Chapter
22-1

C H A P T E R 22
Chapter
22-2
Intermediate Accounting
13th Edition
Kieso, Weygandt, and Warfield

Chapter
22-3
Learning Objectives

Chapter
22-4
Accounting Changes and Error Analysis
Accounting Changes
Changes in accounting principle
Changes in accounting estimate
Reporting in reporting entity
Correction of errors
Summary
Motivations for change of method
Error Analysis
Balance sheet errors
Income statement errors
Balance sheet and income statement effects
Comprehensive example
Preparation of statements with error corrections

Accounting Changes
Chapter
22-5
Accounting Alternatives:
1)
2)
Diminish the comparability of financial information.
Obscure useful historical trend data.
Types of Accounting Changes:
Change in Accounting Principle.
Changes in Accounting Estimate.
Change in Reporting Entity.
Errors are not considered an accounting change.
LO 1 Identify the types of accounting changes.

Changes in Accounting Principle
A change from one generally accepted accounting principle to another. Examples include:
 Average cost to LIFO.
 Completed-contract to percentage-of-completion.
Chapter
22-6
Adoption of a new principle in recognition of events that have occurred for the first time or that were previously immaterial is not an accounting change.
LO 2 Describe the accounting for changes in accounting principles.

Chapter
22-7
Changes in Accounting Principle
Three approaches for reporting changes:
1) Currently.
2) Retrospectively.
3) Prospectively (in the future).
FASB requires use of the retrospective approach.
Rationale - Users can then better compare results from one period to the next.
LO 2 Describe the accounting for changes in accounting principles.

Chapter
22-8
Changes in Accounting Principle
Company reporting the change
1)
2) adjusts its financial statements for each prior period presented to the same basis as the new accounting principle.
adjusts the carrying amounts of assets and liabilities as of the beginning of the first year presented, plus the opening balance of retained earnings.
LO 3 Understand how to account for retrospective accounting changes.

Changes in Accounting Principle
Retrospective Accounting Change: Long-Term Contracts
Illustration: Denson Company has accounted for its income from long-term construction contracts using the completedcontract method. In 2010 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 completedcontract method and plans to continue doing so in the future.
(We assume a 40 percent enacted tax rate.)
Chapter
22-9
LO 3 Understand how to account for retrospective accounting changes.

Changes in Accounting Principle
Income statements for 2008–2010
Illustration 22-1
Chapter
22-10
LO 3

Changes in Accounting Principle
Data for Retrospective Change Example
Illustration 22-2
Journal entry to record change at beginning of 2010:
Construction in Process
Deferred Tax Liability
Retained Earnings
220,000
Chapter
22-11
88,000
132,000
LO 3 Understand how to account for retrospective accounting changes.

Changes in Accounting Principle
Reporting a Change in Principle
Major disclosure requirements are as follows.
1. Nature and reason for the change in accounting principle.
2. The method of applying the change, and: a. A description of the prior-period information that has been retrospectively adjusted, if any.
b. The effect of the change on income from continuing operations, net income, any other affected line items.
c. The cumulative effect of the change on retained earnings or other components of equity or net assets as of the beginning of the earliest period presented.
Chapter
22-12
LO 3 Understand how to account for retrospective accounting changes.

Changes in Accounting Principle
Reporting a Change in Principle
Illustration 22-3
Chapter
22-13
LO 3 Understand how to account for retrospective accounting changes.

Changes in Accounting Principle
Retained Earnings Adjustment
Assuming a retained earnings balance of $1,360,000 at the beginning of 2008.
Illustration 22-4
Before Change
Chapter
22-14
LO 3 Understand how to account for retrospective accounting changes.

Changes in Accounting Principle
Retained Earnings Adjustment
Illustration 22-5
After Change
Chapter
22-15
LO 3 Understand how to account for retrospective accounting changes.

Changes in Accounting Principle
E22-1 (Change in Principle—Long-Term Contracts):
Cherokee Construction Company changed from the completed-contract to the percentage-of-completion method of accounting for long-term construction contracts during
2010. For tax purposes, the company employs the completed-contract method and will continue this approach in the future. (Hint: Adjust all tax consequences through the Deferred Tax Liability account.) The appropriate information related to this change is as follows.
Chapter
22-16
LO 3 Understand how to account for retrospective accounting changes.

Changes in Accounting Principle
E22-1 (Change in Principle—Long-Term Contracts):
Instructions: (assume a tax rate of 35%)
(b) What entry(ies) are necessary to adjust the accounting records for the change in accounting principle?
(a) What is the amount of net income and retained earnings that would be reported in 2010? Assume beginning retained earnings for
2009 to be $100,000.
Chapter
22-17
LO 3 Understand how to account for retrospective accounting changes.

Changes in Accounting Principle
Example: Pre-Tax Income from Long-Term Contracts
35%
PercentageCompleted Tax
Date of-Completion Contract Difference Effect
2009
2010
$ 780,000
700,000
$ 610,000
480,000
170,000
220,000
59,500
77,000
Net of
Tax
$ 110,500
143,000
Journal entry
2010 Construction in progress
Deferred tax liability
Retained earnings
Chapter
22-18
170,000
59,500
110,500
LO 3 Understand how to account for retrospective accounting changes.

Changes in Accounting Principle
Example: Comparative Statements
Income
Statement
Statement of
Retained
Earnings
Pre-tax income
Income tax (35%)
Net income
Beg. Retained earnings
Accounting change
Beg. R/Es restated
Net income
End. Retained earnings
2010
$ 700,000
245,000
$ 455,000
$ 496,500
110,500
$ 607,000
455,000
$ 1,062,000
Restated
2009
$ 780,000
273,000
$ 507,000
$ 100,000
100,000
507,000
$ 607,000
Previous
2009
$ 610,000
213,500
$ 396,500
$ 100,000
100,000
396,500
$ 496,500
Chapter
22-19
LO 3 Understand how to account for retrospective accounting changes.

Changes in Accounting Principle
Direct and Indirect Effects of Changes
Direct Effects The FASB takes the position that companies should retrospectively apply the direct effects of a change in accounting principle.
Indirect Effects do not change prior-period amounts.
Chapter
22-20
LO 3 Understand how to account for retrospective accounting changes.

Changes in Accounting Principle
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.
Chapter
22-21
If any of the above conditions exists, the company prospectively applies the new accounting principle.
LO 4 Understand how to account for impracticable changes.

Chapter
22-22
Changes in Accounting Estimate
The following items require estimates.
1.
Uncollectible receivables.
2.
Inventory obsolescence.
3.
Useful lives and salvage 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.
LO 5 Describe the accounting for changes in estimates.

Changes in Accounting Estimate
Companies report prospectively changes in accounting estimates. They 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.
The FASB views changes in estimates as normal recurring corrections and adjustments and prohibits retrospective treatment.
Chapter
22-23
LO 5 Describe the accounting for changes in estimates.

Change in Estimate Example
Illustration: Arcadia High School (Phoenix), 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 2008 (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 prior years’ depreciation expense?
Required
Calculate depreciation expense for 2008.
Chapter
22-24
LO 5 Describe the accounting for changes in estimates.

Change in Estimate Example After 7 years
Equipment cost
Salvage value
Depreciable base
Useful life (original)
Annual depreciation
$510,000
- 10,000
500,000
First, establish
NBV at date of change in estimate.
10 years
$ 50,000 x 7 years = $350,000
Chapter
22-25
Balance Sheet (Dec. 31, 2007)
Fixed Assets:
Equipment $510,000
Accumulated depreciation 350,000
Net book value (NBV) $160,000
LO 5 Describe the accounting for changes in estimates.

Change in Estimate Example
Net book value $160,000
Salvage value (if any) 5,000
Depreciable base 155,000
Useful life
Annual depreciation
8 years
$ 19,375
Second, calculate depreciation expense for 2008.
Chapter
22-26
Journal entry for 2008
Depreciation expense
Accumulated depreciation
19,375
19,375
Solution on notes page
LO 5 Describe the accounting for changes in estimates.

Changes in Accounting Estimate
Chapter
22-27
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.
However, for a change in estimate that affects several periods (such as a change in the service lives of depreciable assets), companies should disclose the effect on income from continuing operations and related pershare amounts of the current period.
LO 5 Describe the accounting for changes in estimates.

Change in Reporting Entity
Examples of a change in reporting entity are:
1.
Presenting consolidated statements in place of statements of individual companies.
2.
Changing specific subsidiaries that constitute the group of companies for which the entity presents consolidated financial statements.
3.
Changing the companies included in combined financial statements.
4.
Changing the cost, equity, or consolidation method of accounting for subsidiaries and investments.
Reported by changing the financial statements of all prior periods presented.
Chapter
22-28
LO 6 Identify changes in a reporting entity.

Correction of Errors
Chapter
22-29
Accounting errors include the following types:
1.
A change from an accounting principle that is not generally accepted to an accounting principle 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.
LO 7 Describe the accounting for correction of errors.

Chapter
22-30
Correction of Errors
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.
LO 7 Describe the accounting for correction of errors.

Chapter
22-31
Correction of Errors
Illustration: In 2011 the bookkeeper for Selectro Company discovered an error:
In 2010 the company failed to record $20,000 of depreciation expense on a newly constructed building. This building is the only depreciable asset Selectro owns. The company correctly included the depreciation expense in its tax return and correctly reported its income taxes payable.
LO 7 Describe the accounting for correction of errors.

Correction of Errors
Illustration: Selectro’s income statement for 2010 with and without the error.
Illustration 22-19
Show the entries that Selectro should have made and did make for recording depreciation expense and income taxes.
Chapter
22-32
LO 7 Describe the accounting for correction of errors.

Correction of Errors
Illustration: Show the entries that Selectro should have made and did make for recording depreciation expense and income taxes.
Illustration 22-20
Correcting
Entry in
2011
Chapter
22-33
LO 7 Describe the accounting for correction of errors.

Correction of Errors
Illustration: Show the entries that Selectro should have made and did make for recording depreciation expense and income taxes.
Illustration 22-20
Correcting
Entry in
2011
Chapter
22-34
Retained Earnings 12,000
LO 7 Describe the accounting for correction of errors.

Correction of Errors
Illustration: Show the entries that Selectro should have made and did make for recording depreciation expense and income taxes.
Illustration 22-20
Correcting
Entry in
2011
Chapter
22-35
Retained Earnings
Deferred Tax Liability
12,000
8,000
Reversal
LO 7 Describe the accounting for correction of errors.

Correction of Errors
Illustration: Show the entries that Selectro should have made and did make for recording depreciation expense and income taxes.
Illustration 22-20
Correcting
Entry in
2011
Chapter
22-36
Retained Earnings
Deferred Tax Liability
12,000
8,000
Accumulated Depreciation—Buildings
Record
20,000
LO 7 Describe the accounting for correction of errors.

Correction of Errors
Illustration (Single-Period Statement): Assume that
Selectro Company has a beginning retained earnings balance at January 1, 2011, of $350,000. The company reports net income of $400,000 in 2011.
Illustration 22-21
Chapter
22-37
LO 7 Describe the accounting for correction of errors.

Correction of Errors
Comparative Statements
A 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.
Chapter
22-38
LO 7 Describe the accounting for correction of errors.

Correction of Errors
Woods, Inc.
Statement of Retained Earnings
For the Year Ended December 31, 2010
Balance, January 1
Net income
Dividends
Balance, December 31
$ 1,050,000
360,000
(300,000)
$ 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.
Chapter
22-39
LO 7 Describe the accounting for correction of errors.

Correction of Errors
Woods, Inc.
Statement of Retained Earnings
For the Year Ended December 31, 2010
Balance, January 1, as previously reported
Prior period adjustment, net of tax
Balance, January 1, as restated
Net income
Dividends
Balance, December 31
$ 1,050,000
(50,000)
1,000,000
360,000
(300,000)
$ 1,060,000
Chapter
22-40
Solution on notes page LO 7 Describe the accounting for correction of errors.

Illustration 22-23
Chapter
22-41
LO 7 Describe the accounting for correction of errors.

Illustration 22-23
Chapter
22-42
LO 7 Describe the accounting for correction of errors.

Chapter
22-43
Motivations for Change of
Accounting Method
Why companies may prefer certain accounting methods. Some reasons are:
1.
2.
Political costs.
Capital Structure.
3.
4.
Bonus Payments.
Smooth Earnings.
LO 8 Identify economic motives for changing accounting methods.

Error Analysis
Companies must answer three questions:
1.
What type of error is involved?
2.
3.
What entries are needed to correct for the error?
After discovery of the error, how are financial statements to be restated?
Companies treat errors as prior-period adjustments and report them in the current year as adjustments to the beginning balance of Retained Earnings.
Chapter
22-44
LO 9 Analyze the effect of errors.

Chapter
22-45
Balance Sheet Errors
Balance sheet errors affect only the presentation of an asset, liability, or stockholders’ equity account.
When the error is discovered in the error year, the company reclassifies the item to its proper position.
If the error is discovered in a prior year, the company should restate the balance sheet of the prior year for comparative purposes.
LO 9 Analyze the effect of errors.

Chapter
22-46
Income Statement Errors
Improper classification of revenues or expenses.
A company must make a reclassification entry when it discovers the error in the error year.
If the error is discovered in a prior year, the company should restate the income statement of the prior year for comparative purposes.
LO 9 Analyze the effect of errors.

Balance Sheet and Income Statement Errors
Errors affecting both balance sheet and income statement.
This type of error classified as:
1.
Counterbalancing errors
2.
Noncounterbalancing errors
Chapter
22-47
LO 9 Analyze the effect of errors.

Balance Sheet and Income Statement Errors
Will be offset or corrected over two periods.
If company has closed the books: a.
If the error is already counterbalanced, no entry is necessary.
b.
If the error is not yet counterbalanced, make entry to adjust the present balance of retained earnings.
Chapter
22-48
For comparative purposes, restatement is necessary even if a correcting journal entry is not required.
LO 9 Analyze the effect of errors.

Balance Sheet and Income Statement Errors
Will be offset or corrected over two periods.
If company has not closed the books: a.
If error already counterbalanced, make entry to correct the error in the current period and to adjust the beginning balance of Retained Earnings.
b.
If error not yet counterbalanced, make entry to adjust the beginning balance of Retained Earnings.
Chapter
22-49
LO 9 Analyze the effect of errors.

Balance Sheet and Income Statement Errors
Not offset in the next accounting period.
Companies must make correcting entries, even if they have closed the books.
Chapter
22-50
LO 9 Analyze the effect of errors.

Error Analysis 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
Interest receivable
Prepaid insurance
5,100
90,000
$ 1,500
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?
Chapter
22-51
LO 9 Analyze the effect of errors.

Error Analysis 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
Supplies on hand
1,400
1,400
2.
Accrued salaries and wages on December 31, 2010, amounted to $4,400.
Salaries and wages expense
Accured salaries and wages
2,900
2,900
Chapter
22-52
Solution on notes page LO 9 Analyze the effect of errors.

Error Analysis 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
Interest receivable
750
750
4.
The unexpired portions of the insurance policies totaled
$65,000 as of December 31, 2010.
Insurance expense
Prepaid insurance
25,000
25,000
Chapter
22-53
Solution on notes page LO 9 Analyze the effect of errors.

Error Analysis 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.
Rental income
Unearned rent
12,000
12,000
6.
Depreciation for the year was erroneously recorded as
$5,000 rather than the correct figure of $50,000.
45,000
Chapter
22-54
Depreciation expense
Accumulated depreciation
Solution on notes page
45,000
LO 9 Analyze the effect of errors.

Error Analysis 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
Interest receivable
Prepaid insurance
5,100
90,000
$ 1,500
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?
Chapter
22-55
LO 9 Analyze the effect of errors.

Error Analysis 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 $1,100.
Retained earnings
Supplies on hand
1,400
1,400
2.
Accrued salaries and wages on December 31, 2010, amounted to $4,400.
Retained earnings
Accured salaries and wages
2,900
2,900
Chapter
22-56
Solution on notes page LO 9 Analyze the effect of errors.

Error Analysis 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
Interest receivable
750
750
4.
The unexpired portions of the insurance policies totaled
$65,000 as of December 31, 2010.
Retained earnings
Prepaid insurance
25,000
25,000
Chapter
22-57
Solution on notes page LO 9 Analyze the effect of errors.

Error Analysis 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
Unearned rent
12,000
12,000
6.
Depreciation for the year was erroneously recorded as
$5,000 rather than the correct figure of $50,000.
45,000
Chapter
22-58
Retained earnings
Accumulated depreciation
Solution on notes page
45,000
LO 9 Analyze the effect of errors.

 One area in which iGAAP and U.S. GAAP differ is the reporting of error corrections in previously issued financial statements. While both GAAPs require restatement, U.S. GAAP is an absolute standard—that is, there is no exception to this rule.
 The accounting for changes in estimates is similar between U.S.
GAAP and iGAAP.
Chapter
 Under U.S. GAAP and iGAAP, if determining the effect of a change in accounting principle is considered impracticable, then a company should report the effect of the change in the period in which it believes it practicable to do so, which may be the current period.
22-59

Chapter
22-60
 Under iGAAP, the impracticality exception applies both to changes in accounting principles and to the correction of errors. Under U.S.
GAAP, this exception applies only to changes in accounting principle.
 IAS 8 does not specifically address the accounting and reporting for indirect effects of changes in accounting principles. As indicated in the chapter, U.S. GAAP has detailed guidance on the accounting and reporting of indirect effects.

Chapter
22-61
Change from the equity method to the fair-value method.
 Earnings or losses previously recognized under the equity method should remain as part of the carrying amount of the investment.
 The cost basis is the carrying amount of the investment at the date of the change.
 The investor applies the new method in its entirety.
 At the next reporting date, the investor should record the unrealized holding gain or loss to recognize the difference between the carrying amount and fair value.
LO 10 Make the computations and prepare the entries necessary to record a change from or to the equity method of accounting.

Dividends in Excess of Earnings
Accounted for such dividends as a reduction of the
investment carrying amount, rather than as revenue.
Reason: Dividends in excess of earnings are viewed as a a reduction of the equity investment.
Chapter
22-62
LO 10 Make the computations and prepare the entries necessary to record a change from or to the equity method of accounting.

Dividends in Excess of Earnings
Illustration: On January 1, 2009, Investor Company purchased
250,000 shares of Investee Company’s 1,000,000 shares of outstanding stock for $8,500,000. Investor correctly accounted for this investment using the equity method. After accounting for dividends received and investee net income, in 2009, Investor reported its investment in Investee Company at $8,780,000 at
December 31, 2009. On January 2, 2010, Investee Company sold
1,500,000 additional shares of its own common stock to the public, thereby reducing Investor Company’s ownership from 25 percent to 10 percent.
Chapter
22-63
LO 10 Make the computations and prepare the entries necessary to record a change from or to the equity method of accounting.

Dividends in Excess of Earnings
Illustration 22A-1
Chapter
22-64
LO 10 Make the computations and prepare the entries necessary to record a change from or to the equity method of accounting.

Impact on Investment Carrying Amount
Illustration 22A-2
2010 &
2011
2012
Chapter
22-65
Cash
Dividend Revenue
400,000
400,000
Cash
Available-for-Sale Securities
Dividend Revenue
Solution on notes page
210,000
60,000
150,000
LO 10 Make the computations and prepare the entries necessary to record a change from or to the equity method of accounting.

Chapter
22-66
 Companies use retrospective application.
 The carrying amount of the investment, results of current and prior operations, and retained earnings of the investor are adjusted as if the equity method has been in effect during all of the previous periods.
 Companies also eliminate any balances in the Unrealized
Holding Gain or Loss—Equity account and the Securities
Fair Value Adjustment account.
LO 10 Make the computations and prepare the entries necessary to record a change from or to the equity method of accounting.

Copyright
Chapter
22-67
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