Test Bank Chapter 21 Accounting Changes and Error Analysis

CHAPTER 21

ACCOUNTING CHANGES AND ERROR ANALYSIS

CHAPTER STUDY OBJECTIVES

1. Identify and differentiate among the types of accounting changes and explain how to account for them. There are three types of accounting changes. (1) Change in accounting policy: a change in the specific principles, bases, rules, or practices that an entity applies in the preparation of its financial statements. (2) Change in an accounting estimate: a change in the carrying amount of an asset or liability or the amount of an asset’s periodic consumption from reassessing the current status of the asset or liability or the expected future benefits or obligations associated with it. (3) Correction of a prior period error: a change caused by an omission from or misstatement in prior years’ financial statements from the misuse of or failure to use reliable information that existed at the time the statements were completed and that could have been used in their preparation and presentation.

Accounting changes could be accounted for retrospectively, currently, or prospectively. The retrospective method requires restatement of prior periods as if the accounting change had been used from the beginning, or the error had never been made. The current method calculates a catch-up adjustment related to the effect on all prior years, and reports it in the current period. Prospective treatment requires making no adjustment for past effects, but instead, beginning to use the new method in the current and future periods.

A change in accounting policy due to the initial application of a new primary source of GAAP is accounted for according to the transitional provisions of that standard. If none is provided, or if it is a voluntary change, retrospective application is used. A change in an accounting estimate is accounted for prospectively. Errors are corrected through full retrospective restatement.

Comparative periods are presented as if the new accounting policy had always been applied. The opening balance of each affected component of equity is adjusted for the earliest prior period presented, and all other affected comparative amounts for each prior period provided are restated. When the effects on particular prior periods are impracticable to determine, the cumulative effect of the change is shown as an adjustment to the beginning retained earnings of the earliest prior period possible. Required disclosures therefore include identifying the nature of the change, the effect on each financial statement item affected, the amounts relating to periods prior to those that are presented, and why full retrospective application was not applied, if applicable. If the change resulted from applying transitional provisions, information about the standards and the provisions is provided, including, if under IFRS, the effects on future periods. If it is a voluntary change, excluding specific ASPE accounting changes, the reasons why the new policy results in more relevant information are disclosed. Information about the future effect of changes in primary sources of GAAP that are issued but not yet effective is also required under IFRS. An opening SFP is required under IFRS for the earliest comparative period presented.

Comparative amounts for prior periods affected by errors are restated, unless under IFRS it is not practicable to identify the effect on specific past periods. If the error is in a period before the earliest comparative statements included, the opening balances of the earliest comparative period are restated. An opening SFP is required under IFRS for the earliest comparative period presented as is information about the nature of any impracticality. The nature of the error and the amount of the adjustment to each comparative financial statement line item and to EPS are all required disclosures.

Under prospective treatment of accounting for changes in estimates, only the current and future fiscal periods are affected. There is no adjustment of current-year opening balances and no attempt is made to “catch up” for prior periods. The nature and amount of a change in an accounting estimate that affects the current period or, under IFRS, is expected to affect future periods, is required to be disclosed.

2. Identify economic motives for changing accounting methods and interpret financial statements where there have been retrospective changes to previously reported results. Some of the aspects that affect decisions about the choice of accounting methods are (1) political costs, (2) the capital structure, (3) bonus payments, and (4) the desire to smooth earnings. Financial statement users should analyze the information presented about accounting changes and adjust any trend information affected.

3. Identify differences in accounting between IFRS and APSE. The accounting standards under ASPE are very similar to those under IFRS. Minor differences exist, such as IAS 8’s permitting partial retrospective treatment for the correction of an accounting error, ASPE allowing specific voluntary changes without justification on a “reliable and more relevant” basis, and IFRS requiring additional disclosures.

4. Correct the effects of errors and prepare restated financial statements. Three types of errors can occur: (1) errors that affect only the SFP, (2) errors that affect only the income statement, and (3) errors that affect both the SFP and the income statement. This last type of error is classified either as (a) a counterbalancing error, where the effects are offset or corrected over two periods; or (b) a non-counterbalancing error, where the effects take longer than two periods to correct themselves.

Multiple Choice QUESTIONS

Answer No. Description

b 1. Identify accounting changes

d 2. Voluntary change in accounting policy

c 3. Identify changes in accounting policy

c 4. Identify accounting errors

a 5. Identify changes in accounting policy

c 6. Identify a correction of an error

b 7. Accounting policy changes and errors

d 8. Cumulative effect of accounting policy changes

a 9. Alternative accounting methods allowed for accounting changes

d 10. Transitional provisions

c 11. Identify correct statement

a 12. Retrospective application

a 13. Change accounted for prospectively

b 14. Change in accounting estimate

d 15. Accounting for retrospective change

b 16. Underlying principle of retrospective application

c 17. Change in inventory costing method

c 18. Disclosures for accounting errors

b 19. Adjustments required when transitioning to IFRS

b 20. Use of retrospective treatment

c 21. Disclosures required under IFRS

d 22. Change in depreciation method

b 23. Identify a change in accounting estimate

b 24. Change in asset service life

c 25. Calculate net income with change in inventory costing method

c 26. Cumulative effect of inventory costing change

a 27. Cumulative effect of inventory costing change

c 28. Calculate effect on retained earnings of error in recording asset

a 29. Calculate cumulative effect of error on income statement

c 30. Calculate revised depreciation expense

d 31. Calculate revised depreciation expense

c 32. Calculate net income with change in depreciation method

a 33. Calculate effect on net income with change in an accounting estimate

d 34. Calculate depreciation expense after a change in estimated life

c 35. Balance of accumulated depreciation after a change in estimate

b 36. Calculate carrying value of a patent with a change in estimate

a *37. Correcting counterbalancing errors

b *38. Identifying counterbalancing errors

b *39. Counterbalancing errors

c *40. Impact of failure to record purchase and count in ending inventory

d *41. Impact of incorrectly recording depreciation

c *42. Impact of failure to accrue insurance costs

d *43. Effect of errors on net income

c *44. Effect of errors on working capital

c *45. Effect of errors on retained earnings

a *46. Effect of errors on net income and retained earnings

Answer No. Description

a *47. Effect of errors on net income

b *48. Effect of errors on retained earnings

c *49. Effect of errors on working capital

a *50. Retained earnings balance with multiple errors

b *51. Depreciation expense to be recorded following an error

*This topic is dealt with in an Appendix to the chapter.

EXERCISES

Item Description

E21-52 Conditions and disclosures for a change in accounting policy under IFRS and ASPE

E21-53 Matching accounting changes to situations

E21-54 Matching disclosures to situations

E21-55 Change in estimate, voluntary change in accounting policy, correction of errors

E21-56 Recognition of accounting changes or corrections

E21-57 Effects of errors on financial statements

E21-58 Effects of errors on net income

E21-59 Factors in choosing accounting methods and procedures

E21-60 IASB and accounting policies and estimates

*E21-61 Error corrections

*E21-62 Non-counterbalancing error correction

*This topic is dealt with in an Appendix to the chapter.

PROBLEMS

Item Description

P21-63 Corrections of errors in prior years

P21-64 Accounting for accounting changes and error corrections

P21–65 Changes in estimates

P21-66 Accounting policies under IFRS and ASPE

*P21-67 Error corrections and adjustments

*This topic is dealt with in an Appendix to the chapter.

MULTIPLE CHOICE QUESTIONS

1. Which of the following is NOT considered to be an accounting change?

a) change in accounting estimate

b) change in the composition of the board of directors

c) change in accounting policy

d) correction of a prior period error

Difficulty: Easy

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

2. One condition required by IFRS is that a voluntary change in accounting policy must result in information that is

a) more reliable than before.

b) more reliable, but equally as relevant as before.

c) both more reliable and more relevant.

d) more relevant, but equally as reliable as before.

Difficulty: Easy

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

3. Which of the following is NOT considered to be a change in accounting policy?

a) changing from weighted average to FIFO for valuing inventories

b) initial adoption of a new accounting standard

c) reclassifying items on the financial statements of prior periods to make the statements more comparable

d) changing from the cost basis to the fair value model for measuring investments

Difficulty: Easy

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

4. All of the following are considered to be accounting errors except for

a) changing from the cash basis to the accrual basis.

b) expensing the cost of a new machine.

c) changing depreciation methods from declining balance to straight line.

d) failing to accrue wages payable at year end.

Difficulty: Easy

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

5. All the following are considered to be changes in accounting policy except for

a) a change in depreciation method.

b) a change from FIFO to weighted average cost.

c) the initial adoption of a new accounting standard.

d) a change in accounting for a defined benefit pension plan from deferral and amortization to immediate recognition.

Difficulty: Easy

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

6. An example of a correction of an error in previously issued financial statements is a change

a) from the FIFO method of inventory valuation to the average cost method.

b) in the service life of plant assets, based on changes in the economic environment.

c) from the cash basis of accounting to the accrual basis of accounting.

d) in the tax assessment related to a prior period.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

7. All the following are allowed for accounting changes, except for

a) using retrospective application for an accounting policy change without restatement, if restatement is impractical.

b) using net accounting errors for disclosure purposes.

c) using prospective application for an accounting policy change, if allowed in the transition policy.

d) using prospective application for a change in estimate.

Difficulty: Easy

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

8. The cumulative effect of a change in accounting policy is reported

a) as an unusual item.

b) between discontinued operations and net income on the income statement.

c) as an adjustment to only the current year's beginning retained earnings.

d) as an adjustment of beginning retained earnings of the earliest year presented.

Difficulty: Easy

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

9. Which of the following alternative accounting methods is(are) allowed by ASPE and IFRS for reporting accounting changes?

a) prospective and retrospective

b) current and retrospective

c) current and prospective

d) retrospective only

Difficulty: Easy

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

10. For changes in accounting policy that result from applying the transitional provisions of a primary source of GAAP, the following disclosure is required:

a) management's opinion on whether the change is in line with company goals.

b) the impact on the statement of cash flows.

c) how the adjustment will impact the future periods.

d) a description of the provisions affecting future periods if the change may have an effect in future periods.

Difficulty: Easy

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

11. Which of the following statements is CORRECT?

a) Changes in accounting policy are always handled in the current or prospective period.

b) Prior year statements should always be restated for changes in accounting estimates.

c) A change from the deferral and amortization method to the immediate recognition method of accounting for defined benefit pension plans should be treated as a change in accounting policy.

d) Correction of prior period error should be presented as an adjustment on the current income statement.

Difficulty: Easy

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

12. Retrospective application is required for all

a) errors and non-mandated policy changes.

b) changes in estimates and non-mandated policy changes.

c) errors and changes in estimates.

d) changes in estimates.

Difficulty: Easy

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

13. Which type of accounting change may be accounted for in current and future periods only?

a) change in accounting estimate

b) change in inventory costing method

c) change in accounting policy

d) correction of an error

Difficulty: Easy

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

14. Which of the following is (are) the proper time period(s) to record the effects of a change in accounting estimate?

a) retrospectively only

b) current period and prospectively

c) current period and retrospectively

d) current period only

Difficulty: Easy

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

15. Accounting for a retrospective change requires

a) reissuing all prior financial statements affected by the change.

b) adjusting the ending balance of retained earnings for the current year.

c) reporting the “catch-up” adjustment on the current income statement.

d) adjusting the opening balance of each affected component of equity for the current year.

Difficulty: Easy

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

16. The underlying principle of the retrospective application method is to

a) apply changes currently and in the future.

b) present all comparative periods as if the new accounting policy had always been used.

c) make assumptions about what management’s intent was in prior years.

d) disclose all mistakes made in the past.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

17. Stockton Ltd. changed its inventory system from FIFO to average cost. What type of accounting change does this represent?

a) A change in accounting estimate for which the financial statements for the prior periods included for comparative purposes do not need to be restated.

b) A change in accounting policy for which the financial statements for prior periods included for comparative purposes do not need to be restated.

c) A change in accounting policy for which the financial statements for prior periods included for comparative purposes should be restated.

d) A change in accounting estimate for which the financial statements for prior periods included for comparative purposes should be restated.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

18. All items below are required disclosures for the correction of an accounting error except

a) the nature of the error.

b) the amount of the correction to basic and fully diluted EPS and to each line item on the financial statements presented for comparative.

c) internal control breakdown that caused the error.

d) the amount of the correction made at the beginning of the earliest prior period presented.

Difficulty: Easy

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

19. When an entity is first transitioning to IFRS, any adjustments required to bring GAAP measures in line with IFRS

a) are recognized directly in other comprehensive income.

b) are recognized directly in retained earnings.

c) must be accounted for by prospective application.

d) are ignored.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

20. Which of the following should be given retrospective treatment?

Change in Change from

Estimated Lives Unacceptable Policy

of Depreciable Assets to Acceptable Policy

a) yes yes

b) no yes

c) yes no

d) no no

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

21. Under IFRS, which of the following disclosures is NOT required for the correction of an accounting error?

a) the amount of the correction made to each affected financial statement item for each prior period presented

b) the nature of the error

c) who was responsible for the error

d) the effect of the correction on both basic and diluted earnings per share for each prior period presented

Difficulty: Easy

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

22. A publicly traded corporation changes from straight-line depreciation to double declining balance. Management believes that this will result in equally reliable and more relevant information. The change will be treated as a change in accounting estimate. The entry to record this change should include a

a) debit to Accumulated Depreciation.

b) credit to Other Comprehensive Income.

c) credit to Deferred Tax Asset.

d) no entry is needed.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

23. When a company decides to switch from deferring development costs to expensing them immediately, this change should probably be treated as a

a) change in accounting policy.

b) change in accounting estimate.

c) prior period adjustment.

d) correction of an error.

Difficulty: Easy

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

24. The service life of a building that has been depreciated for 30 years of an originally estimated 50-year life (no residual value) has been revised to an estimated remaining life of 10 years. Based on this information, the accountant should

a) continue to depreciate the building over the original 50-year life.

b) depreciate the remaining book value over the remaining life of the asset.

c) adjust accumulated depreciation to its appropriate balance through net income, based on a 40-year life, and then depreciate the adjusted book value as though the estimated life had always been 40 years.

d) adjust accumulated depreciation to its appropriate balance through retained earnings, based on a 40-year life, and then depreciate the adjusted book value as though the estimated life had always been 40 years.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

25. Randall Corp. began operations on January 1, 2022, and uses FIFO to cost its inventory. Management is contemplating a change to the average cost method and is interested in determining what effect such a change will have on pre-tax income. Accordingly, the following information has been developed:

Ending Inventory 2022 2023

FIFO $480,000 $540,000

Average cost 400,000 500,000

Pre-tax Income (calculated using FIFO) 750,000 900,000

Based upon the above information, a change to the average cost method in 2023 would result in pre-tax income for 2023 of

a) $790,000.

b) $860,000.

c) $940,000.

d) $980,000.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $900,000 + [($500,000 – $400,000) – ($540,000 – $480,000)] = $940,000

26. On January 1, 2023, Bluebird Ltd. changed its inventory valuation method from weighted-average cost to FIFO for financial statement and income tax purposes, to make its reporting as reliable and more relevant. The change resulted in a $900,000 increase in the beginning inventory at January 1, 2023. Assume a 25% income tax rate. The cumulative effect of this accounting change reported for the year ended December 31, 2023 is

a) $0.

b) $225,000.

c) $675,000.

d) $900,000.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $900,000 × (1 – .25) = $675,000

27. On January 1, 2023, Miner Corp. changed its inventory costing from FIFO to average cost for financial statement and income tax purposes, to make its reporting as reliable and more relevant. The change resulted in a $600,000 increase in the beginning inventory at January 1, 2023. Assume a 30% income tax rate. The cumulative effect of this accounting change should be reported by Chickadee in its 2023

a) Retained earnings statement as a $420,000 addition to the beginning balance.

b) Income statement as $420,000 other comprehensive income.

c) Retained earnings statement as a $600,000 addition to the beginning balance.

d) Income statement as a $600,000 cumulative effect of accounting change.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $600,000 × (1 – .3) = $420,000

28. On January 2, 2021, Moose Corp. purchased machinery for $270,000. The entire cost was incorrectly recorded as an expense. The machinery has a nine-year life and a $18,000 residual value. Moose uses straight-line depreciation for all its plant assets. The error was not discovered until May 1, 2023, and the appropriate corrections were made. Ignore income tax considerations.

Before the corrections were made, retained earnings was understated by

a) $270,000.

b) $242,000.

c) $214,000.

d) $186,000.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $270,000 – [($270,000 – $18,000) ÷ 9 x 2] = $214,000

29. On January 2, 2021, Beaver Corp. purchased machinery for $270,000. The entire cost was incorrectly recorded as an expense. The machinery has a nine-year life and a $18,000 residual value. Beaver uses straight-line depreciation for all its plant assets. The error was not discovered until May 1, 2023, and the appropriate corrections were made. Ignore income tax considerations.

Beaver’s income statement for the year ended December 31, 2023 would show the cumulative effect of this error in the amount of

a) $0.

b) $186,000.

c) $214,000.

d) $242,000.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: Not booked through I/S, booked through R/E

30. On January 1, 2020, Cumberland Ltd. bought machinery for $750,000. The company used straight-line depreciation for this machinery, over an estimated useful life of ten years, with no residual value. At the beginning of 2023, Cumberland decided the estimated useful life of this machinery was only eight years (from the date of acquisition), still with no residual value. For calendar 2023, the depreciation expense for this machinery is

a) $75,000.

b) $65,625.

c) $105,000.

d) $93,750.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: Accumulated depreciation to December 31/22: $750,000 ÷ 10 x 3 = $225,000

new annual expense ($750,000 – $225,000) ÷ (8 – 3) = $525,000 ÷ 5 = $105,000

31. On January 1, 2020, Missoula Corporation bought machinery for $800,000. It used double declining balance depreciation for this asset, with an estimated life of eight years, and an estimated $200,000 residual value. At the beginning of 2023, Missoula decided to change to the straight-line method of depreciation for this equipment and treated the change as a change in estimate. For calendar 2023, the depreciation expense for this machinery is

a) $100,000.

b) $92,500.

c) $75,050.

d) $27,500.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: Accumulated depreciation to December 31/22 (DDB):
($800,000 × .25) + ($600,000 × .25) + ($450,000 × .25) = $462,500
new depreciable amount $800,000 – $200,000 – $462,500 = $137,500
new annual expense $137,500 ÷ 5 = $27,500

32. On January 1, 2020, Casino Inc. purchased a machine for $300,000. The machine has an estimated five-year life, and no residual value. Double declining balance depreciation has been used for financial statement reporting and CCA for income tax reporting. Effective January 1, 2023, Casino decided to change to straight-line depreciation for this machine and treated the change as a change in accounting policy. For calendar 2023, Casino’s pre-tax income before depreciation on this asset is $250,000. Their income tax rate has been 30% for many years. What net income should Casino report for calendar 2023?

a) $190,000

b) $171,640

c) $133,000

d) $91,000

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $300,000 ÷ 5 = $60,000 (annual depreciation using S/L)
($250,000 – $60,000) × (1 – .3) = $133,000

33. Major Corp. purchased a machine on January 1, 2020, for $900,000. The machine is being depreciated on a straight-line basis, using an estimated useful life of six years and no residual value. On January 1, 2023, Major determined, because of additional information, that the machine had an estimated useful life of eight years from the date of acquisition with no residual value. An accounting change was made in 2023 to reflect this additional information.

Assuming that the direct effects of this change are limited to the effect on depreciation and the related tax provision, and that the income tax rate for all years since the machine was purchased was 30%, what should be reported in the income statement for calendar 2023 as the cumulative effect on prior years of changing the estimated useful life of the machine?

a) $0

b) $60,000

c) $90,000

d) $315,000

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $0, use prospective application since this is a change in estimate

34. Minor Corp. purchased a machine on January 1, 2020, for $900,000. The machine is being depreciated on a straight-line basis, using an estimated useful life of six years and no residual value. On January 1, 2023, Minor determined, because of additional information, that the machine had an estimated useful life of eight years from the date of acquisition with no residual value. An accounting change was made in 2023 to reflect this additional information.

What is the amount of depreciation expense on this machine that should be reported in Major’s income statement for calendar 2023?

a) $225,000

b) $180,000

c) $112,500

d) $90,000

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: ($900,000 ÷ 6) × 3 = $450,000; $900,000 – $450,000 = $450,000
$450,000 ÷ 5 = $90,000

35. On January 1, 2019, Plover Ltd. purchased a machine for $495,000 and depreciated it using the straight-line method with an estimated useful life of eight years with no residual value. On January 1, 2022, Plover determined that the machine had a useful life of only six years from the date of acquisition but will have a residual value of $45,000. An accounting change was made in 2022 to reflect these additional facts. At December 31, 2023, the accumulated depreciation account for this machine should have a balance of

a) $273,750.

b) $281,250.

c) $361,875.

d) $375,000.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: Accumulated depreciation to December 31/22: $495,000 × 3 ÷ 8 = $185,625
new annual rate ($495,000 – $185,625 – $45,000) ÷ 3 = $88,125
Accumulated depreciation at December 31/23 = $185,625 + ($88,125 x 2) = $361,875

36. On January 1, 2020, Wren Corp. purchased a patent for $238,000. The patent is being amortized straight-line with no residual value over its remaining legal life of 15 years. However, at the beginning of 2023, Wren determined that the economic benefits of the patent would not last longer than ten years from the date of acquisition. What amount should be reported in the 2023 of financial position for the patent, net of accumulated amortization, at December 31, 2023?

a) $142,800

b) $163,200

c) $168,000

d) $174,550

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: Accumulated amortization to December 31/22: $238,000 × 3 ÷ 15 = $47,600
new annual rate [($238,000 – $47,600) ÷ 7] = $27,200
patent at December 31/23 = $238,000 – $47,600 – $27,200 = $163,200

*37. If an error has already counter-balanced itself, and the books have already been closed, which of the following is required?

a) No journal entry is required.

b) A journal entry into the next period is required.

c) An entry is necessary to adjust the present balance of retained earnings and the other affected balance sheet account(s).

d) The books must be re-opened and journal entry for the current period should be created.

Difficulty: Easy

Learning Objective: Correct the effects of errors and prepare restated financial statements.

Section Reference: Appendix 21A: Error Analysis

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

*38. All of the following involve counterbalancing errors except for the

a) failure to record prepaid expenses.

b) failure to record an asset impairment.

c) understatement of ending inventory.

d) overstatement of purchases.

Difficulty: Easy

Learning Objective: Correct the effects of errors and prepare restated financial statements.

Section Reference: Appendix 21A: Error Analysis

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

*39. Counterbalancing errors do NOT include

a) errors that correct themselves in two years.

b) errors that correct themselves in three or more years.

c) an understatement of ending inventory.

d) an overstatement of unearned revenue.

Difficulty: Easy

Learning Objective: Correct the effects of errors and prepare restated financial statements.

Section Reference: Appendix 21A: Error Analysis

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

*40. A company using a perpetual inventory system neglected to record a purchase of merchandise on account at year end. This merchandise was also omitted from the year-end physical count. How will these errors affect assets, liabilities, and shareholders' equity at year end and net income for the year?

Assets Liabilities Shareholders' Equity Net Income

a) no effect understate overstate overstate

b) no effect overstate understate understate

c) understate understate no effect no effect

d) understate no effect understate understate

Difficulty: Medium

Learning Objective: Correct the effects of errors and prepare restated financial statements.

Section Reference: Appendix 21A: Error Analysis

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

*41. MissTake Corp. is a small private corporation that does NOT prepare comparative statements. At the end of its 2023 fiscal year, it was discovered that the 2022 depreciation expense on its computer equipment had been incorrectly debited to maintenance expense. How should MissTake deal with this situation?

a) Prepare an adjusting entry to debit depreciation expense and credit maintenance expense.

b) Prepare an adjusting entry to debit retained earnings and credit maintenance expense.

c) Restate its 2022 financial statements.

d) Ignore it, its is likely immaterial.

Difficulty: Medium

Learning Objective: Correct the effects of errors and prepare restated financial statements.

Section Reference: Appendix 21A: Error Analysis

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

*42. On December 31, 2023, the bookkeeper at Thrush Corp. did NOT record special insurance costs that had been incurred (but NOT yet paid), related to a building that Thrush Corp. is constructing. What is the effect of the omission on accrued liabilities and retained earnings in the December 31, 2023 statement of financial position?

Accrued Liabilities Retained Earnings

a) no effect no effect

b) no effect overstated

c) understated no effect

d) understated overstated

Difficulty: Medium

Learning Objective: Correct the effects of errors and prepare restated financial statements.

Section Reference: Appendix 21A: Error Analysis

CPA: Financial Reporting

Bloomcode: Analysis

AACSB: Analytic

*43. Cheyenne Ltd.'s December 31 year-end financial statements contained the following errors:

Dec. 31, 2022 Dec. 31, 2023

Ending inventory $1,500 understated $2,200 overstated

Depreciation expense $400 understated

An insurance premium of $3,600 was prepaid in 2022 covering the calendar years 2022, 2023, and 2024. This had been debited to insurance expense. In addition, on December 31, 2023, fully depreciated machinery was sold for $1,900 cash, but the sale was NOT recorded until 2024. There were no other errors during 2023 or 2024 and no corrections have been made for any of the errors. Ignore income tax considerations.

What is the total net effect of the errors on Cheyenne’s 2023 net income?

a) Net income understated by $2,900

b) Net income overstated by $1,500

c) Net income overstated by $2,600

d) Net income overstated by $3,000

Difficulty: Medium

Learning Objective: Correct the effects of errors and prepare restated financial statements.

Section Reference: Appendix 21A: Error Analysis

CPA: Financial Reporting

Bloomcode: Analysis

AACSB: Analytic

Feedback: $1,500 (o) + $2,200 (o) + $1,200 (o) – $1,900 (u) = $3,000 (o)

*44. Cheyenne Ltd.'s December 31 year-end financial statements contained the following errors:

Dec. 31, 2022 Dec. 31, 2023

Ending inventory $1,500 understated $2,200 overstated

Depreciation expense $400 understated

What is the total net effect of the errors on the amount of Cheyenne's working capital at December 31, 2023?

a) Working capital overstated by $1,000

b) Working capital overstated by $300

c) Working capital understated by $900

d) Working capital understated by $2,400

Difficulty: Medium

Learning Objective: Correct the effects of errors and prepare restated financial statements.

Section Reference: Appendix 21A: Error Analysis

CPA: Financial Reporting

Bloomcode: Analysis

AACSB: Analytic

Feedback: $2,200 (o) – $1,200 (u) – $1,900 (u) = $900 (u)

*45. Cheyenne Ltd.'s December 31 year-end financial statements contained the following errors:

Dec. 31, 2022 Dec. 31, 2023

Ending inventory $1,500 understated $2,200 overstated

Depreciation expense $400 understated

What is the total effect of the errors on the balance of Cheyenne's retained earnings at December 31, 2023?

a) Retained earnings understated by $2,000

b) Retained earnings understated by $900

c) Retained earnings understated by $500

d) Retained earnings overstated by $700

Difficulty: Medium

Learning Objective: Correct the effects of errors and prepare restated financial statements.

Section Reference: Appendix 21A: Error Analysis

CPA: Financial Reporting

Bloomcode: Analysis

AACSB: Analytic

Feedback: $400 (o) + $2,200 (o) – $1,200 (u) – $1,900 (u) = $500 (u)

*46. At December 31, 2023, Grant Corp.’s auditor discovered the following errors:

1. Accrued salaries payable of $11,000 were NOT recorded at December 31, 2022.

2. Office supplies on hand of $5,000 at December 31, 2023 had been treated as expense instead of supplies inventory.

Neither of these errors was discovered nor corrected. The effect of these two errors would cause

a) 2023 net income to be understated $16,000 and December 31, 2023 retained earnings to be understated $5,000.

b) 2022 net income and December 31, 2022 retained earnings to be understated $11,000 each.

c) 2022 net income to be overstated $6,000 and 2023 net income to be understated $5,000.

d) 2023 net income and December 31, 2023 retained earnings to be understated $5,000 each.

Difficulty: Medium

Learning Objective: Correct the effects of errors and prepare restated financial statements.

Section Reference: Appendix 21A: Error Analysis

CPA: Financial Reporting

Bloomcode: Analysis

AACSB: Analytic

Feedback: 2023 NI = $11,000 (u) + $5,000 (u) = $16,000 (u)
2023 RE = $5,000 (u)
The $11,000(o) from 2022 is offset by the $11,000(u) in 2023

*47. Fairfax Inc. began operations on January 1, 2022. Financial statements for 2022 and 2023 contained the following errors:

Dec. 31, 2022 Dec. 31, 2023

Ending inventory $33,000 too high $39,000 too low

Depreciation expense 21,000 too high —

Insurance expense 15,000 too low 15,000 too high

Prepaid insurance 15,000 too high —

In addition, on December 31, 2023 fully depreciated equipment was sold for $7,200, but the sale was NOT recorded until 2024. No corrections have been made for any of the errors. Ignore income tax considerations.

The total effect of the errors on Fairfax's 2023 net income is

a) understated by $94,200.

b) understated by $61,200.

c) overstated by $28,800.

d) overstated by $49,800.

Difficulty: Medium

Learning Objective: Correct the effects of errors and prepare restated financial statements.

Section Reference: Appendix 21A: Error Analysis

CPA: Financial Reporting

Bloomcode: Analysis

AACSB: Analytic

Feedback: $33,000 (u) + $39,000 (u) + $15,000 (u) + $7,200 (u) = $94,200 (u)

*48. Fairfax Inc. began operations on January 1, 2022. Financial statements for 2022 and 2023 contained the following errors:

Dec. 31, 2022 Dec. 31, 2023

Ending inventory $33,000 too high $39,000 too low

Depreciation expense 21,000 too high —

Insurance expense 15,000 too low 15,000 too high

Prepaid insurance 15,000 too high —

The total effect of the errors on Fairfax's retained earnings at December 31, 2023 is that the balance is understated by

a) $82,200.

b) $67,200.

c) $46,200.

d) $34,200.

Difficulty: Medium

Learning Objective: Correct the effects of errors and prepare restated financial statements.

Section Reference: Appendix 21A: Error Analysis

CPA: Financial Reporting

Bloomcode: Analysis

AACSB: Analytic

Feedback: $39,000 (u) + $21,000 (u) – $15,000 (o) + $15,000 (u) + $7,200 (u) = $67,200 (u)

*49. Fairfax Inc. began operations on January 1, 2022. Financial statements for 2022 and 2023 contained the following errors:

Dec. 31, 2022 Dec. 31, 2023

Ending inventory $33,000 too high $39,000 too low

Depreciation expense 21,000 too high —

Insurance expense 15,000 too low 15,000 too high

Prepaid insurance 15,000 too high —

The total effect of the errors on Fairfax's working capital at December 31, 2023 is that working capital is understated by

a) $100,200.

b) $79,200.

c) $46,200.

d) $31,200.

Difficulty: Medium

Learning Objective: Correct the effects of errors and prepare restated financial statements.

Section Reference: Appendix 21A: Error Analysis

CPA: Financial Reporting

Bloomcode: Analysis

AACSB: Analytic

Feedback: $39,000 (u) + $7,200 (u) = $46,200 (u)

*50. Eagle Corp. is a calendar-year corporation whose financial statements for 2022 and 2023 included errors as follows:

Year Ending Inventory Depreciation Expense

2022 $36,000 overstated $30,000 overstated

2023 12,000 understated 10,000 understated

Assume that purchases were recorded correctly and that no correcting entries were made at December 31, 2022 or December 31, 2023. Ignoring income taxes, by how much should Eagle's retained earnings be retrospectively adjusted at January 1, 2024?

a) $32,000 increase

b) $8,000 increase

c) $4,000 decrease

d) $2,000 increase

Difficulty: Medium

Learning Objective: Correct the effects of errors and prepare restated financial statements.

Section Reference: Appendix 21A: Error Analysis

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $12,000 (u) + $30,000 (u) – $10,000 (o) = $32,000 (u)

*51. On January 1, 2022, Condor Corp. acquired a machine for $200,000. It is to be depreciated straight line over five years, with no residual value. As a result of a bookkeeping error, no depreciation was recognized in Condor's 2022 financial statements. The oversight was discovered during the preparation of Condor's 2023 financial statements. Depreciation expense on this machine for 2023 should be

a) $0.

b) $40,000.

c) $50,000.

d) $80,000.

Difficulty: Medium

Learning Objective: Correct the effects of errors and prepare restated financial statements.

Section Reference: Appendix 21A: Error Analysis

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $200,000 ÷ 5 = $40,000

EXERCISES

Ex. 21-52 Conditions and disclosures for a change in accounting policy under IFRS and ASPE

Able Enterprises is a large consumable distributor. The company has been using the weighted average method for its inventory valuation but would like to move to using FIFO. The company is publicly traded.

Instructions

a) Under what conditions would it be acceptable for Able to move from using the weighted average method to FIFO? Under what situations can a company reporting under IFRS make changes to its accounting policy?

b) Would your answer in part a change if the company adhered to ASPE rather than IFRS? Explain under what situations a change policy could be made under ASPE.

c) Critical Thinking: As the CFO you have informed your accounting team that if management makes the change to FIFO that they will be possible for ensuring that the correct disclosures are made. A new junior accountant is confused by this. Explain the main objectives of accounting and disclosure standards for accounting changes.

Solution 21-52

a) Under IFRS, there are only two situations where a change in accounting policy is acceptable:

1. The change is required by a primary source of GAAP.

2. A voluntary change results in the information in the financial statements being as reliable and more relevant.

b) Voluntary changes are allowed under ASPE without having to meet the “reliable and more relevant” criterion. These include accounting and reporting

1. for investments in subsidiary companies, and in companies where the investor has significant influence or joint control.

2. for expenditures during the development phase on internally generated intangible assets.

3. for defined benefit plans.

4. for accounting for income taxes.

5. for measuring the equity component of a compound financial instrument.

c) CRITICAL THINKING: The three main objectives of accounting and disclosure standards for accounting changes include:

1. Limiting the types of changes permitted.

2. Standardizing the reporting for each type of change.

3. Ensuring that readers of accounting reports have the necessary information to understand the effects of such changes on the financial statements.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex. 21-53 Matching accounting changes to situations

The three types of accounting changes are:

Code

a) Change in accounting policy

b) Change in accounting estimate

c) Error correction

Instructions

Following are a series of situations. You are to enter a code letter to the left to indicate the type of change.

1. Change due to debiting a new asset to an expense account.

2. Change from FIFO to weighted average costing.

3. Change due to failure to recognize unearned portion of revenue.

4. Change in amortization period for an intangible asset.

5 Change in the calculation of warranty liabilities.

6. Change due to failure to recognize and accrue income.

7. Change in residual value of a depreciable plant asset.

8. Change from an unacceptable accounting policy to an acceptable accounting policy.

9. Adoption of a new accounting standard.

10. Change due to expensing prepaid assets.

11. Change from straight-line to double declining-balance method of depreciation.

12. Change in estimated service life of a depreciable plant asset.

13. Change from one acceptable policy to another acceptable policy.

14. Change due to understatement of inventory.

15. Change in estimated net realizable value of accounts receivable.

Solution 21-53

1. c

2. a

3. c

4. b

5. b

6. c

7. b

8. c

9. a

10. c

11. b

12. b

13. a

14. c

15. b

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex. 21-54 Matching disclosures to situations

In the blank to the left of each statement, fill in the letter from the following list which best describes the treatment of the item on the financial statements of Sora Inc. for the current year ending December 31, 2023:

a) Change in accounting policy requiring retrospective application

b) Change in estimate

c) Correction of error

d) None of the above

1. In 2023, the company changed its method of recognizing income from the completed-contract method to the percentage-of-completion method.

2. At the end of 2023, an audit revealed that the corporation's allowance for doubtful accounts was too large and should be reduced to 2%. When the audit was performed in 2022, the allowance seemed appropriate.

3. Depreciation on a truck, acquired in 2019, was understated because the service life had been overestimated. The understatement had been made in order to show higher net income in 2020 and 2021.

4. The company switched from average cost to FIFO inventory costing during the current year.

5. In 2023, Sora introduced a new pension plan for its employees, which included past service costs of $50,000. It decided to recognize the $50,000 as part of its 2023 pension expense.

6. During 2023, a long-term bond with a carrying value of $3,600,000 was retired at a cost of $4,100,000.

7. After negotiations with Canada Revenue Agency, income taxes owing for 2022 were established at $42,900. They were originally estimated to be $28,600.

8. In 2023, the company incurred interest expense of $29,000 on a 20-year bond issue.

9. In calculating the depreciation in 2021 for buildings, an error was made which overstated income in that year by $75,000. The error was discovered in 2023.

10. In 2023, the company changed its method of depreciating plant assets from the double declining-balance method to the straight-line method.

Solution 21-54

1. a

2. b

3. c

4. a

5. d

6. d

7. b

8. d

9. c

10. b

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex. 21-55 Change in estimate, voluntary change in accounting policy, correction of errors

As part of Zip Transports loan covenants, the company must provide its accountant prepared financial statements to its banker on an annual basis. The bank will then conduct a financial analysis of the statements to assess overall company stability and ensure that ZIP is in compliance with the covenants. The bank notices that there appears to significant changes to Zip’s accounting policies and disclosures. The bank contacts Zip’s CFO asking for a detailed explanation of these changes.

Instructions

a) Provide the bank with a detailed report and examples of each of the following:

1. Change in estimate

2. Voluntary change in accounting policy

3. Correction of an error

Make sure to address any differences in reporting under IFRS versus ASPE in your explanation.

b) CRITICAL THINKING: Why do you think the banker ask for a detailed explanation of the changes? What challenges is the banker experiencing in conducting the annual review?

Solution 21-55

Changes in Estimate

Accounting estimates will change as new events occur, as more experience is acquired, or new information is obtained. Changes in estimates are handled prospectively; that is in current and future periods. No restatement of previous financial statements is made. Financial statement disclosure includes the nature and amount of the change for the current period under ASPE and future periods under IFRS unless it is impracticable to estimate its affect. Immaterial changes in estimates do not need to be disclosed. Examples include:

- collectability of receivables

- change in depreciation methods

- estimated lives or residual values

- warranty costs

Voluntary Changes in Accounting Policy

The financial statements need to be adjusted to reflect the change in all of the prior years presented, the current year, and the cumulative effect of the change on prior periods, net of tax, should be shown as an adjustment to beginning retained earnings in the current year. Disclosure should include the amount of the adjustment for the current period and each prior period presented, including the effect on each financial statement line item and the per share amounts, the amount of the adjustment related to periods prior to those presented, either that the change has been applied retrospectively, or without restatement and an explanation why this was impractical, and justification of the change. Examples include: - change in the basis of inventory pricing

- change in the method of accounting for construction contracts

- change in the method of accounting for instalment sales

- change in the method of accounting for defined pension plans

Correction of an Error

Corrections of errors are recorded in the year discovered, are corrected retrospectively with restatement of all prior years presented, and the beginning balance of retained earnings is adjusted. The nature of the error, the amount of the correction for each prior period presented, and the amount related to periods prior to those presented, and that the comparative information has been restated, must all be disclosed. Examples include:

- a change from an accounting policy that is not generally accepted to an accounting policy that is accepted

- mathematical mistakes

- changes in estimates that occur because the estimates are not made in good faith

- an oversight

- a misuse of facts

- misclassification of an asset as an expense or vice versa

b) CRITICAL THINKING:

Accounting changes often make it difficult to develop meaningful trend data, which would undermine one of the major reasons why the accounting information was useful in the past. Financial statement readers should look closely at all accounting changes and adjust any trend data appropriately. Although most adjustments result in no change in the company’s cash position, some adjustments can end up converting previously reported operating cash flows to investing or financing flows. Most changes tend to shift earnings from one accounting period to another. The disclosures required by the accounting standards are the best source of input for the analysis.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex. 21-56 Recognition of accounting changes or corrections

Meck Pharmaceuticals new CFO who has been reviewing the company’s past financial statements and its current accounting policies. Based on his analysis, the accounting team has been instructed to make the following changes:

1. Change from straight-line method of depreciation to double declining balance method

2. Change from the cash basis to the accrual basis of accounting

3. Change from FIFO to weighted average cost method for inventory valuation purposes

4. Change due to failure to record depreciation in a previous period

5. Change in the net realizable value of certain receivables

Instructions

For each of the items above, indicate the type of accounting change the accounting team has been instructed to make and how each is recognized in the accounting records for the current year.

Solution 21-56

1. Change in accounting estimate; prospective application for current and future periods only.

2. Correction of an error; retrospective treatment; restatement of financial statements of all prior periods presented; adjustment of beginning retained earnings of the current period. If restatement is not practical, restatement may be omitted.

3. Change in accounting policy; retrospective treatment; adjustment of beginning retained earnings, restatement of financial statements of all prior periods presented. If restatement is not practical, restatement may be omitted.

4. Correction of an error; restatement of financial statements of the period affected; adjustment of beginning retained earnings of the first period after the error.

5. Change in accounting estimate; prospective application for current and future periods only.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex. 21-57 Effects of errors on financial statements

Show how the following independent errors will affect net income on the income statement and the shareholders' equity section of the statement of financial position (SFP) using the symbol + (plus) for overstated, – (minus) for understated, and 0 (zero) for no effect.

2022 2023

Income SFP Income SFP

Statement Statement

1. Ending 2022 inventory overstated

2. Failure to accrue 2022 interest revenue

3. A capital expenditure for factory equipment (useful life, 5 years) was charged to expense in error in 2022

4. Failure to accrue 2022 wages

5. Ending inventory in 2022 understated

6. Overstated 2022 depreciation expense; 2023 expense correct

Solution 21-57

2022 2023

Income Income

Statement SFP Statement SFP

1. Ending 2022 inventory overstated.

+ + – 0

– – + 0

_ _ + _

+ + – 0

– – + 0

– – 0 –

2. Failure to accrue 2022 interest revenue.

3. A capital expenditure for factory equipment (useful life, 5 years) was charged to expense in 2022.

4. Failure to accrue 2022 wages.

5. Ending inventory in 2022 understated.

6. Overstated 2022 depreciation expense; 2023 expense correct.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex. 21-58 Effects of errors on net income

Hummingbird Corp. began operations on January 1, 2022. Financial statements for 2022 and 2023 contained the following errors:

Dec. 31, 2022 Dec. 31, 2023

Ending inventory $20,000 too high $35,000 too high

Depreciation expense 16,000 too low —

Accumulated depreciation 16,000 too low 16,000 too low

Insurance expense 14,000 too high 10,000 too low

Prepaid insurance 14,000 too low 4,000 too low

In addition, on December 26, 2023, fully depreciated equipment was sold for $19,000, but the sale was NOT recorded until 2024. No corrections have been made for any of the errors.

Instructions

a) Ignoring income tax, show your calculation of the total effect of the errors on 2023 net income.

b) CRITICAL THINKING: How do these types of errors get corrected on the financial statements? Within your explanation include a discussion on how a retrospective application for accounting changes is applied.

Solution 21-58

2022 ending inventory $(20,000)

2023 ending inventory 35,000

Insurance expense 10,000

Unrecorded gain (19,000)

Overstatement of 2023 income $ 6,000

Note: The error in depreciation expense has no effect on 2023 income. The error in prepaid insurance is related to the error in insurance expense.

b) CRITICAL THINKING: The general requirement for changes in accounting policy and the required method for error correction is that the change’s cumulative effect be shown as an adjustment to the beginning retained earnings. Income statements of the affected prior periods presented for comparison purposes are restated to show, on a retrospective basis, the effects of the new accounting policy. When historical summaries are reported, the adjustments are reported in each prior year affected. When the effects on particular prior periods of a change in accounting policy is impractical to determine, the cumulative effect of the change (net of tax) is shown as an adjustment to the beginning retained earnings. Comparative financial statements of prior periods presented for comparison are not restated.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex. 21-59 Factors in choosing accounting methods and procedures

Max Systems is a new technology start-up. The company is currently in the process of incorporating and choosing appropriate accounting policies for this firm. The management team wants to make sure it understands the economic consequences of the policys the company chooses.

Instructions

a) Explain what management means when it uses the term “economic consequences”.

b) Identify and provide a detailed explanation of the four economic factors as discussed in the textbook that the management team of Max Systems may wish to consider when choosing the company’s accounting policies.

Solution 21-59

a) Management pays careful attention to the accounting methods it follows and often changes accounting methods not for conceptual reasons but rather for economic reasons. As indicated throughout this textbook, such arguments have come to be known as economic consequences arguments, since they focus on the supposed impact of accounting on the behaviour of investors, creditors, competitors, governments, and the managers of the reporting companies themselves, rather than addressing the conceptual justification for accounting standards.

b) Research has shown that choices of accounting policies often have economic consequences for business organizations. As a result, management may choose accounting policies based on the expected economic impact of the policy. Some of these reasons are political costs, capital structure, bonus payments, and smoothing of earnings. Each of these is explained in more detail below:

1. Political costs: The larger the firm, the more likely it is to become subject to legislation such as anti-competition regulations and the more likely it is to be required to pay higher taxes. Therefore, companies that are politically visible may try to report income numbers that are low in order to avoid the scrutiny of regulators.

2. Capital structure: Several studies have found that a company’s capital structure can affect the selection of accounting methods. For example, a company with a high debt-to-equity ratio is more likely to be constrained by debt covenants. A company may be considered in default on its bonds if the debt-to-equity ratio is too high. As a result, this type of company is more likely to select accounting methods that will increase net income—such as capitalizing interest instead of expensing it, or using the full cost method instead of the successful efforts approach for exploration and development costs in the oil and gas industry.

3. Bonus payments: Studies have found that if compensation plans tie managers’ bonus payments to income, management may select accounting methods that maximize bonus payments.

4. Smooth earnings: Substantial increases in earnings attract the attention of politicians, regulators, and competitors. In addition, large increases in income create problems for management because the same results are difficult to achieve in subsequent years. Compensation plans may adjust to these higher numbers as a baseline and make it difficult for management to achieve its profit goals and receive bonuses in the following years. On the other hand, decreases in earnings might signal that the company is in financial trouble. Furthermore, significant changes in income raise concerns on the part of shareholders, lenders, and other interested parties about the riskiness of the company. For all these reasons, companies have an incentive to “manage” or “smooth” their earnings.

Difficulty: Easy

Learning Objective: Identify economic motives for changing accounting methods and interpret financial statements where there have been retrospective changes to previously reported results.

Section Reference: Analysis

CPA: Communication

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Communication

Ex. 21-60 IASB and accounting policies and estimates

As part of its disclosure initiative, why is the IASB looking at the definitions of accounting policies and accounting estimates?

Solution 21-60

The IASB is looking at the definitions of accounting policies and accounting estimates as some preparers and users feel that the definitions currently provided in IFRS are not sufficiently detailed or informative. What is the issue? As noted in the chapter, accountants are increasingly called to deal with measurement uncertainty and must continually estimate and re-estimate many financial statement elements. If we look at recently issued IFRS, we can see that, as new standards are issued or old standards revised, the IASB is including additional guidance regarding tools and techniques to measure and deal with estimation uncertainty. Therefore, as the amount of guidance increases (including specific methods to estimate amounts), the act of estimating becomes in many ways more complex and companies must carefully consider which methodologies should be used to measure things and how they should be applied. Thus the line between changes in accounting policies and changes in estimates is becoming more blurred.

Difficulty: Easy

Learning Objective: Identify differences in accounting between IFRS and APSE.

Section Reference: IFRS/ASPE Comparison

CPA: Communication

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Communication

*Ex.21–61 Error corrections

TokTik Inc.'s December 31 year-end financial statements contained the following errors:

Dec. 31, 2022 Dec. 31, 2023

Ending inventory $1,800 overstated $2,100 understated

Depreciation expense $200 understated

An insurance policy of $4,500 was prepaid in 2022 covering the calendar years 2022, 2023, and 2024 but had been debited to insurance expense. On December 31, 2023, fully depreciated equipment was sold for $2,500 cash, but the sale was NOT recorded until 2024. There were no other errors during this period and no corrections have been made.

Instructions

a) Calculate the net effect of the errors on TokTik’s 2023 net income.

b) Calculate the total effect of the errors on the balance of TokTik’s retained earnings at December 31, 2023.

c) Calculate the net effect of the errors on TokTik’s working capital at December 31, 2023.

*Solution 21-61

a) $1,800 understated + $2,100 understated – $1,500* overstated + $2,500 understated = $4,900 understated

b) $2,100 understated + $1,500* understated + $2,500 understated – $200 overstated = $5,900 understated

c) $2,100 understated + $1,500* understated + $2,500 Understated = $6,100 understated

*$4,500 ÷ 3 = $1,500

Difficulty: Medium

Learning Objective: Correct the effects of errors and prepare restated financial statements.

Section Reference: Appendix 21A: Error Analysis

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

*Ex. 21-62 Non-counterbalancing error correction

Turkey Corp. bought a machine on January 3, 2021 for $275,000. It had a $15,000 estimated residual value and a ten-year life. The corporation uses straight-line depreciation. An expense account was debited in error on the purchase date, but this was NOT discovered until late 2023.

Instructions

Prepare the correcting entry or entries related to the machine for 2023. Ignore income tax effects.

*Solution 21-62

Annual depreciation is ($275,000 – $15,000) ÷ 10 = $26,000

Machinery 275,000

Retained Earnings 223,000

Accumulated Depreciation—Machinery (2 × $26,000) 52,000

Depreciation Expense 26,000

Accumulated Depreciation—Machinery 26,000

Difficulty: Medium

Learning Objective: Correct the effects of errors and prepare restated financial statements.

Section Reference: Appendix 21A: Error Analysis

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

PROBLEMS

Pr. 21-63 Correction of errors in prior years

Goldfinch Inc. reported net incomes for the last three years as follows:

2021, $62,000; 2022, $63,000; 2023, $60,000

In reviewing the accounts in 2024 (after the books for the prior year had been closed), you find that the following errors have been made:

2021 2022 2023

Overstatement of ending inventory $7,000 $8,500 $4,000

Understatement of accrued advertising expense 1,100 2,000 1,200

Instructions

a) Calculate corrected net incomes for 2021, 2022, and 2023.

b) Prepare the entry required in 2024 to correct the books. Ignore income taxes.
Show any calculations.

Solution 21-63

a) 2021 2022 2023

Net income (unadjusted) $62,000 $63,000 $60,000

Overstatement of ending inventory—2021 (7,000) 7,000

Overstatement of ending inventory—2022 (8,500) 8,500

Overstatement of ending inventory—2023 (4,000)

Understatement of accrued advertising expense—2021 (1,100) 1,100

Understatement of accrued advertising expense—2022 (2,000) 2,000

Understatement of accrued advertising expense—2023 _________ _________ (1,200)

Net income (corrected) $53,900 $60,600 $65,300

b) Retained Earnings 5,200

Advertising Expense 1,200

Inventory 4,000

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Analysis

AACSB: Analytic

Pr. 21-64 Accounting for accounting changes and error corrections

Parrot Corp. reported net incomes for the last three years as follows:

2023 2022 2021

$240,000 $225,000 $180,000

During the 2023 year-end audit, the following items come to your attention:

1. Parrot bought a truck on January 1, 2020 for $98,000 cash, with an $8,000 estimated residual value and a six-year life. The company debited an expense account for the entire cost of the asset. Parrot uses straight-line depreciation for all trucks.

2. During 2023, Parrot changed from straight-line depreciation for its cement plant to double declining balance. The following calculations present depreciation on both bases:

2023 2022 2021

Straight-line $18,000 $18,000 $18,000

Double declining balance 23,100 30,000 36,000

The net income for 2023 was calculated using the double declining balance method.

3. In reviewing its provision for uncollectible accounts during 2023, the corporation has determined that 1% is the appropriate amount of bad debt expense to be charged to operations. The company had used 1/2 of 1% as its rate in 2022 and 2021 when the expense had been $9,000 and $6,000, respectively. Parrot recorded bad debt expense using the new rate for 2023. If they had used the old rate, they would have recorded $3,000 less bad debt expense on December 31, 2023.

Instructions (Ignore all income tax effects)

a) Prepare the general journal entry required to correct the books for the item 1 situation (only) of this problem, assuming that the books have not been closed for 2023.

b) Present comparative income statement data for the years 2021 to 2023, starting with income before the cumulative effect of any accounting changes.

c) Assume that the beginning retained earnings balance (unadjusted) for 2021 was $630,000. At what adjusted amount should the beginning retained earnings balance for 2021 be shown, assuming that comparative financial statements were prepared?

d) Assume that the beginning retained earnings balance (unadjusted) for 2023 is $900,000 and that comparative financial statements are not prepared. At what adjusted amount should this beginning retained earnings balance be shown?

Solution 21-64

Annual depreciation would be ($98,000 – $8,000) ÷ 6 = $15,000

a) Vehicles 98,000

Depreciation Expense (2023 only) 15,000

Accumulated Depreciation—Vehicles (4 years, 2020–2023) 60,000

Retained Earnings 53,000

b) 2023 2022 2021

Income before cumulative effect of

of error correction $240,000 $225,000 $180,000

Depreciation of truck (15,000) (15,000) (15,000)

$225,000 $210,000 $165,000

Note items 2 and 3 are considered changes in estimates, and are accounted for prospectively.

c) Retained earnings (unadjusted) $630,000

Correction of 2020 error ($98,000 – $15,000) 83,000

Retained earnings (adjusted) $713,000

d) Retained earnings (unadjusted) $900,000

Correction of error ($98,000 – $45,000) 53,000

Retained earnings (adjusted) $953,000

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Analysis

AACSB: Analytic

Pr.21-65 Changes in estimates

Green Home Automation (GHA) Inc. is a publicly traded company that designs and manufactures environmentally-friendly windows. The high-tech windows have the ability to both cool homes in the summer and warm them in the winter. The company owns the following assets:

1. Manufacturing equipment that was purchased for $495,000 on August 1, 2019. The equipment was estimated to have a useful life of 10 years with no residual value.

2. A patent for the heating / cooling technology that was purchased for $315,000 on August 1, 2019. The patent is estimated to have a remaining legal life of 12 years with no residual value.

GHA has a fiscal year end of July 31 and uses straight-line depreciation. On August 1, 2022, GHA determines that the equipment actually only has a 7-year useful life from the acquisition date, but with a residual value of $25,000. In addition, the economic benefits of the patent were determined to only last 6 years from the acquisition date.

Instructions

a) Calculate the depreciation expense for each asset for 2023.

b) Calculate the balance in the accumulated depreciation account for each asset on July 31, 2023.

c) Calculate the net amount to be reported in the 2023 of financial position for each of these assets at July 31, 2023.

Solution 21-65

Manufacturing Equipment:

Accumulated depreciation to July 31/22: $495,000 ÷ 10 × 3 = $148,500
a) 2022 depreciation expense: ($495,000 – $148,500 – $25,000) ÷ 4 = $80,375
b) Accumulated depreciation at July 31/23: $148,500 + $80,375 = $228,875

c) Equipment net value at July 31/23: $495,000 – $228,875 = $266,125

Patent:

Accumulated amortization to July 31/22: $315,000 ÷ 12 × 3 = $78,750
a) 2022 amortization expense: [($315,000 – $78,750) ÷ 3] = $78,750

b) Accumulated amortization – patents: $78,750 + $78,750 = $157,500
c) Patent net book value at July 31/23: $315,000 – $157,500 = $157,500

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Pr. 21-66 Accounting policies under IFRS and ASPE

Explain how management should apply accounting policies under IFRS and ASPE when there is no specific IFRS or primary source of GAAP to refer.

Solution 21-66

Under IFRS, accounting policies applied are determined by applying the IFRS. If there is no specific IFRS that applies, management applies judgement in determining a policy that is relevant to the needs of users and is reliable. Judgement considers first the requirements of IFRS in similar situations, and then the definitions, recognition criteria, and elements in the Framework for the Preparation and Presentation of Financial Statements.

Under ASPE, if not dealt with in a primary source or if additional guidance is needed, management uses policies consistent with the primary sources, and that are developed using professional judgement and the concepts in Section 1000.

Difficulty: Easy

Learning Objective: Identify differences in accounting between IFRS and APSE.

Section Reference: IFRS/ASPE Comparison

CPA: Communication

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Communication

*Pr. 21-67 Error corrections and adjustments

The controller for Stork Corp. is concerned about certain business transactions that the company experienced during 2023. The controller, after discussing these matters with various individuals, has come to you as the CFO for advice. Stork follows ASPE. The transactions at issue are presented below:

1. The company has decided to switch from the direct write-off method for accounting for bad debts to the percentage-of-sales approach. Assume that Stork has recognized bad debt expense as the receivables have actually become uncollectible in the following way:

2022 2023

From 2022 sales 10,600 4,000

From 2023 sales 15,000

The controller estimates that an additional $21,800 in bad debts will be written off in 2024: $3,800 applicable to 2022 sales and $18,000 to 2023 sales.

2. Inventory has been shipped on consignment. These transactions have been recorded as ordinary sales and billed as such (on account). At December 31, 2023, inventory billed and in the hands of consignees amounted to $160,000. The percentage markup on selling price is 20%. Assume that the consigned inventory is sold the following year. The company uses the perpetual inventory system.

3. During 2023, Stork sold $300,000 worth of goods on the instalment basis. The cost of sales associated with these instalment sales is $225,000. The company inadvertently handled these sales and related costs as part of their regular sales transactions. Cash of $86,000, including a down payment of $30,000, was collected on these instalment sales during 2023. Due to questionable collectability, the instalment method was considered appropriate.

Instructions

a) Assume that Stork Corp. reported pre-tax income of $500,000 for 2023. Present a schedule showing the corrected pre-tax income after the above transactions are taken into account. Ignore income tax effects.

b) Prepare the correcting journal entries required at December 31, 2023, assuming that the books have been closed.

c) CRITICAL THINKING: The CEO of Stork Corp. is reviewing the controller’s work. She is unclear why the reported pre-tax income is now lower than it was prior to these adjustments. She asks you why this occurred and for of a comprehensive explanation regard how and when accounting changes are made. Provide her with this information.

*Solution 21-67

a) Reported net income $500,000

1. Additional charge for bad debts

2022 debts written off in 2023 (add back) $ 4,000

2023 debts to be written off in 2024 (deduct) (18,000) (14,000)

2. Consignment (20% × $160,000) (32,000)

3. Gross profit—Recognized 75,000

Should be 25% × $86,000 (21,500) (53,500)

Corrected income $400,500

b) 1. Retained Earnings 21,800

Allowance for Doubtful Accounts 21,800

2. Consignment Inventory 128,000

Retained Earnings 32,000

Accounts Receivable 160,000

3. Retained Earnings 53,500

Deferred Gross Profit 53,500

c) CRITICAL THINKING: In this case Stork made an adjustment to its accounting policies and there was a change in estimates. Accounting changes may result for any of the following reasons:

1. A change in accounting policy. Changes in the choice of “specific principles, bases, conventions, rules, and practices applied by an entity in preparing and presenting financial statements” are all changes in accounting policies. The initial adoption of a new accounting standard and a change from a weighted average cost flow formula to one based on FIFO (as long as this results in reliable and more relevant information) are both examples of a change in policy.

2. A change in accounting estimate. A change in an accounting estimate is an adjustment to the carrying amount of an asset or a liability or the amount of an asset’s periodic consumption, and results from an assessment of the present status of or the expected future benefits and obligations associated with an asset or liability. Examples include a change in the estimate of the service life of an asset that is subject to depreciation, and a change in the estimate of the net realizable value of accounts receivable.

3. Correction of a prior period error. Prior period errors are omissions from or mistakes in the financial statements of one or more prior periods that are caused by the misuse of, or failure to use, reliable information that existed when those financial statements were completed and could reasonably have been found and used in their preparation and presentation. An example is the failure to recognize depreciation on a group of capital assets that were used in operations for a specific prior period.

Difficulty: Medium

Learning Objective: Identify and differentiate among the types of accounting changes and explain how to account for them.

Section Reference: Changes in Accounting Policies and Estimates, and Errors

Learning Objective: Correct the effects of errors and prepare restated financial statements.

Section Reference: Appendix 21A: Error Analysis

CPA: Financial Reporting

Bloomcode: Analysis

AACSB: Analytic

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Aug 21, 2025

Chapter Name:

Chapter 21 Accounting Changes and Error Analysis

Author:

Donald E. Kieso

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Test Bank Chapter 21 Accounting Changes and Error Analysis

ACCOUNTING CHANGES AND ERROR ANALYSIS

CHAPTER STUDY OBJECTIVES

Solution 21-53

Solution 21-54

Solution 21-55

Solution 21-56

Solution 21-58

Solution 21-59

Solution 21-60

*Solution 21-61

*Solution 21-62

Solution 21-63

Solution 21-64

Solution 21-65

Solution 21-66

*Solution 21-67

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