accounting changes methods of accounting for changes appropriate method for specific situations
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Accounting Changes
Methods of accounting for changes
Appropriate method for specific situations
Accounting Changes
“The only constant in this world is change”
Accounting is no different. How do changes affect financial
statements? How should decision makers respond to
accounting changes?
Accounting Change Events
Error - books are wrong Change in principle - LIFO to FIFO Change in estimate - useful life of assets Change in entity - firms merge
Three Methods to Account for Changes
Retrospective method Current method Prospective method
Retrospective method
completely restate the financial statements as if the new method or information had been used from the day the company first opened for business
adjust beginning Retained Earnings and permanent accounts for earliest year presented
Current method
change current period’s financial statements but leave the prior statements alone
cumulative effect of change appears as nonrecurring item in financial statements
prior year statements are not changed; however, pro forma disclosure may be required (for disclosure only - no formal entry)
Prospective method
use the new information or new method in preparing current and future financial statements
no entry to adjust for cumulative effect no adjustment to prior statements for
comparative purposes
Which method should be used?
Correction of an error retrospective method
Change in estimate prospective method
Change in principle retrospective method if change due to new FASB - the standard
will tell which method to use
Examples
(1) Decide which type of change is involved.
(2) Determine the method to be used for the change.
Accounting Changes/Errors
Change in plant asset’s salvage value. Estimate – prospective
Change due to overstatement of inventory. Error – retrospective
Change from FIFO to LIFO inventory Principle – retrospective
Change to consolidation of subsidiaries Entity – retrospective
Accounting Changes/Errors
Change from SYD to SL depreciation method. Estimate effected by principle change –
prospective
Change in rate used to compute warranty costs. Estimate – prospective
Change from an unacceptable accounting principle to an acceptable principle Error - retrospective
Company A
Acquired asset in 2006 for $500,000 Used SL depreciation, 10 yr life, no
salvage In 2009, change to SYD depreciation
Type of Change and Approach
switch from SL to SYD change in estimate prospective approach
Change in Depreciation Method
Method 2006 200720082009
SL Depr 50 50 50 50
Bal, A/D 50 100 150
Book Value (2009)=500,000-150,000
= 350,000
SYD Depr (2009) = 350,000 x 7/28
= 87,500
Record $87,500 in depreciation in 2009
Company B
In 2008, switched inventory method from FIFO to Average Cost
Net income under both methods is:
FIFO Average Cost
2005 26,000 24,000
2006 30,000 25,000
2007 28,000 27,000
2008 34,000 30,000
Type of Change and Approach
Switch from FIFO to Average Cost Change in accounting principle Retrospective approach
Journal Entry in 2008
2005 26,000 – 24,000 = 2,000 2006 30,000 – 25,000 = 5,000 2007 28,000 – 27,000 = 1,000
8,000
Retained Earnings 8,000 Inventory 8,000
Reported Net Income
2008 2007 2006 2005
Net income 30,000 27,000 25,000 24,000
Company C
Acquired asset in January 2005 for $140,000
$140,000 was debited to expense rather than PPE
In 2009, begin using SL depreciation, 10 yr life, no salvage
Type of Change and Approach
expensed purchase of machine in 2006 correction of an error retrospective approach
Correction of an Error
Machine should have a balance of $140,000
A/D should have a balance of
4 x 14,000 = $56,000 Adjust Retained Earnings and accounts
Machine 140,000
A/D 56,000
Ret Earnings 84,000
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