Exercise 20-1A change in depreciation method is considered a change in accounting estimate

resulting from a change in accounting principle. In other words, a change in the depreciation method is similar to changing the economic useful life of a depreciable asset, and therefore the two events should be reported the same way. Accordingly, Bearing reports the change prospectively; previous financial statements are not revised. Instead, the company simply employs the straight-line method from then on. The undepreciated cost remaining at the time of the change would be depreciated straight-line over the remaining useful life.

Asset’s cost $105,000Accumulated depreciation to date (calculated below) (48,600 ) Undepreciated cost, Jan. 1, 2013 $ 56,400Estimated residual value (6,000 ) To be depreciated over remaining 7 years $ 50,400

7 yearsAnnual straight-line depreciation 2013-2019 $ 7,200

Calculation of SYD depreciation

(10+9+8) x [$105,000 – 6,000]) = $48,60055

Adjusting entry (2013 depreciation):

Depreciation expense (calculated above)............................................ 7,200Accumulated depreciation........................................................... 7,200

© The McGraw-Hill Companies, Inc., 2013Alternate Exercise and Problem Solutions 20-1

Chapter 20 Accounting Changes and Error Corrections

EXERCISES

Exercise 20-2Requirement 1

To record the change:Retained earnings ...................................................................................... 24,600

Inventory ($96,000 – 71,400)................................................ 24,600

Requirement 2 Emerson applies the average cost method retrospectively; that is, to all prior

periods as if it always had used that method. In other words, all financial statement amounts for individual periods that are included for comparison with the current financial statements are revised for period-specific effects of the change.

Then, the cumulative effects of the new method on periods prior to those presented are reflected in the reported balances of the assets and liabilities affected as of the beginning of the first period reported and a corresponding adjustment is made to the opening balance of retained earnings for that period. Let’s say Emerson reports 2013-2011 comparative statements of shareholders’ equity. The $24,600 adjustment above is due to differences prior to the 2013 change. The portion of that amount due to differences prior to 2011 is subtracted from the opening balance of retained earnings for 2011.

The effect of the change on each line item affected should be disclosed for each period reported as well as any adjustment for periods prior to those reported. Also, the nature of and justification for the change should be described in the disclosure notes.

© The McGraw-Hill Companies, Inc., 201320-2 Intermediate Accounting, 7e

Exercise 20-3Requirement 1

Accrued liability and expenseWarranty expense (4% x $720,000)......................................................... 28,800

Estimated warranty liability .............................................. 28,800

Actual expenditures (summary entry)Estimated warranty liability ................................................. 17,600

Cash, wages payable, parts and supplies, etc. ................... 17,600

Requirement 2

Actual expenditures (summary entry)Estimated warranty liability ($15,000 – 4,600)......................... 10,400Loss on product warranty (4% – 3%] x $500,000)..................... 5,000

Cash, wages payable, parts and supplies, etc. ................... 15,400* *(4% x $500,000) – $4,600 = $10,400

Problem 20-1a. This is a change in estimate.

No entry is needed to record the change

2013 adjusting entry:Warranty expense (3% x $800,000)........................................... 24,000

Estimated warranty liability .................................... 24,000

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PROBLEMS

A disclosure note should describe the effect of a change in estimate on income before extraordinary items, net income, and related per-share amounts for the current period.

b. This is a change in estimate.

No entry is needed to record the change

2013 adjusting entry:Depreciation expense (determined below) ..................... 180,000

Accumulated depreciation ...................................... 180,000

Calculation of annual depreciation after the estimate change:$4,000,000 Cost

$100,000 Old depreciation ($4,000,000 ÷ 40 years) x 3 yrs (300,000 ) Depreciation to date (2010-2012)

$ 3,700,000 Undepreciated cost (2,800,000 ) New estimated salvage value

$ 900,000 To be depreciated ÷ 5 Estimated remaining life (5 years: 2013-2017)$ 180,000 New annual depreciation

A disclosure note should describe the effect of a change in estimate on income before extraordinary items, net income, and related per-share amounts for the current period.

© The McGraw-Hill Companies, Inc., 201320-4 Intermediate Accounting, 7e

Problem 20-1 (continued)

c. This is a change in accounting principle that usually is reported prospectively.

No entry is needed to record the change.

When a company changes to the LIFO inventory method from another inventory method, accounting records usually are insufficient to determine the cumulative income effect of the change necessary to retrospectively revise accounts. So, a company changing to LIFO usually reports the beginning inventory in the year the LIFO method is adopted ($13 million in this case) as the base year inventory for all future LIFO calculations. The disclosure required is a footnote to the financial statements describing the nature of and justification for the change as well as an explanation as to why the retrospective application was impracticable.

© The McGraw-Hill Companies, Inc., 2013Alternate Exercise and Problem Solutions 20-5

Problem 20-1 (continued)

d. This is a change in accounting estimate resulting from a change in accounting principle.

No entry is needed to record the change

2013 adjusting entry:Depreciation expense (determined below) ..................... 72,000

Accumulated depreciation ...................................... 72,000

A change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle. Accordingly, DD reports the change prospectively; previous financial statements are not revised. Instead, the company simply employs the straight-line method from now on. The undepreciated cost remaining at the time of the change is depreciated straight-line over the remaining useful life.

($ in 000s)Asset’s cost $990Accumulated depreciation to date (calculated below) (486 ) Undepreciated cost, Jan. 1, 2013 $504Estimated residual value (0 ) To be depreciated over remaining 7 years $504

7 yearsAnnual straight-line depreciation 2013-2019 $ 72

Calculation of SYD depreciation:

(10+9+8) x $990,000) = $486,00055

© The McGraw-Hill Companies, Inc., 201320-6 Intermediate Accounting, 7e

Problem 20-1 (concluded)

e. This is a change in estimate.

To revise the liability on the basis of the new estimate:Loss – litigation................................................................ 5,000,000

Liability – litigation ($45 million – 40 million)........................ 5,000,000

A disclosure note should describe the effect of a change in estimate on income before extraordinary items, net income, and related per-share amounts for the current period.

f. This is a change in accounting principle accounted for prospectively.

Because the change will be effective only for assets placed in service after the date of change, the change doesn’t affect assets depreciated in prior periods. The nature of and justification for the change should be described in the disclosure notes. Also, the effect of the change on the current period’s financial statements should be disclosed.

© The McGraw-Hill Companies, Inc., 2013Alternate Exercise and Problem Solutions 20-7

Problem 20-2a. To correct the error:

Equipment (cost).................................................................... 9,000Accumulated depreciation ([$9,000 ÷ 5] x 2 years))................... 3,600Retained earnings ($9,000 – [$1,800 x 2 years)).................................. 5,400

2013 adjusting entry:Depreciation expense ($9,000 ÷ 5) ......................................... 1,800

Accumulated depreciation............................................... 1,800

b. To reverse erroneous entry:Cash ................................................................................... 51,000

Office supplies ................................................................ 51,000

To record correct entry:Storage boxes ..................................................................... 51,000

Cash ............................................................................... 51,000

c. To correct the error:Inventory ...................................................................................................... 112,000

Retained earnings ............................................................................... 112,000

d. To correct the error:Retained earnings ([$10 x 4,000 shares] – $4,000)..................... 36,000

Paid-in capital – excess of par......................................... 36,000Note: A “small” stock dividend (<25%) requires that the market value of the additional shares be “capitalized.”.

e. To correct the error:Retained earnings (overstatement of 2012 income).......................... 120,000

Interest expense (overstatement of 2013 interest) .................. 120,000

2013 adjusting entry:Interest expense (4/6 x $180,000)............................................ 120,000

Interest payable (4/6 x $180,000)........................................ 120,000

f. To correct the error:Prepaid insurance ($216,000 ÷ 3 yrs x 2 years: 2013-2014) ........ 144,000

Retained earnings ($216,000 – [$216,000 ÷ 3 years]) ........... 144,000

2013 adjusting entry:Insurance expense ($216,000 ÷ 3 years) ............................................ 72,000

Prepaid insurance ........................................................... 72,000

© The McGraw-Hill Companies, Inc., 201320-8 Intermediate Accounting, 7e