1. 4-1
4. Explain the reporting of accounting changes and errors.
5. Describe related equity statements.
After studying this chapter, you should be able to:
Accounting Policies, Changes in
Accounting Estimates and Errors
CHAPTER 2
LEARNING OBJECTIVES
2. 4-2
Retrospective adjustment.
Cumulative effect adjustment to beginning retained earnings.
Approach preserves comparability across years.
Examples include:
► Change from FIFO to average-cost.
► Change from the percentage-of-completion to the
completed-contract method.
Accounting Changes
and Errors
Changes in Accounting Principle
LO 4
LEARNING OBJECTIVE 1
Explain the reporting of
accounting changes and errors.
3. 4-3
Change in Accounting Principle: Gaubert Inc. decided in March
2019 to change from FIFO to weighted-average inventory pricing.
Gaubert’s income before taxes, using the new weighted-average
method in 2019, is $30,000.
ILLUSTRATION 4.17
Calculation of a Change in
Accounting Principle
ILLUSTRATION 4.18
Income Statement
Presentation of a Change
in Accounting Principle
(Based on 30% tax rate)
Pretax Income Data
Changes in Accounting Principle
LO 4
4. 4-4
Accounted for in the period of change or the period of
and the future periods if the change affects both.
Not handled retrospectively.
Not considered errors.
Examples include:
► Useful lives and residual values of depreciable assets.
► Uncollectible receivables.
► Inventory obsolescence.
Change in Accounting Estimates
Accounting Changes
LO 4
5. 4-5
Change in Estimate: Arcadia HS, purchased equipment for
$510,000 which was estimated to have a useful life of 10 years
with a residual value of $10,000 at the end of that time.
Depreciation has been recorded for 7 years on a straight-line
basis. In 2019 (year 8), it is determined that the total estimated
life should be 15 years with a residual value of $5,000 at the
end of that time.
Questions:
Does prior years’ depreciation need to be restated?
Calculate the depreciation expense for 2019.
Change in Accounting Estimates
LO 4
6. 4-6
Equipment cost $510,000
Residual value - 10,000
Depreciable base 500,000
Useful life (original) 10 years
Annual depreciation $ 50,000
Equipment $510,000
Fixed Assets:
Accumulated depreciation 350,000
Net book value (NBV) $160,000
Balance Sheet (Dec. 31, 2018)
After
7 years
x 7 years = $350,000
First, establish NBV
at date of change in
estimate.
Change in Accounting Estimates
LO 4
7. 4-7
Net book value $160,000
Residual value (new) 5,000
Depreciable base 155,000
Useful life remaining 8 years
Annual depreciation $ 19,375
Depreciation
Expense calculation
for 2019.
Depreciation Expense 19,375
Accumulated Depreciation 19,375
Journal entry for 2019
After
7 years
Change in Accounting Estimates
LO 4
8. 4-8
Result from:
► mathematical mistakes.
► mistakes in application of accounting principles.
► oversight or misuse of facts.
Corrections treated as prior period adjustments.
Adjustment to the beginning balance of retained
earnings.
Corrections of Errors
Accounting Errors
LO 4
9. 4-9
Illustration: In 2019, Tsang Ltd. determined that it incorrectly
overstated its accounts receivable and sales revenue by
NT$100,000 in 2018. In 2019, Tsang makes the following entry
to correct for this error (ignore income taxes).
Retained Earnings 100,000
Accounts Receivable 100,000
Corrections of Errors
LO 4
10. 4-10
Type of
Situation
Changes in Accounting Principle
Criteria Change from one generally accepted accounting
principle to another.
Examples Change in the basis of inventory pricing from FIFO to
average-cost.
Placement on
Income
Statement
Recast prior years’ income statements on the same
basis as the newly adopted principle.
ILLUSTRATION 4.19
Summary of Accounting
Changes and Errors
LO 4
Accounting Errors
Summary
11. 4-11
Type of
Situation
Changes in Accounting Estimate
Criteria Normal, recurring corrections and adjustments.
Examples Changes in the realizability of receivables and
inventories; changes in estimated lives of equipment,
intangible assets; changes in estimated liability for
warranty costs, income taxes, and salary payments.
Placement on
Income
Statement
Show change only in the affected accounts (not shown
net of tax) and disclose the nature of the change.
ILLUSTRATION 4.19
Summary of Accounting
Changes and Errors
LO 4
Accounting Errors
Summary
12. 4-12
Type of
Situation
Corrections of Errors
Criteria Mistake, misuse of facts.
Examples Error in reporting income and expense.
Placement on
Income
Statement
Restate prior years’ income statements to correct for
error.
ILLUSTRATION 4.19
Summary of Accounting
Changes and Errors
LO 4
Summary
Accounting Errors
13. 4-13
Increase
Net income
Change in accounting
principle
Prior period
adjustments
Decrease
Net loss
Dividends
Change in accounting
principles
Prior period
adjustments
Retained Earnings Statement
Related Equity
Statements
LO 5
LEARNING OBJECTIVE 2
Describe related equity
statements.
14. 4-14
Balance, January 1 ₩1,050,000
Net income 360,000
Dividends (300,000)
Balance, December 31 ₩1,110,000
CHOI LTD.
Statement of Retained Earnings
For the Year Ended December 31, 2019
Before issuing the report for the year ended December 31, 2019, you
discover a ₩50,000 error (net of tax) that caused 2018 inventory to
be overstated (overstated inventory caused COGS to be lower and
thus net income to be higher in 2018). Would this discovery have
any impact on the reporting of the Statement of Retained Earnings for
2019?
Retained Earnings Statement
LO 5
15. 4-15
Balance, January 1 ₩1,050,000
Prior period adjustment - error correction (50,000)
Balance, January 1 (restated) 1,000,000
Net income 360,000
Dividends (300,000)
Balance, December 31 ₩1,060,000
CHOI LTD.
Statement of Retained Earnings
For the Year Ended December 31, 2019
Retained Earnings Statement
LO 5
16. 4-16
Restrictions on Retained Earnings
Disclosed
In notes to the financial statements.
As Appropriated Retained Earnings.
Retained Earnings Statement
LO 5
17. 4-17
All changes in equity during a period except those resulting
from investments by owners and distributions to owners.
Includes:
all revenues and gains, expenses and losses reported in
net income, and
all gains and losses that bypass net income but affect
equity.
Comprehensive Income
LO 5
Related Equity Statements
18. 4-18
Income Statement (in thousands)
Sales 285,000
$
Cost of goods sold 149,000
Gross profit 136,000
Operating expenses:
Selling expenses 10,000
Administrative expenses 43,000
Total operating expense 53,000
Income from operations 83,000
Other revenue (expense):
Interest revenue 17,000
Interest expense (21,000)
Total other (4,000)
Income before taxes 79,000
Income tax expense 24,000
Net income 55,000
$
Other Comprehensive
Income
Unrealized gains and
losses on non-trading
equity securities.
Translation gains and
losses on foreign
currency.
Plus others
+
Reported in Equity
Net Income
Comprehensive Income
LO 5
19. 4-19
Companies must display the components of other
comprehensive income in one of two ways:
1. A single continuous statement (one statement
approach) or
2. two separate, but consecutive statements of net income
and other comprehensive income (two statement
approach).
Comprehensive Income
LO 5
20. 4-20
One Statement Approach
Comprehensive Income
Advantage –
does not require
the creation of a
new financial
statement.
Disadvantage -
net income buried
as a subtotal on
the statement.
ILLUSTRATION 4.21
One Statement Format:
Comprehensive Income
LO 5
22. 4-22
Statement of Changes in Equity
Required, in addition to a statement of comprehensive
income.
Generally comprised of
► Share capital—ordinary,
► Share premium—ordinary,
► Retained earnings, and the
► Accumulated balances in other comprehensive
income.
LO 5
Related Equity Statements
23. 4-23
Reports the change in each equity account and in total
equity for the period. Includes the following:
1. Accumulated comprehensive income for the period.
2. Contributions (issuances of shares) and distributions
(dividends) to owners.
3. Reconciliation of the carrying amount of each component
of equity from the beginning to the end of the period.
Statement of Changes in Equity
LO 5
25. 4-25
Regardless of the display format used, V. Gill reports the
accumulated other comprehensive income of €90,000 in the
equity section of the statement of financial position as follows.
Statement of Changes in Equity
ILLUSTRATION 4.24
Presentation of Accumulated Other Comprehensive Income in the Statement of Financial Position LO 5
26. 4-26
About The Numbers
The terminology used in the IFRS literature is sometimes different than what is
used in U.S. GAAP. For example, here are some of the differences.
GLOBAL ACCOUNTING INSIGHTS
LO 6
