .............................................................
Deferred tax liability ($10 x 40%) ........................................................
Retained earnings (difference) .......................................................................
($ in millions)
10
4
6
In prior years, inventory would have been $10 million higher by FIFO, and cost of goods sold
would have been $10 million lower. Thus, pretax income would have been $10 million higher.
However, with a 40% tax rate, net income would have been higher by only $6 million. This is the
increase in retained earnings.
The reason for the credit to deferred tax liability requires you to reflect back on what you learned
about accounting for income taxes. The reason is that an accounting method used for tax purposes
cannot be changed retrospectively for prior years. The Internal Revenue Code requires that taxes
saved previously ($4 million in this case) from having used another inventory method must now be
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Accounting Changes and Error Correction
repaid (over no longer than 6 years). Recall from Chapter 16 that in the meantime, there is
temporary difference, reflected in the deferred tax liability.
3. Disclosure notes. A change in principle requires that the new method be justified as clearly more
appropriate. In the first set of financial statements after the change, a disclosure note is needed to
provide that justification. The footnote also should point out that comparative information has been
revised, or that retrospective revision has not been made because it is impracticable, and report any
per share amounts affected for the current period and all prior periods presented.
EXCEPTIONS NECESSITATING THE PROSPECTIVE APPROACH
1.
WHEN RETROSPECTIVE APPLICATION IS IMPRACTICABLE
Sometimes a lack of information makes it impracticable to report a change retrospectively so the
new method is simply applied prospectively.

If it’s impracticable to adjust each year reported, the change is applied retrospectively as of
the earliest year practicable.

If full retrospective application isn’t possible, the new method is applied prospectively
beginning in the earliest year practicable.
Footnote disclosure should indicate reasons why retrospective application was impracticable.
2.
WHEN MANDATED BY AUTHORITATIVE PRONOUNCEMENTS
Another exception to retrospective application is when an FASB Statement or another authoritative
pronouncement requires prospective application for specific changes in accounting methods.
3.
CHANGING DEPRECIATION, AMORTIZATION, DEPLETION METHODS
We account for a change in depreciation method as a change in accounting estimate that is achieved
by a change in accounting principle. Therefore, we account for such a change prospectively; that is,
precisely the way we account for changes in estimates.
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Accounting Changes and Error Correction
Changes in Estimate
Estimates are commonplace in accounting. Depreciation, for example, involves estimating, not only
of the useful lives of depreciable assets, but also their anticipated residual values. Inevitably,
though, many estimates turn out to be incorrect, forcing the revision of estimates. This is called a
change in estimate.
Because revisions are viewed as a natural consequence of making estimates, when a company
revises a previous estimate, prior financial statements are not revised. Instead, the company simply
incorporates the new estimate in any related accounting determinations from that point on.
Illustration – Estimated Useful Life of Patent
The Wireless Company has a patent on a wireless internet connection process. Wireless has
amortized the patent on a straight-line basis since 2011, when it was acquired at a cost of $16
million at the beginning of that year. Recent technological advances in the industry caused
management to decide that the patent would benefit the company over a total of five years
rather than the 8-year life being used to amortize its cost. The decision was made at the end
of 2013 (before adjusting and closing entries).
The journal entry to record the adjustment:
Patent amortization expense (determined below) ......................................
Patent ................................................................................................
($ in millions)
4
4
Calculation of annual amortization after the estimate change:
($ in millions)
$16
$2
x 2 years
(4)
$12
÷ 3
$ 4
Cost
Old annual amortization ($16 ÷ 8 years)
Amortization to date (2011-2012)
Unamortized cost (balance in the patent account)
Estimated remaining life (5 years – 2 years)
New annual amortization
Illustration – Changing Depreciation Method
Milano Motorworks switched from the SYD depreciation method to straight-line
depreciation in 2013. The change affects its equipment purchased at the beginning of 2011 at
a cost of $180,000. The equipment has an estimated useful life of 5 years and an estimated
residual value of $9,000.
The depreciation prior to the change is as follows:
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Accounting Changes and Error Correction
Sum-of-the-Years-Digits Depreciation:
2011 depreciation
$ 60,000 ($180,000 x 5/15)
2012 depreciation
Accumulated depreciation
48,000 ($180,000 x 4/15)
$108,000
Since a change in depreciation method is considered a change in accounting estimate resulting from
a change in accounting principle, Milano reports the change prospectively. Previous financial
statements are not revised; the company simply employs the straight-line method from 2013 on.
The company depreciates the undepreciated cost remaining at the time of the change on a straightline basis over the remaining useful life as follows:
Calculation of Straight-Line Depreciation:
Asset’s cost
Accumulated depreciation to date (calculated above)
Undepreciated cost, Jan. 1, 2013
Estimated residual value
To be depreciated over remaining 3 years
Annual straight-line depreciation 2013-2015
$180,000
(108,000)
$ 72,000
(9,000)
$ 63,000
3 years
$ 21,000
Adjusting entry (2013, 2014, and 2015 depreciation):
Depreciation expense (calculated above) .....................
Accumulated depreciation ......................................
21,000
21,000
The situation arises infrequently in practice because most companies changing depreciation methods
do not apply the change to existing assets, but instead to assets placed in service after that date. In
those instances, the new method is simply applied prospectively.
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Accounting Changes and Error Correction
Changes in Reporting Entity
A reporting entity can be a single company. Also a group of companies that reports a single set of
financial statements can be a reporting entity. Occasionally, changes occur that cause the financial
statements to be those of a different reporting entity. This occurs as a result of:
 Presenting consolidated financial statements in place of statements of individual companies,
 Changing specific companies that comprise the group for which consolidated or combined
statements are prepared, or
 A business combination accounted for as a pooling of interests.
A change in reporting entity is accounted for retrospectively. That is, financial statements of prior
periods are restated to report the financial information for the new reporting entity in all periods.
PART B: CORRECTION OF ERRORS
Mistakes happen. When errors are discovered, they should be corrected and accounted for
retrospectively. Previous years' financial statements that were incorrect as a result of an error are
retrospectively restated, and any account balances that are incorrect are corrected by a journal entry.
If retained earnings is one of the accounts incorrect, the correction is reported as a “prior period
adjustment” to the beginning balance in a statement of shareholders’ equity. And, a disclosure note
should describe the nature of the error and the impact of its correction on operations.
 A journal entry is recorded to correct any account balances that are incorrect as a result of
the error.
 If the error created an incorrect balance in retained earnings, the correction is reported as an
adjustment to the beginning balance in a statement of retained earnings, or statement of
shareholders’ equity.
 Prior years' financial statements are restated to eliminate the error (if the error affected those
statements).
 A disclosure note should report the nature of the error and the impact of its correction on net
income, income before extraordinary items, and earnings per share.
To determine which balances are in need of correction, it’s helpful to write down the entry(s) made
and those that should have been made. Comparing the correct and incorrect entries can simplify the
analysis.
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Accounting Changes and Error Correction
Illustration
The Diversified Company purchased a five-year casualty insurance policy at the beginning of
2014 for $450,000. The full amount was debited to insurance expense at the time. The error
was discovered in January of 2016.
Analysis:
Correct
(Should Have Been Recorded)
2014 Prepaid insurance
Cash
Incorrect
(As Recorded)
450,000
450,000
2014 Insurance expense
Prepaid insurance
90,000
2015 Insurance expense
Prepaid insurance
90,000
Insurance expense
Cash
450,000
450,000
Adjusting entry omitted
90,000
Adjusting entry omitted
90,000
If recorded correctly, during the two year period insurance expense would have been
$180,000. Instead, it was $450,000. Expenses, therefore, were overstated by $270,000, so
net income during the period was understated by $270,000. Ignoring taxes, this means
retained earnings is currently understated by that amount.
Also, prepaid insurance should have a balance of $270,000 ($450,000 – 90,000 – 90,000).
The journal entry to correct the error:
Prepaid insurance ........................................................................
Retained earnings ...................................................................
270,000
270,000

The financial statements the last two years that were incorrect as a result of the error
would be retrospectively restated to report the prepaid insurance acquired and reflect the
correct amount of insurance expense when those statements are reported again for
comparative purposes in the current annual report.

A “prior period adjustment” to retained earnings would be reported

A disclosure note should describe the nature of the error and the impact of its correction
on each year’s net income, income before extraordinary items, and earnings per share.
International Financial Reporting Standards
The changes to and from the LIFO method do not occur if IFRS is being applied because LIFO is
not a permissible method for accounting for inventory under IFRS.
When correcting errors in previously issued financial statements, IFRS permits the effect of the error
to be reported in the current period if it’s not considered practicable to report it retrospectively as is
required by U.S. GAAP.
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Accounting Changes and Error Correction
SELF-STUDY QUESTIONS AND EXERCISES
Concept Review
1. Accounting changes are categorized as changes in
, or
,
or
.
2. Changes in
occur when companies switch from one acceptable accounting
method to another.
3. Changes in
occur when new information causes companies to revise estimates
made previously.
4. Changes in
occur when the group of companies comprising the reporting entity
changes.
5. Accounting changes can be accounted for
(prior years revised) or
_______________________ (only current and future years affected).
6. Most changes in accounting principles are recorded and reported retrospectively. For each year
reported in the _____________ statements, the firm revises those statements to appear as if the
newly adopted accounting method had been applied all along.
7. A change in principle requires that the new method be justified as clearly more appropriate. In
the first set of financial statements after the change, a ______________ ______ is needed to
provide that justification.
8. Sometimes a lack of information makes it impracticable to report a change retrospectively so the
new method is applied __________________.
9. A change in depreciation method is considered a change in accounting ____________ that is
achieved by a change in accounting principle.
10. When it’s not possible to distinguish between a change in principle and a change in estimate, the
change should be treated as a change in
.
11. When an error is discovered, previous years' financial statements that were incorrect as a result
of the error are
to reflect the correction.
12. When an error is discovered, any account balances that currently are incorrect as a result of the
error should be corrected by a journal entry. If retained earnings is one of the accounts whose
balance
is
incorrect,
the
correction
is
reported
as
a
to the beginning balance in a statement of shareholders’
equity (or statement of retained earnings if that’s presented instead).
13. If merchandise inventory is understated at the end of 2013, 2013’s cost of goods sold would be
_______________, causing 2013 net income to be
.
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Accounting Changes and Error Correction
Answers:
1. principle, estimate, reporting entity 2. principle 3. estimate 4. reporting entity
5. retrospectively, prospectively 6. comparative 7. disclosure note 8. prospectively 9. estimate 10.
estimate 11. retrospectively restated 12. prior period adjustment 13. overstated, understated
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Accounting Changes and Error Correction
REVIEW EXERCISES
Exercise 1
At the beginning of 2013, Brass Menageries changed its method of valuing inventory from the FIFO
cost method to the average cost method. At December 31, 2012 and 2011, Brass Menageries'
inventories were $140,000 and $135,000, respectively, on a FIFO cost basis but would have totaled
$125,000 and 122,500, respectively, if determined on an average cost basis.
Required:
1. Prepare the journal entry needed in 2013 related to the change.
2. Briefly describe any other measures Brass Menageries would take in connection with reporting
the change.
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Accounting Changes and Error Correction
Solution:
1. Brass Menageries creates a journal entry to bring up to date all account balances affected.
Retained earnings (The difference in net income before 2012) .............................
Deferred tax asset ($15,000 x 40%) .......................................................................
Inventory ($140,000 – 125,000) .......................................................................
9,000
6,000
15,000
2. Prior years' financial statements are revised to reflect the use of the new accounting method. Also, Brass
Menageries also will revise all previous period’s financial statements (in this case 2012) as if the new
method (average cost) were used in those periods. In other words, for each year in the comparative
statements reported, the balance of each account affected will be revised to appear as if the average
method had been applied all along. Since retained earnings is one of the accounts whose balance requires
adjustment (and it usually is), Brass Menageries makes an adjustment to the beginning balance of retained
earnings for the earliest period (2012) reported in the comparative statements of shareholders’ equity.
Also, in the first set of financial statements after the change, a disclosure note describes the nature of the
change, justifies management’s decision to make the change, and indicates its effect on each item affected
in the financial statements.
Exercise 2
Ballpark Awnings estimates warranty expense as 3% of credit sales. After a review during 2013,
Ballpark decided that 2% of credit sales is a more realistic estimate of its payment practices.
Ballpark’s credit sales in 2013 were $25 million. The effective income tax rate is 40%.
Required:
1. By what amount is warranty expense reported last year restated?
2. Prepare the adjusting entry to record warranty expense in 2013.
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Accounting Changes and Error Correction
Solution:
1.
No account balances are adjusted.
2.
The adjusting entry to record warranty expense simply will reflect the new percentage. In 2013, the entry would
be:
Warranty expense (2% x $25 million)
Warranty liability
500,000
500,000
Exercise 3
At the beginning of 2010, AY Corporation purchased computer equipment for $480,000. Its useful
life was estimated to be six years with no salvage value. The cost was mistakenly recorded as
network maintenance expense. AY depreciates assets by the straight-line method. The error was
discovered at the end of 2014, prior to adjusting and closing entries.
Required:
1. Prepare the journal entries that should have been made to record the acquisition and depreciation
of the equipment. Alongside those entries prepare the entries that were incorrectly made.
Determine the account balances that are incorrect as a result of the error. Ignore income taxes.
2. Prepare the journal entry to correct the error. Ignore income taxes.
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Accounting Changes and Error Correction
Solution:
1.
Analysis:
Correct
(Should Have Been Recorded)
2010
2010
2011
2012
2013
Incorrect
(As Recorded)
Computer equip.
Cash
480,000
Expense
Accum. deprec.
80,000
Expense
Accum. deprec.
80,000
Expense
Accum. deprec.
80,000
Expense
Accum. deprec.
80,000
480,000
Expense
Cash
480,000
480,000
depreciation entry omitted
80,000
depreciation entry omitted
80,000
depreciation entry omitted
80,000
depreciation entry omitted
80,000
During the four-year period, depreciation expense was understated by $320,000 million, but other expenses were
overstated by $480,000, so earnings during the period was understated by $160,000. This means retained earnings is
currently understated by that amount.
Accumulated depreciation is understated by $320,000. Computer equipment is understated by $480,000.
2.
To correct incorrect accounts:
Computer equipment
Accumulated depreciation
Retained earnings
480,000
320,000
160,000
Exercise 4
Assume the error described in Exercise 3 was not discovered until the year 2016.
Required:
Prepare the journal entry to correct the error. Ignore income taxes
Solution:
No entry would be required. After the six-year useful life the total depreciation expense would be the same as the
expense incorrectly recorded at the time of purchase. So, retained earnings no longer is incorrect. Also, the asset
would be fully depreciated and probably written off the books. In other words the error at this point has corrected
itself. Financial statements were incorrect for six years, but now all account balances are correct.
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Accounting Changes and Error Correction
MULTIPLE CHOICE
Enter the letter corresponding to the response that best completes each of the following statements
or questions.
1.
Fickle Company purchased a machine at a total cost of $220,000 (no residual value) at
the beginning of 2010. The machine was being depreciated over a 10-year life using the
sum-of-the-years'-digits method. At the beginning of 2013, it was decided to change to
straight-line. Ignoring taxes, the 2013 adjusting entry will include a debit to depreciation
expense of:
a. $11,000
b. $16,000
c. $22,000
d. $38,000
2.
In the previous question, an accompanying disclosure note would include each of the
following except:
a. The cumulative effect of the change.
b. Justification that the change is preferable.
c. The effect of a change on any financial statement line items affected for all periods
reported.
d. The effect of a change on per share amounts affected for all periods reported.
3.
Which of the following is not usually accounted for retrospectively?
a. Change in the composition of firms reporting on a consolidated basis.
b. Change from LIFO to FIFO.
c. Change from expensing extraordinary repairs to capitalizing the expenditures.
d. Change from FIFO to LIFO.
4.
Which of the following is accounted for prospectively?
a. Changes from Average to FIFO.
b. Change in reporting entity.
c. Correction of an error.
d. Change in the percentage used to determine warranty expense.
5.
Early in 2013, Brandon Transport discovered that a five-year insurance premium
payment of $250,000 at the beginning of 2010 was debited to insurance expense. The
correcting entry would include:
a.
A debit to prepaid insurance of $250,000.
b.
A debit to insurance expense of $100,000.
c.
A debit to prepaid insurance of $150,000.
d.
A credit to retained earnings of $100,000.
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Accounting Changes and Error Correction
___ 6.
Which of the following is not a change in accounting principle usually accounted for by
restrospectively revising prior financial statements?
a. Change from SYD to DDB.
b. Change from FIFO to the average method.
c. Change from the average method to FIFO.
d. Change from LIFO to FIFO.
___ 7.
State Materials, Inc. changed from the FIFO method of costing inventories to the
weighted average method during 2013. When reported in the 2013 comparative financial
statements, the 2012 inventory amount will be:
a.
Decreased.
b.
Increased.
c.
Increased or decreased, depending on how prices changed during 2013.
d.
Unaffected.
___ 8.
The prospective approach usually is required for:
a.
A change in estimate.
b.
A change in reporting entity.
c.
A change in accounting principle.
d.
A correction of an error.
___ 9.
Lamont Communications has amortized a patent on a straight-line basis since it was
acquired in 2010 at a cost of $50 million. During 2013 management decided that the
benefits from the patent would be received over a total period of 8 years rather than the
20-year legal life being used to amortize the cost. Lamont’s 2013 financial statements
should include:
a.
A patent balance of $50 million.
b.
Patent amortization expense of $2.5 million.
c.
Patent amortization expense of $5 million.
d.
A patent balance of $34 million.
___ 10.
Which of the following is not true regarding the correction of an error?
a. A journal entry is made to correct any account balances that are incorrect as a result
of the error.
b. The correction is reported prospectively; previous financial statements are not
revised.
c. Prior years' financial statements are restated to reflect the correction of the error (if
the error affected those statements).
d. A disclosure note should describe the nature of the error and the impact of its
correction on net income, income before extraordinary items, and earnings per share.
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Accounting Changes and Error Correction
___ 11.
In 2013, it was discovered that Trilogy Company had debited expense for the full cost of
an asset purchased on January 1, 2010. The cost was $12 million with no expected
residual value. Its useful life was 5 years and straight-line depreciation is used by the
company. The correcting entry assuming the error was discovered in 2013 before the
adjusting and closing entries includes:
a. A credit to accumulated depreciation of $7.2 million.
b. A debit to accumulated depreciation of $4.8 million
c. A credit to an asset of $12 million.
d. A debit to retained earnings of $4.8 million.
___ 12.
Blair Pen Company overstated its inventory by $10 million at the end of 2013. The
discovery of this error during 2014, before adjusting or closing entries, would require:
a.
A debit to inventory of $10 million.
b.
A prospective adjustment in the 2014 income statement.
c.
An increase in retained earnings.
d.
None of the above.
___ 13.
The discovery of the error described in the previous question in 2015, before adjusting or
closing entries, would require:
a.
A credit to inventory of $10 million.
b.
A decrease in retained earnings.
c.
An increase in retained earnings.
d.
None of the above.
___ 14.
A change in accounting principle that usually should not be reported by revising the
financial statements of prior periods is a change from the:
a.
The weighted-average method to the LIFO method.
b.
The weighted-average method to the FIFO method.
c.
FIFO method to the weighted-average method.
d.
LIFO method to the weighted-average method.
___ 15.
Retrospective restatement usually is not applied for a:
a.
Change in accounting principle.
b.
Change in accounting estimate.
c.
Change in entity.
d.
Correction of error.
___ 16.
Retrospective restatement usually is appropriate for a change in:
a.
b.
c.
d.
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Accounting Principle
Yes
Yes
No
No
Accounting Estimate
Yes
No
Yes
No
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Accounting Changes and Error Correction
___ 17.
A change in the residual value of a building depreciated on a straight-line basis is:
a.
A change that should be reported in earnings of the period of change.
b.
A change reported by restating prior years’ financial statements.
c.
An error correction.
d.
A change reported in the current and future periods when the change affects both.
___ 18.
Which of the accounting changes listed below is more associated with financial
statements prepared in accordance with U.S. GAAP than with International Financial
Reporting Standards?
a. Change in depreciation method.
b. Change in reporting entity.
c. Change in estimated useful life of depreciable assets.
d. Change from the FIFO method of costing inventories to the LIFO method.
___ 19.
Answers:
1. b.
2. a.
3. d.
4. d.
5. d.
Which of the following statements is true regarding correcting errors in previously issued
financial statements prepared in accordance with International Financial Reporting
Standards?
a. The error can be reported prospectively if it’s not considered practicable to report it
retrospectively.
b. The error can be reported in the current period if it’s not considered practicable to
report it prospectively.
c. The error can be reported in the current period if it’s not considered practicable to
report it retrospectively.
d. Retrospective application is required with no exception.
6.
7.
8.
9.
10.
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a.
c.
a.
d.
b.
11.
12.
13.
14.
15.
a.
d.
d.
a.
b.
16.
17.
18.
19.
b.
d.
d.
c.
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Accounting Changes and Error Correction
CPA Exam Questions
1. b. The depreciation prior to the change is as follows:
SYD Depreciation:
2011 depreciation
$11,400 ($34,200 x 5/15)
2012 depreciation
9,120 ($34,200 x 4/15)
Accumulated depreciation
$20,520
Since a change in depreciation method is considered a change in
accounting estimate resulting from a change in accounting principle, Kap
reports the change prospectively, just like a change in estimate. Kap
depreciates the remaining undepreciated cost on a straight-line basis over the
remaining useful life:
Asset’s cost
Accumulated depreciation to date (calculated above)
Undepreciated cost, Jan. 1, 2013
Estimated residual value
To be depreciated over remaining 3 years
Annual straight-line depreciation 2013–2015
$36,000
(20,520)
$15,480
(1,800)
$13,680
/ 3 years
$ 4,560
2. b. Most changes in accounting principle are accounted for retrospectively. That is,
financial statements of prior periods are restated to report the financial
information for the new reporting entity in all periods. Changes in estimate are
accounted for prospectively.
3. a. The change in the estimate for warranty costs is based on new information
obtained from experience and qualifies as a change in accounting estimate. A
change in accounting estimate affects current and future periods and is not
accounted for by restating prior periods. The accounting change is a part of
continuing operations but is not reported net of taxes.
4. b. This is a change in reporting entity to be accounted for retrospectively. That is,
financial statements of prior periods are restated to report the financial information for
the new reporting entity in all periods.
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5. b. The insurance premiums of $60,000 were charged in error to insurance expense
on the 2012 income statements. The premiums should have been allocated
equally at $20,000 per year for 2012, 2013, and 2014. Therefore, the beginning
retained earnings at 2013 are understated by $28,000—the effect of the error
($40,000) less the $12,000 tax effect ($40,000 × 30%). The corrected retained
earnings would be the beginning balance plus the correction of the error
($400,000 + 28,000 = $428,000).
6. c. The $60,000 understated ending inventory would cause the 2012 cost of goods
sold to be overstated, understating net income and retained earnings. That same
error would cause 2013 beginning inventory to be understated, overstating net
income and retained earnings by the same amount, effectively correcting the
retained earnings balance. The $75,000 overstated ending inventory would
cause the 2013 cost of goods sold to be understated, overstating net income and
retained earnings.
IFRS CPA Exam Questions
7. b According to IAS 8: Accounting Policies, Changes in Accounting Estimates and
Errors, a change in accounting policy normally should be recognized
retrospectively for all periods presented in the financial statements. This is true also
for US GAAP.
8. d Errors discovered in reporting periods subsequent to the error that has occurred
should be recognized in the financial statements as if the error had not occurred
by restating those financial statements both in all periods affected and
cumulatively in opening retained earnings for the earliest period presented if the
error occurred before that date. As an adjustment to beginning retained earnings
for the reporting period in which the error was discovered is incorrect because
when an error is corrected all affected financial statement captions for the
current and prior periods should be restated. A note disclosure is necessary
when an error is corrected but a note disclosure is never sufficient for error
correction. The only amounts recognized in the current statement of
comprehensive income for an error that occurred in a prior period are the
amounts specific to the current period. This is true also for U.S. GAAP. When
correcting errors in previously issued financial statements, IFRS (IAS No. 81)
permits the effect of the error to be reported in the current period if it’s not
considered practicable to report it retrospectively as is required by U.S. GAAP.
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9. d IAS 8 states that a change in accounting policy because of the entity’s initial
application of an IFRS should be applied in accordance with the transitional
guidance in that IFRS. If the IFRS does not include specific transitional
guidance or if the change is being made voluntarily, the change should be
applied retrospectively, unless it is impracticable to do so. Prospectively is
incorrect because the default application required by IAS 8 is not prospective
application. Practicably is incorrect because practicability is a separate issue
that is not considered in isolation from other IFRS guidance. In accordance
with management’s judgment is incorrect because while management is
responsible for all financial reporting matters, it must apply IFRS to its financial
statements in accordance with the applicable IFRS.
10. c Errors discovered in reporting periods subsequent to the error that has occurred
should be recognized in the financial statements as if the error had not occurred
by restating those financial statements both in all periods affected and
cumulatively in opening retained earnings for the earliest period presented if
the error occurred before that date. As an adjustment to beginning retained
earnings for the reporting period in which the error was discovered is incorrect
because when an error is corrected all affected financial statement captions for
the current and prior periods should be restated. A note disclosure is necessary
when an error is corrected but a note disclosure is never sufficient for error
correction. The only amounts recognized in the current statement of
comprehensive income for an error that occurred in a prior period are the
amounts specific to the current period. When correcting errors in previously
issued financial statements, IFRS (IAS No. 82) permits the effect of the error to
be reported in the current period if it’s not considered practicable to report it
retrospectively as is required by U.S. GAAP.
11. a According to IAS 8: Accounting Policies, Changes in Accounting Estimates
and Errors, a change in accounting policy is permitted if the change will result
in a more reliable and more relevant presentation of the financial statements.
12. c Upon first-time adoption of IFRS, an entity may elect to use fair value as
deemed cost for any individual item of property, plant, and equipment.
Intangible assets can be revalued to fair value only when there is an active
market. Neither of the other two asset responses is allowed to be revalued.
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13. a A company’s first IFRS financial statements must include at least three balance
sheets and two of each of the other financial statements. If the company’s first
IFRS reporting period is as of and for the year ended December 31, year 2, the
first balance sheet will be the opening balance sheet of year 1. The date of
transition to IFRS is the date of the opening balance sheet. Thus, the
company’s date of transition to IFRS is January 1, year 1.
14. a
15. b LIFO is not a permissible method for accounting for inventory under IFRS.
CMA Exam Questions
1. d. A change in the liability is merely a change in an estimate; it is not a change in
principle. A change in estimate should be accounted for prospectively, that is,
in the current and future periods.
2. a. Prior-period adjustments (error corrections) are to be accounted for through
retained earnings, not the income statement. Thus, the beginning balance of
retained earnings should be credited for revenue that was erroneously not
accrued in a prior period. The amount of the credit at May 31, 2013, is $91,800
(2012 accrued interest revenue).
3. c. The correction of an error in the financial statements of a prior period is
accounted for and reported as a prior-period adjustment and excluded from the
determination of net income for the current period.
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