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C H A P T E R C H A P T E R 88

MFRS 108 CHANGES IN ACCOUNTING MFRS 108 CHANGES IN ACCOUNTING POLICIES, ESTIMATIONS AND POLICIES, ESTIMATIONS AND

CORRECTION OF ERRORSCORRECTION OF ERRORS

Intermediate AccountingIFRS Edition

Kieso, Weygandt, and Warfield

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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

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Changes in accounting

policy

Changes in accounting

estimate

Correction of errors

Summary

Motivations for change of

policy

Accounting Changes Error Analysis

Statement of financial

position errors

Income statement errors

Statement of financial

position 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

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Types of Accounting Changes:

1. Change in Accounting Policy.

2. Changes in Accounting Estimate.

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

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Changes in Accounting PolicyChanges in Accounting PolicyAccounting policies define as ‘specific principles’ bases, Accounting policies define as ‘specific principles’ bases, conventions, rules and practices applied by an entity in preparing conventions, rules and practices applied by an entity in preparing and presenting financial statements.and presenting financial statements.

An entity is only allowed to change its accounting policy under An entity is only allowed to change its accounting policy under one of the following two circumstances:one of the following two circumstances:Initial application of a standard or interpretationInitial application of a standard or interpretation

The change is required by a standard or an interpretation.The change is required by a standard or an interpretation.

Voluntary changeVoluntary change

The change results in the financial statements providing The change results in the financial statements providing reliable and more relevant information about the effects of reliable and more relevant information about the effects of transactions, other events or conditions on the entity’s financial transactions, other events or conditions on the entity’s financial position, financial performance or cash flows.position, financial performance or cash flows.

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Average cost to LIFO.

Completed-contract to percentage-of-completion.

Change from one accepted accounting policy to another.

Examples include:

Changes in Accounting PolicyChanges in Accounting PolicyChanges in Accounting PolicyChanges in Accounting Policy

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.

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Three approaches for reporting changes:

1) Currently.

2) Retrospectively.

3) Prospectively (in the future).

IASB 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.


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Retrospective Accounting Change Approach

LO 3 Understand how to account for retrospective accounting changes.

IFRS permits a change in policy if:

1) It is required by IFRS; or

2) It results in the financial statements providing more

reliable and relevant information.


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Retrospective Accounting Change Approach


Company reporting the change

1) Adjusts its financial statements for each prior period

presented to the same basis as the new accounting

policy.

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.


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Illustration: Denson Company has accounted for its income from

long-term construction contracts using the cost-recovery (zero-

profit) method. In 2011, 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 cost-recovery method and

plans to continue doing so in the future. (Assume a 40 percent

enacted tax rate.)


Retrospective Accounting Change: Long-Term Contracts


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Illustration 22-1



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MethodMethod1.1. Get the Difference Pre- Income B/4 Tax Get the Difference Pre- Income B/4 Tax

before 2011and year 2011 under two methodbefore 2011and year 2011 under two method

2.2. Difference amount x tax rate 40%Difference amount x tax rate 40%

3.3. Journal entries beginning 2011Journal entries beginning 2011

Dr CIP 220,000 Cr Deferred tax 88,000 Cr Dr CIP 220,000 Cr Deferred tax 88,000 Cr Retained earningsRetained earnings

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Data for Retrospective ChangeIllustration 22-2

Construction in Process 220,000

Deferred Tax Liability 88,000

Retained Earnings 132,000


Journal entry beginning of

2010


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Reporting a Change in policy


Major disclosure requirements are as follows.

1. Nature of the change in accounting policy;

2. Reasons why applying the new accounting policy provides reliable

and more relevant information;

3. For the current period and each prior period presented, to the

extent practicable, the amount of the adjustment:

1. For each financial statement line (Tutorial 2) item

affected; and

2. Basic and diluted earnings per share.

4. Amount of the adjustment relating to periods before those

presented, to the extent practicable.


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Illustration 22-3Reporting a Change in policy


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Retained Earnings Adjustment


Illustration 22-4

Retained earnings balance is €1,360,000 at the beginning of 2009.

Before Change


22-17 LO 3 Understand how to account for retrospective accounting changes.

Illustration 22-5After Change

Retained Earnings Adjustment


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Retained Earnings After Retrospective Retained Earnings After Retrospective ApplicationApplication

Eg 2011 and 2010 Financial StatementsEg 2011 and 2010 Financial Statements 20102010

2011 2010

Closing 2009 RE (OLD Policy) Or Opening RE 2010 (OLD Policy)

Add / Less (Diff of Net Income Btw Old and New Policy)

New Policy RE of 2010 (Closing)

Net Income (New Policy)

Closing Retained Earnings (New Policy)

22-19 LO 3 Understand how to account for retrospective accounting changes.

Direct Effects - IASB takes the position that companies

should retrospectively apply the direct effects of a

change in accounting policy.

Indirect Effect is any change to current or future cash

flows of a company that result from making a change in

accounting policy that is applied retrospectively.

Direct and Indirect Effects of Changes


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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.


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Changes in EstimatesChanges in Estimates Many items in the financial statements are estimated.

Estimation involves judgment based on the most recent available information that is reliable. These estimates may have to be revised due to changes business activities.

Revision of an estimate is called changes in estimates.

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 statement is made.

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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. Bad debts.

2. Inventory obsolescence.

3. Useful lives and residual 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.

8. Fair value of financial assets or financial liabilities.

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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.

IASB views changes in estimates as normal recurring corrections

and adjustments and prohibits retrospective treatment.

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Prospective ReportingProspective Reporting

Companies should not adjust previously Companies should not adjust previously reported results for changes in estimates.reported results for changes in estimates.

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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 2010 (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 2010.

No Entry No Entry RequiredRequired

Change in Estimate ExampleChange in Estimate ExampleChange in Estimate ExampleChange in Estimate Example


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Equipment $510,000

Fixed Assets:

Accumulated depreciation 350,000

Net book value (NBV) $160,000

Balance Sheet (Dec. 31, 2009)

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.


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Net book value $160,000

Salvage value (if any) 5,000

Depreciable base 155,000

Useful life (15-7 yrs) 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 2010.for 2010.

Second, calculate Second, calculate depreciation expense depreciation expense

for 2010.for 2010.

Depreciation expense 19,375


Journal entry for 2010


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Disclosures

Companies should disclose the nature and amount of a

change in an accounting estimate that has an effect in the

current period or is expected to have an effect in future periods.

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.

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ErrorsErrors FRS 108 defines prior period errors as ‘omissions FRS 108 defines prior period errors as ‘omissions

from, and misstatements in the entity’s financial from, and misstatements in the entity’s financial statements for one or more prior periods arising statements for one or more prior periods arising from a failure to use, or misuse of, reliable from a failure to use, or misuse of, reliable information. A prior period error has to be corrected information. A prior period error has to be corrected by retrospective restatement. by retrospective restatement.

Types of errors Types of errors

1.1. Mathematical mistakesMathematical mistakes

2.2. Misclassification of expensesMisclassification of expenses

3.3. Misuse of factsMisuse of facts

4.4. An oversightAn oversight

5.5. Any changes in accounting policy against GAAPAny changes in accounting policy against GAAP

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Correction of ErrorsCorrection of ErrorsCorrection of ErrorsCorrection of Errors

LO 6 Describe the accounting for correction of errors.

Types of Accounting Errors:

1. A change from an accounting policy 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.

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Correction of Errors (ImportantCorrection of Errors (Important) ***) ***Correction of Errors (ImportantCorrection of Errors (Important) ***) ***

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.


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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.


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Woods, Inc.Statement of Retained Earnings

For the Year Ended December 31, 2010

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, 2010, you discover

a $62,500 error that caused the 2009 inventory to be overstated (overstated

inventory caused COGS to be lower and thus net income to be higher in

2009). Would this discovery have any impact on the reporting of the

Statement of Retained Earnings for 2010? Assume a 20% tax rate.



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Woods, Inc.Statement of Retained Earnings

For the Year Ended December 31, 2010

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$



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Retained Earnings (RE) – Error in year Retained Earnings (RE) – Error in year 20092009

2010 2009

RE 2009 Closing (Before Error Adj)

Less : Add Error

Retained earnings (RE) Closing 2009 (After adjustment)

RE 2009 Opening (2008 RE Closing)

Net Income Net Income (After Adj error)

(Dividend) (Dividend)

Retained Earnings2010 (Closing)

Retained earning Closing 2009 (After adjustment)

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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 6

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E22-19 (Error Analysis; Correcting Entries): A partial trial balance of

Dickinson Corporation is as follows on December 31, 2010.

Error Analysis ExampleError Analysis ExampleError Analysis ExampleError Analysis Example

Dr. Cr.

Supplies on hand 2,500$

Accured salaries and wages 1,500$

Interest receivable 5,100

Prepaid insurance 90,000

Unearned rent 0

Accured interest payable 15,000

LO 8 Analyze the effect of errors.

Instructions: (a) Assuming that the books have not been closed, what are

the adjusting entries necessary at December 31, 2010?

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Salaries and wages expense 2,900

Accured salaries and wages 2,900

Supplies expense 1,400

Supplies on hand 1,400



1. A physical count of supplies on hand on December 31, 2010, totaled

$1,100.

2. Accrued salaries and wages on December 31, 2010, amounted to

$4,400.

(a) Assuming that the books have not been closed, what are the

adjusting entries necessary at December 31, 2010?

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Interest revenue 750

Interest receivable 750

Insurance expense 25,000




3. Accrued interest on investments amounts to $4,350 on December 31,

2010.

4. The unexpired portions of the insurance policies totaled $65,000 as

of December 31, 2010.



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Depreciation expense 45,000




5. $24,000 was received on January 1, 2010 for the rent of a building for

both 2010 and 2011. 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.



Retained earnings 12,000

Unearned rent 12,000

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E22-19 (Error Analysis; Correcting Entries) A partial trial balance of

Dickinson Corporation is as follows on December 31, 2010.



Instructions: (b) Assuming that the books have been closed, what are

the adjusting entries necessary at December 31, 2010?

Dr. Cr.

Supplies on hand 2,500$

Accured salaries and wages 1,500$

Interest receivable 5,100


Unearned rent 0

Accured interest payable 15,000

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Accured salaries and wages 2,900


Supplies on hand 1,400



(b) Assuming that the books have been closed, what are the adjusting

entries necessary at December 31, 2010?

1. A physical count of supplies on hand on December 31, 2010, totaled

$1,400.

2. Accrued salaries and wages on December 31, 2010, amounted to

$4,400.

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Retained earnings 750

Interest receivable 750



3. Accrued interest on investments amounts to $4,350 on December 31,

2010.

4. The unexpired portions of the insurance policies totaled $65,000 as

of December 31, 2010.

(b) Assuming that the books have been closed, what are the adjusting

entries necessary at December 31, 2010?

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Unearned rent 12,000



5. $24,000 was received on January 1, 2010 for the rent of a

building for both 2010 and 2011. 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


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FRS 108 FRS 108 Accounting Accounting Policies, Policies, Changes in Changes in Accounting Accounting Estimates and Estimates and ErrorsErrors

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