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SMU ACCT 3311 - Accounting Changes and Error Analysis

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Slide 1Discussion QuestionsCorrection of ErrorsCorrection of ErrorsError AnalysisCounterbalancing ErrorsCorrection of Accounting ErrorsExample 5Example 5: ContinuedExample 6: Classifying Accounting ChangesExample 6: Classifying Accounting ChangesExample 6: Classifying Accounting ChangesExample 7: Error AnalysisExample 7: Error AnalysisSummary of Accounting Changes and ErrorsIFRSIFRSSummary of Accounting Changes and ErrorsSummary of Accounting Changes and ErrorsExample 8:Example 8: ContinuedExample 8: ContinuedExample 9:Example 9: ContinuedCHAPTER 22 ACCOUNTING CHANGES AND ERROR ANALYSISSommers – ACCT 3311Discussion QuestionsQ22–12 How should consolidated financial statements be reported this year when statements of individual companies were presented last year?Correction of ErrorsTypes of Accounting Errors:•A change from an accounting principle that is not generally accepted to an accounting policy that is acceptable. •Mathematical mistakes.•Changes in estimates that occur because a company did not prepare the estimates in good faith. •Failure to accrue or defer certain expenses or revenues.•Misuse of facts.•Incorrect classification of a cost as an expense instead of an asset, and vice versa.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.Balance sheet errors affect only the presentation of an asset, liability, or stockholders’ equity account.Current year error - reclassify item to its proper position.Prior year error - restate the balance sheet of the prior year for comparative purposes.Error AnalysisIncome Statement errors cause the improper classification of revenues or expenses.Current year error - reclassify item to its proper position.Prior year error - restate the income statement of the prior year for comparative purposes.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.For comparative purposes, restatement is necessary even if a correcting journal entry is not required.Counterbalancing ErrorsIf 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.Correction of Accounting ErrorsFour-step process1. Prepare a journal entry to correct any balances.2. Retrospectively restate prior years’ financial statements that were incorrect.3. Report correction as a prior period adjustment if retained earnings is one of the incorrect accounts affected.4. Include a disclosure note.Example 5Goddard Company has used the FIFO method of inventory valuation since it began operations in 2008. Goddard decided to change to the average cost method for determining inventory costs at the beginning of 2011. The following schedule shows year-end inventory balances under the FIFO and average cost methods:Year FIFO Average Cost2008 $45,000 $54,0002009 78,000 71,0002010 83,000 78,000Ignoring income taxes, prepare the 2011 journal entry to adjust the accounts to reflect the average cost method.How much higher or lower would cost of goods sold be in the 2010 revised income statement?Example 5: Continued2008 2009 2010Ignoring income taxes, prepare the 2011 journal entry to adjust the accounts to reflect the average cost method.How much higher or lower would cost of goods sold be in the 2010 revised income statement?Example 6: Classifying Accounting ChangesType of Change Reporting ApproachP. Change in accounting principle R. Retrospective approachE. Change in accounting estimate P. Prospective approachEP. Change in estimate resulting from a change in principleX. Correction of an errorN. Neither an accounting change nor an accounting error.1. Wagner changed its method of depreciating computer equipment from the DDB method to the straight-line method.2. Wagner determined that a liability insurance premium it both paid and expensed in 2010 covered the 2010–2012 period.Example 6: Classifying Accounting ChangesType of Change Reporting ApproachP. Change in accounting principle R. Retrospective approachE. Change in accounting estimate P. Prospective approachEP. Change in estimate resulting from a change in principleX. Correction of an errorN. Neither an accounting change nor an accounting error.3. Wagner custom-manufactures farming equipment on a contract basis. Wagner switched its accounting for these long-term contracts from the completed-contract method to the percentage-of-completion method.4. Due to an unexpected relocation, Wagner determined that its office building, previously depreciated using a 45-year life, should be depreciated using an 18-year life.5. Wagner offers a three-year warranty on the farming equipment it sells. Manufacturing efficiencies caused Wagner to reduce its expectation of warranty costs from 2% of sales to 1% of sales.Example 6: Classifying Accounting ChangesType of Change Reporting ApproachP. Change in accounting principle R. Retrospective approachE. Change in accounting estimate P. Prospective approachEP. Change in estimate resulting from a change in principleX. Correction of an errorN. Neither an accounting change nor an accounting error.6. Wagner changed from LIFO to FIFO to account for its materials and work-in-process inventories.7. Wagner changed from FIFO to average cost to account for its equipment inventory.8. Wagner sells extended service contracts on some of its equipment sold. Wagner performs services related to these contracts over several years, so in 2011 Wagner changed from recognizing revenue from these service contracts on a cash basis to the accrual basis.Example 7: Error AnalysisYou have been hired as the new controller for the Ralston Company. Shortly after joining the company in 2011, you discover the following errors related to the 2009 and 2010 financial statements:a. Inventory at 12/31/09 was understated by $6,000.b. Inventory at 12/31/10 was overstated by $9,000.c. On


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