22-1 prepared by coby harmon university of california, santa barbara intermediate accounting
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22-1
Prepared by Coby Harmon
University of California, Santa Barbara
Intermediate Accounting
22-2
Intermediate Accounting
14th Edition
22Accounting Changes and Error Analysis
Kieso, Weygandt, and Warfield
22-3
1. Identify the two types of accounting changes.
2. Describe the accounting for changes in accounting policies.
3. Understand how to account for retrospective accounting changes.
4. Understand how to account for impracticable changes.
5. Describe the accounting for changes in estimates.
6. Describe the accounting for correction of errors.
7. Identify economic motives for changing accounting policies.
8. Analyze the effect of errors.
Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives
22-4
Changes in accounting
policy
Changes in accounting
estimate
Change in reporting entity
Correction of errors
Summary
Motivations for change of
method
Accounting Changes Error Analysis
Balance sheet errors
Income statement errors
Balance sheet and income
statement effects
Comprehensive example
Preparation of statements
with error corrections
Accounting Changes and Error AnalysisAccounting Changes and Error AnalysisAccounting Changes and Error AnalysisAccounting Changes and Error Analysis
22-5
Types of Accounting Changes:
1. Change in Accounting Policy.
2. Changes in Accounting Estimate.
3. Change in Reporting Entity.
Errors are not considered an accounting change.
LO 1 Identify the two types of accounting changes.
Accounting Alternatives:
Diminish the comparability of financial information.
Obscure useful historical trend data.
Accounting ChangesAccounting ChangesAccounting ChangesAccounting Changes
22-6
Average cost to LIFO.
Completed-contract to percentage-of-completion.
Change from one accepted accounting policy to another.
Examples include:
Changes in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting Principle
LO 2 Describe the accounting for changes in accounting policies.
Adoption of a new policy in recognition of events that have occurred for
the first time or that were previously immaterial is not an accounting
change.
22-7
Three approaches for reporting changes:
1) Currently.
2) Retrospectively.
3) Prospectively (in the future).
FASB requires use of the retrospective approach.
Rationale - Users can then better compare results from one period to
the next.
LO 2 Describe the accounting for changes in accounting policies.
Changes in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting Principle
22-8
Retrospective Accounting Change Approach
LO 3 Understand how to account for retrospective accounting changes.
Company reporting the change
1) Adjusts its financial statements for each prior period
presented to the same basis as the new accounting
principle.
2) Adjusts the carrying amounts of assets and liabilities as
of the beginning of the first year presented, plus the
opening balance of retained earnings.
Changes in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting Principle
22-9
Illustration: Denson Company has accounted for its income from
long-term construction contracts using the completed-contract
method. In 2012, the company changed to the percentage-of-
completion method. Management believes this approach provides
a more appropriate measure of the income earned. For tax
purposes, the company uses the completed-contract method and
plans to continue doing so in the future. (Assume a 40 percent
enacted tax rate.)
LO 3 Understand how to account for retrospective accounting changes.
Retrospective Accounting Change: Long-Term Contracts
Changes in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting Principle
22-10
Illustration 22-1
LO 3 Understand how to account for retrospective accounting changes.
Changes in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting Principle
22-11
Data for Retrospective ChangeIllustration 22-2
Construction in Process 220,000
Deferred Tax Liability
88,000
Retained Earnings
132,000LO 3 Understand how to account for retrospective accounting changes.
Journal entry beginning of
2012
Changes in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting Principle
22-12
Reporting a Change in Principle
LO 3 Understand how to account for retrospective accounting changes.
Major disclosure requirements are as follows.
1. Nature of the change in accounting policy;
2. The method of applying the change, and:
a. A description of the prior period information that has been
retrospectively adjusted, if any.
b. The effect of the change on income from continuing operations,
net income (or other appropriate captions of changes in net assets
or performance indicators), any other affected line item.
c. The cumulative effect of the change on retained earnings or other
components of equity or net assets in the balance sheet as of the
beginning of the earliest period presented.
Changes in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting Principle
22-13 LO 3
Illustration 22-3Reporting a Change in policy
Changes in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting Principle
22-14
Retained Earnings Adjustment
LO 3 Understand how to account for retrospective accounting changes.
Illustration 22-4
Retained earnings balance is $1,360,000 at the beginning of 2010.
Before Change
Changes in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting Principle
22-15 LO 3 Understand how to account for retrospective accounting changes.
Illustration 22-5 After Change
Retained Earnings Adjustment
Changes in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting Principle
22-16
E22-1 (Change in Principle—Long-Term Contracts): Cherokee
Construction Company changed from the completed-contract to the
percentage-of-completion method of accounting for long-term
construction contracts during 2012. For tax purposes, the
company employs the completed-contract method and will continue
this approach in the future. (Hint: Adjust all tax consequences
through the Deferred Tax Liability account.)
LO 3 Understand how to account for retrospective accounting changes.
Changes in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting Principle
22-17
E22-1 (Change in policy—Long-Term Contracts):
LO 3 Understand how to account for retrospective accounting changes.
Instructions: (assume a tax rate of 35%)
(b) What entry(ies) are necessary to adjust the accounting records for
the change in accounting principle?
(a) What is the amount of net income and retained earnings that would
be reported in 2012? Assume beginning retained earnings for 2011 to
be $100,000.
Changes in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting Principle
22-18
Journal entry
2012 Construction in progress 170,000
Deferred tax liability 59,500
Retained earnings 110,500
LO 3 Understand how to account for retrospective accounting changes.
35%Percentage- Completed- Tax Net of
Date of-Completion Contract Difference Effect Tax
2011 780,000$ 610,000$ 170,000 59,500 110,500$
2012 700,000 480,000 220,000 77,000 143,000
Changes in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting Principle
E22-1: Pre-Tax Income from Long-Term Contracts
22-19
Restated Previous2012 2011 2011
Pre-tax income 700,000$ 780,000$ 610,000$
Income tax (35%) 245,000 273,000 213,500
Net income 455,000$ 507,000$ 396,500$
Beg. Retained earnings 496,500$ 100,000$ 100,000$
Accounting change 110,500
Beg. R/Es restated 607,000$ 100,000 100,000
Net income 455,000 507,000 396,500
End. Retained earnings 1,062,000$ 607,000$ 496,500$
LO 3 Understand how to account for retrospective accounting changes.
Income Statement
Statement of Retained
Earnings
Changes in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting Principle
E22-1: Comparative Statements
22-20 LO 3 Understand how to account for retrospective accounting changes.
Direct Effects - FASB takes the position that
companies should retrospectively apply the direct
effects of a change in accounting principle.
Indirect Effect is any change to current or future cash
flows of a company that result from making a change in
accounting principle that is applied retrospectively.
Direct and Indirect Effects of Changes
Changes in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting Principle
22-21
Impracticability
LO 4 Understand how to account for impracticable changes.
Companies should not use retrospective application if one of the
following conditions exists:
1. Company cannot determine the effects of the retrospective
application.
2. Retrospective application requires assumptions about
management’s intent in a prior period.
3. Retrospective application requires significant estimates that
the company cannot develop.
Changes in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting PrincipleChanges in Accounting Principle
If any of the above conditions exists, the company prospectively applies the new accounting principle.
22-22
Changes in Accounting EstimateChanges in Accounting EstimateChanges in Accounting EstimateChanges in Accounting Estimate
LO 5 Describe the accounting for changes in estimates.
Examples of Estimates
1. Uncollectible receivables.
2. Inventory obsolescence.
3. Useful lives and salvage values of assets.
4. Periods benefited by deferred costs.
5. Liabilities for warranty costs and income taxes.
6. Recoverable mineral reserves.
7. Change in depreciation methods.
22-23
Changes in Accounting EstimateChanges in Accounting EstimateChanges in Accounting EstimateChanges in Accounting Estimate
LO 5 Describe the accounting for changes in estimates.
Prospective Reporting
Changes in accounting estimates are reported prospectively.
Account for changes in estimates in
1. the period of change if the change affects that period only,
or
2. the period of change and future periods if the change
affects both.
FASB views changes in estimates as normal recurring corrections
and adjustments and prohibits retrospective treatment.
22-24
Illustration: Arcadia High School purchased equipment for
$510,000 which was estimated to have a useful life of 10 years
with a salvage value of $10,000 at the end of that time.
Depreciation has been recorded for 7 years on a straight-line
basis. In 2012 (year 8), it is determined that the total estimated life
should be 15 years with a salvage value of $5,000 at the end of
that time.
Required:
What is the journal entry to correct
prior years’ depreciation expense?
Calculate depreciation expense for 2012.
No Entry No Entry RequiredRequired
Change in Estimate ExampleChange in Estimate ExampleChange in Estimate ExampleChange in Estimate Example
LO 5 Describe the accounting for changes in estimates.
22-25
Equipment $510,000
Fixed Assets:
Accumulated depreciation 350,000
Net book value (NBV) $160,000
Balance Sheet (Dec. 31, 2011)
Change in Estimate ExampleChange in Estimate ExampleChange in Estimate ExampleChange in Estimate Example After 7 years
Equipment cost $510,000
Salvage value - 10,000
Depreciable base 500,000
Useful life (original) 10 years
Annual depreciation $ 50,000 x 7 years = $350,000
First, establish NBV at date of change in
estimate.
First, establish NBV at date of change in
estimate.
LO 5 Describe the accounting for changes in estimates.
22-26
Net book value $160,000
Salvage value (if any) 5,000
Depreciable base 155,000
Useful life 8 years
Annual depreciation $ 19,375
Change in Estimate ExampleChange in Estimate ExampleChange in Estimate ExampleChange in Estimate Example
Second, calculate Second, calculate depreciation expense depreciation expense
for 2012.for 2012.
Second, calculate Second, calculate depreciation expense depreciation expense
for 2012.for 2012.
Depreciation expense 19,375
Accumulated depreciation 19,375
Journal entry for 2012
LO 5 Describe the accounting for changes in estimates.
22-27
Changes in Accounting EstimateChanges in Accounting EstimateChanges in Accounting EstimateChanges in Accounting Estimate
LO 5 Describe the accounting for changes in estimates.
Disclosures
Companies need not disclose changes in accounting estimate
made as part of normal operations, such as bad debt allowances
or inventory obsolescence, unless such changes are material.
However, for a change in estimate that affects several periods
(such as a change in the service lives of depreciable assets),
companies should disclose the effect on income from continuing
operations and related per-share amounts of the current period.
22-28
Change in Reporting EntityChange in Reporting EntityChange in Reporting EntityChange in Reporting Entity
LO 6 Identify changes in a reporting entity.
Examples of a change in reporting entity are:
1. Presenting consolidated statements in place of statements of individual companies.
2. Changing specific subsidiaries that constitute the group of companies for which the entity presents consolidated financial statements.
3. Changing the companies included in combined financial statements.
4. Changing the cost, equity, or consolidation method of accounting for subsidiaries and investments.
Reported by changing the financial statements of all prior periods presented.
22-29
Correction of ErrorsCorrection of ErrorsCorrection of ErrorsCorrection of Errors
LO 7 Describe the accounting for correction of errors.
Types of Accounting Errors:
1. A change from an accounting principle that is not generally
accepted to an accounting policy that is acceptable.
2. Mathematical mistakes.
3. Changes in estimates that occur because a company did not
prepare the estimates in good faith.
4. Failure to accrue or defer certain expenses or revenues.
5. Misuse of facts.
6. Incorrect classification of a cost as an expense instead of an
asset, and vice versa.
22-30
Correction of ErrorsCorrection of ErrorsCorrection of ErrorsCorrection of Errors
All material errors must be corrected.
Record corrections of errors from prior periods as an
adjustment to the beginning balance of retained earnings
in the current period.
Such corrections are called prior period adjustments.
For comparative statements, a company should restate
the prior statements affected, to correct for the error.
LO 7 Describe the accounting for correction of errors.
22-31
Correction of ErrorsCorrection of ErrorsCorrection of ErrorsCorrection of Errors
Illustration: In 2013 the bookkeeper for Selectro Company
discovered an error:
In 2012 the company failed to record $20,000of depreciation
expense on a newly constructed building. This building is the only
depreciable asset Selectro owns. The company correctly
included the depreciation expense in its tax return and correctly
reported its income taxes payable.
LO 7 Describe the accounting for correction of errors.
22-32
Correction of ErrorsCorrection of ErrorsCorrection of ErrorsCorrection of Errors
Illustration: Selectro’s income statement for 2012 with and
without the error.Illustration 22-19
Show the entries that Selectro should have made and did make for
recording depreciation expense and income taxes.
LO 7 Describe the accounting for correction of errors.
22-33
Correction of ErrorsCorrection of ErrorsCorrection of ErrorsCorrection of Errors
Illustration: Show the entries that Selectro should have made and
did make for recording depreciation expense and income taxes.
Illustration 22-18
Correcting Entry in
2013
LO 7 Describe the accounting for correction of errors.
22-34
Correction of ErrorsCorrection of ErrorsCorrection of ErrorsCorrection of Errors
Illustration: Show the entries that Selectro should have made and
did make for recording depreciation expense and income taxes.
Retained Earnings 12,000Correcting Entry in
2013
LO 7 Describe the accounting for correction of errors.
Illustration 22-18
22-35
Correction of ErrorsCorrection of ErrorsCorrection of ErrorsCorrection of Errors
Illustration: Show the entries that Selectro should have made and
did make for recording depreciation expense and income taxes.
Retained Earnings 12,000
Deferred Tax Liability 8,000
Correcting Entry in
2013
ReversalReversal
LO 7 Describe the accounting for correction of errors.
Illustration 22-18
22-36
Correction of ErrorsCorrection of ErrorsCorrection of ErrorsCorrection of Errors
Illustration: Show the entries that Selectro should have made and
did make for recording depreciation expense and income taxes.
Retained Earnings 12,000
Deferred Tax Liability 8,000
Accumulated Depreciation—Buildings
20,000
Correcting Entry in
2013
RecordRecord
LO 7 Describe the accounting for correction of errors.
Illustration 22-18
22-37
Correction of ErrorsCorrection of ErrorsCorrection of ErrorsCorrection of Errors
Illustration (Single-Period Statement): Assume that Selectro
Company has a beginning retained earnings balance at January 1,
2013, of $350,000. The company reports net income of $400,000 in
2013.Illustration 22-21
LO 7 Describe the accounting for correction of errors.
22-38
Correction of ErrorsCorrection of ErrorsCorrection of ErrorsCorrection of Errors
Comparative Statements
Company should
1. make adjustments to correct the amounts for all affected
accounts reported in the statements for all periods
reported.
2. restate the data to the correct basis for each year
presented.
3. show any catch-up adjustment as a prior period
adjustment to retained earnings for the earliest period it
reported.
LO 7 Describe the accounting for correction of errors.
22-39
Woods, Inc.Statement of Retained Earnings
For the Year Ended December 31, 2012
Balance, January 1 1,050,000$ Net income 360,000 Dividends (300,000) Balance, December 31 1,110,000$
Before issuing the report for the year ended December 31, 2012, you discover
a $62,500 error that caused the 2011 inventory to be overstated (overstated
inventory caused COGS to be lower and thus net income to be higher in
2011). Would this discovery have any impact on the reporting of the
Statement of Retained Earnings for 2012? Assume a 20% tax rate.
Correction of ErrorsCorrection of ErrorsCorrection of ErrorsCorrection of Errors
LO 7 Describe the accounting for correction of errors.
22-40
Woods, Inc.Statement of Retained Earnings
For the Year Ended December 31, 2012
Balance, January 1, as previously reported 1,050,000$
Prior period adjustment, net of tax (50,000)
Balance, January 1, as restated 1,000,000
Net income 360,000
Dividends (300,000)
Balance, December 31 1,060,000$
Correction of ErrorsCorrection of ErrorsCorrection of ErrorsCorrection of Errors
LO 7 Describe the accounting for correction of errors.
22-41
Summary of Accounting Changes and ErrorsSummary of Accounting Changes and ErrorsSummary of Accounting Changes and ErrorsSummary of Accounting Changes and Errors
Illustration 22-23
LO 7
22-42
Summary of Accounting Changes and ErrorsSummary of Accounting Changes and ErrorsSummary of Accounting Changes and ErrorsSummary of Accounting Changes and Errors
Illustration 22-23
LO 7
22-43
Motivations for Change of Motivations for Change of Accounting MethodAccounting Method
Motivations for Change of Motivations for Change of Accounting MethodAccounting Method
LO 8 Identify economic motives for changing accounting policies.
Why companies may prefer certain accounting
methods. Some reasons are:
1. Political costs.
2. Capital Structure.
3. Bonus Payments.
4. Smooth Earnings.
22-44
Error AnalysisError AnalysisError AnalysisError Analysis
LO 9 Analyze the effect of errors.
Companies must answer three questions:
1. What type of error is involved?
2. What entries are needed to correct for the error?
3. After discovery of the error, how are financial statements to
be restated?
Companies treat errors as prior-period adjustments and report
them in the current year as adjustments to the beginning
balance of Retained Earnings.
22-45
Balance sheet errors affect only the presentation of an asset,
liability, or stockholders’ equity account.
Current year error - reclassify item to its proper position.
Prior year error - restate the balance sheet of the prior year
for comparative purposes.
Balance Sheet ErrorsBalance Sheet ErrorsBalance Sheet ErrorsBalance Sheet Errors
LO 9 Analyze the effect of errors.
22-46
Improper classification of revenues or expenses.
Current year error - reclassify item to its proper position.
Prior year error - restate the income statement of the prior
year for comparative purposes.
Income Statement ErrorsIncome Statement ErrorsIncome Statement ErrorsIncome Statement Errors
LO 9 Analyze the effect of errors.
22-47
Counterbalancing Errors
Will be offset or corrected over two periods.
If company has closed the books:
a. If the error is already counterbalanced, no entry is necessary.
b. If the error is not yet counterbalanced, make entry to adjust the present balance of retained earnings.
LO 9 Analyze the effect of errors.
For comparative purposes, restatement is necessary even if a correcting journal entry is not required.
Balance Sheet and Income Statement ErrorsBalance Sheet and Income Statement ErrorsBalance Sheet and Income Statement ErrorsBalance Sheet and Income Statement Errors
22-48
Will be offset or corrected over two periods.
If company has not closed the books:
a. If error already counterbalanced, make entry to correct the error in the current period and to adjust the beginning balance of Retained Earnings.
b. If error not yet counterbalanced, make entry to adjust the beginning balance of Retained Earnings.
LO 9 Analyze the effect of errors.
Balance Sheet and Income Statement ErrorsBalance Sheet and Income Statement ErrorsBalance Sheet and Income Statement ErrorsBalance Sheet and Income Statement Errors
Counterbalancing Errors
22-49
Non-Counterbalancing Errors
Not offset in the next accounting period.
Companies must make correcting entries, even if they have closed the books.
LO 9 Analyze the effect of errors.
Balance Sheet and Income Statement ErrorsBalance Sheet and Income Statement ErrorsBalance Sheet and Income Statement ErrorsBalance Sheet and Income Statement Errors
22-50
E22-19 (Error Analysis; Correcting Entries): A partial trial balance of
Dickinson Corporation is as follows on December 31, 2012.
Error Analysis ExampleError Analysis ExampleError Analysis ExampleError Analysis Example
Dr. Cr.
Supplies 2,500$
Salaries and wages payable 1,500$
Interest receivable 5,100
Prepaid insurance 90,000
Unearned rent 0
Interest payable 15,000
LO 9 Analyze the effect of errors.
Instructions: (a) Assuming that the books have not been closed, what are
the adjusting entries necessary at December 31, 2012?
22-51
Salaries and wages expense 2,900
Salaries and wages payable 2,900
Supplies expense 1,400
Supplies 1,400
Error Analysis ExampleError Analysis ExampleError Analysis ExampleError Analysis Example
LO 9 Analyze the effect of errors.
1. A physical count of supplies on hand on December 31, 2012, totaled
$1,100.
2. Accrued salaries and wages on December 31, 2012, amounted to
$4,400.
(a) Assuming that the books have not been closed, what are the
adjusting entries necessary at December 31, 2012?
22-52
Interest revenue 750
Interest receivable 750
Insurance expense 25,000
Prepaid insurance 25,000
Error Analysis ExampleError Analysis ExampleError Analysis ExampleError Analysis Example
LO 9 Analyze the effect of errors.
3. Accrued interest on investments amounts to $4,350 on December 31,
2012.
4. The unexpired portions of the insurance policies totaled $65,000 as of December 31, 2012.
(a) Assuming that the books have not been closed, what are the
adjusting entries necessary at December 31, 2012?
22-53
Depreciation expense 45,000
Accumulated depreciation 45,000
Rental income 12,000
Unearned rent 12,000
Error Analysis ExampleError Analysis ExampleError Analysis ExampleError Analysis Example
LO 9 Analyze the effect of errors.
5. $24,000 was received on January 1, 2012 for the rent of a building for
both 2012 and 2013. The entire amount was credited to rental income.
6. Depreciation for the year was erroneously recorded as $5,000 rather
than the correct figure of $50,000.
(a) Assuming that the books have not been closed, what are the
adjusting entries necessary at December 31, 2012?
22-54
E22-19 (Error Analysis; Correcting Entries) A partial trial balance of
Dickinson Corporation is as follows on December 31, 2012.
Error Analysis ExampleError Analysis ExampleError Analysis ExampleError Analysis Example
LO 9 Analyze the effect of errors.
Instructions: (b) Assuming that the books have been closed, what are
the adjusting entries necessary at December 31, 2012?
Dr. Cr.
Supplies 2,500$
Salaries and wages payable 1,500$
Interest receivable 5,100
Prepaid insurance 90,000
Unearned rent 0
Interest payable 15,000
22-55
Retained earnings 2,900
Salaries and wages payable 2,900
Retained earnings 1,400
Supplies 1,400
Error Analysis ExampleError Analysis ExampleError Analysis ExampleError Analysis Example
LO 9 Analyze the effect of errors.
(b) Assuming that the books have been closed, what are the adjusting
entries necessary at December 31, 2012?
1. A physical count of supplies on hand on December 31, 2012, totaled
$1,100.
2. Accrued salaries and wages on December 31, 2012, amounted to
$4,400.
22-56
Retained earnings 25,000
Prepaid insurance 25,000
Retained earnings 750
Interest receivable 750
Error Analysis ExampleError Analysis ExampleError Analysis ExampleError Analysis Example
LO 9 Analyze the effect of errors.
3. Accrued interest on investments amounts to $4,350 on December 31,
2012.
4. The unexpired portions of the insurance policies totaled $65,000 as
of December 31, 2012.
(b) Assuming that the books have been closed, what are the adjusting
entries necessary at December 31, 2012?
22-57
Retained earnings 45,000
Accumulated depreciation 45,000
Retained earnings 12,000
Unearned rent 12,000
Error Analysis ExampleError Analysis ExampleError Analysis ExampleError Analysis Example
LO 9 Analyze the effect of errors.
5. $24,000 was received on January 1, 2012 for the rent of a building for
both 2012 and 2013. The entire amount was credited to rental income.
6. Depreciation for the year was erroneously recorded as $5,000 rather
than the correct figure of $50,000.
(b) Assuming that the books have been closed, what are the adjusting
entries necessary at December 31, 2012?
22-58LO 10 Make the computations and prepare the entries necessary to
record a change from or to the equity method of accounting.
Change From The Equity Method
Change from the equity method to the fair-value method.
Earnings or losses previously recognized under the equity method
should remain as part of the carrying amount of the investment.
The cost basis is the carrying amount of the investment at the date
of the change.
The investor applies the new method in its entirety.
At the next reporting date, the investor should record the unrealized
holding gain or loss to recognize the difference between the
carrying amount and fair value.
APPENDIXAPPENDIX 22A CHANGING FROM OR TO THE EQUITY METHOD
22-59
Accounted for such dividends as a reduction of the
investment carrying amount, rather than as revenue.
Reason: Dividends in excess of earnings are viewed as a
________________ with this excess then accounted for as a
reduction of the equity investment.
liquidating dividend
APPENDIXAPPENDIX 22A CHANGING FROM OR TO THE EQUITY METHOD
LO 10 Make the computations and prepare the entries necessary to record a change from or to the equity method of accounting.
Dividends in Excess of Earnings
22-60
Illustration: On January 1, 2011, Investor Company purchased
250,000 shares of Investee Company’s 1,000,000 shares of outstanding
stock for $8,500,000. Investor correctly accounted for this investment
using the equity method. After accounting for dividends received and
investee net income, in 2011, Investor reported its investment in
Investee Company at $8,780,000 at December 31, 2011. On January 2,
2012, Investee Company sold 1,500,000 additional shares of its own
common stock to the public, thereby reducing Investor Company’s
ownership from 25 percent to 10 percent.
APPENDIXAPPENDIX 22A CHANGING FROM OR TO THE EQUITY METHOD
LO 10 Make the computations and prepare the entries necessary to record a change from or to the equity method of accounting.
Dividends in Excess of Earnings
22-61
Illustration 22A-1
APPENDIXAPPENDIX 22A CHANGING FROM OR TO THE EQUITY METHOD
LO 10 Make the computations and prepare the entries necessary to record a change from or to the equity method of accounting.
Dividends in Excess of Earnings
22-62
Illustration 22A-2Impact on Investment Carrying Amount
Cash 400,000Dividend Revenue
400,000
Cash 210,000Equity Investments (AFS)
60,000Dividend Revenue
150,000
2012 & 2013
2014
APPENDIXAPPENDIX 22A CHANGING FROM OR TO THE EQUITY METHOD
LO 10
22-63
Change To The Equity Method
Companies use retrospective application.
The carrying amount of the investment, results of current
and prior operations, and retained earnings of the investor
are adjusted as if the equity method has been in effect
during all of the previous periods.
Companies also eliminate any balances in the Unrealized
Holding Gain or Loss—Equity account and the Securities
Fair Value Adjustment account.
APPENDIXAPPENDIX 22A CHANGING FROM OR TO THE EQUITY METHOD
LO 10 Make the computations and prepare the entries necessary to record a change from or to the equity method of accounting.
22-64
RELEVANT FACTS
One area in which GAAP and IFRS differ is the reporting of error corrections in previously issued financial statements. While both sets of standards require restatement, GAAP is an absolute standard—that is, there is no exception to this rule.
The accounting for changes in estimates is similar between GAAP and IFRS.
Under GAAP and IFRS, if determining the effect of a change in accounting policy is considered impracticable, then a company should report the effect of the change in the period in which it believes it practicable to do so, which may be the current period.
22-65
RELEVANT FACTS
Under IFRS, the impracticality exception applies both to changes in accounting principles and to the correction of errors. Under GAAP, this exception applies only to changes in accounting principle.
IFRS (IAS 8) does not specifically address the accounting and reporting for indirect effects of changes in accounting principles. As indicated in the chapter, GAAP has detailed guidance on the accounting and reporting of indirect effects.
22-66
Which of the following is false?
a. GAAP and IFRS have the same absolute standard regarding
the reporting of error corrections in previously issued financial
statements.
b. The accounting for changes in estimates is similar between
GAAP and IFRS.
c. Under IFRS, the impracticality exception applies both to
changes in accounting principles and to the correction of errors.
d. GAAP has detailed guidance on the accounting and reporting of
indirect effects; IFRS does not.
IFRS SELF-TEST QUESTION
22-67
Which of the following is not classified as an accounting change by
IFRS?
a. Change in accounting policy.
b. Change in accounting estimate.
c. Errors in financial statements.
d. None of the above.
IFRS SELF-TEST QUESTION
22-68
IFRS requires companies to use which method for reporting changes
in accounting policies?
a. Cumulative effect approach.
b. Retrospective approach.
c. Prospective approach.
d. Averaging approach.
IFRS SELF-TEST QUESTION
22-69
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