INTERMEDIATE Intermediat ACCOUNTING Intermediat e e Accounting Accounting F I F T E E N T H 22-1 E D I T I O N Prepared by Coby Harmon Prepared by Prepared by University of California, Barbara CobySanta Harmon Harmon Westmont College SantaCoby University of California, Barbara University of California, Santa Barbara Westmont College kieso weygandt warfield team for success PREVIEW OF CHAPTER 22 Intermediate Accounting 15th Edition Kieso Weygandt Warfield 22-2 22 Accounting Changes and Error Analysis LEARNING OBJECTIVES After studying this chapter, you should be able to: Identify the types of accounting changes Describe the accounting for changes in accounting principles Describe the accounting for changes in estimates Identify changes in a reporting entity Understand how to account for retrospective accounting changes Describe the accounting for correction of errors Understand how to account for impracticable changes Identify economic motives for changing accounting methods Analyze the effect of errors 22-3 Accounting Changes Accounting Alternatives:  Diminish the comparability of financial information  Obscure useful historical trend data Types of Accounting Changes: Change in Accounting Policy Changes in Accounting Estimate Change in Reporting Entity Errors are not considered an accounting change 22-4 LO 22 Accounting Changes and Error Analysis LEARNING OBJECTIVES After studying this chapter, you should be able to: Identify the types of accounting changes Describe the accounting for changes in accounting principles Describe the accounting for changes in estimates Identify changes in a reporting entity Understand how to account for retrospective accounting changes Describe the accounting for correction of errors Understand how to account for impracticable changes Identify economic motives for changing accounting methods Analyze the effect of errors 22-5 Changes in Accounting Principle Change from one accepted accounting policy to another Examples include:  Average cost to LIFO  Completed-contract to percentage-of-completion method Adoption of a new principle in recognition of events that have occurred for the first time or that were previously immaterial is not an accounting change 22-6 LO Changes in Accounting Principle 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 22-7 LO 22-8 LO 22 Accounting Changes and Error Analysis LEARNING OBJECTIVES After studying this chapter, you should be able to: Identify the types of accounting changes Describe the accounting for changes in accounting principles Describe the accounting for changes in estimates Identify changes in a reporting entity Understand how to account for retrospective accounting changes Describe the accounting for correction of errors Understand how to account for impracticable changes Identify economic motives for changing accounting methods Analyze the effect of errors 22-9 Changes in Accounting Principle 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 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 22-10 LO Error Analysis (b) Assuming that the books have been closed, what are the adjusting entries necessary at December 31, 2015? Accrued interest on investments amounts to $4,350 on December 31, 2015 Retained Earnings ($5,100 – $4,350) 750 Interest Receivable 750 The unexpired portions of the insurance policies totaled $65,000 as of December 31, 2015 Retained Earnings 25,000 Prepaid Insurance 25,000 22-69 LO Error Analysis (b) Assuming that the books have been closed, what are the adjusting entries necessary at December 31, 2015? $24,000 was received on January 1, 2015 for the rent of a building for both 2015 and 2016 The entire amount was credited to rental income Retained Earnings Unearned Rent 14,000 Depreciation for the year was erroneously recorded as $5,000 rather than the correct figure of $50,000 Retained Earnings 22-70 14,000 Accumulated Depreciation 45,000 45,000 LO APPENDIX 22A CHANGING FROM OR TO THE EQUITY METHOD Change From The Equity Method Change from the equity method to the fair-value method 22-71  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 LO 10 Make the computations and prepare the entries necessary to record a change from or to the equity method of accounting APPENDIX 22A CHANGING FROM OR TO THE EQUITY METHOD Dividends in Excess of Earnings 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 liquidating dividend with this excess then accounted for as a reduction of the equity investment 22-72 LO 10 APPENDIX 22A CHANGING FROM OR TO THE EQUITY METHOD Dividends in Excess of Earnings Illustration: On January 1, 2013, 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 2013, Investor reported its investment in Investee Company at $8,780,000 at December 31, 2013 On January 2, 2014, 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 22-73 LO 10 APPENDIX 22A CHANGING FROM OR TO THE EQUITY METHOD Dividends in Excess of Earnings Illustration 22A-1 22-74 LO 10 APPENDIX 22A CHANGING FROM OR TO THE EQUITY METHOD Impact on Investment Carrying Amount 2014 and 2015 Illustration 22A-2 Cash Dividend Revenue 400,000 400,000 Cash Equity Investments (AFS) 60,000 Dividend Revenue 210,000 2016 22-75 LO 10 APPENDIX 22A CHANGING FROM OR TO THE EQUITY METHOD 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 22-76 LO 10 RELEVANT FACTS - Similarities 22-77  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 so, which may be the current period LO 11 Compare the procedures for accounting changes and error analysis under GAAP and IFRS RELEVANT FACTS - Differences 22-78  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  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 LO 11 ON THE HORIZON For the most part, IFRS and GAAP are similar in the area of accounting changes and reporting the effects of errors Thus, there is no active project in this area A related development involves the presentation of comparative data Under IFRS, when a company prepares financial statements on a new basis, two years of comparative data are reported GAAP requires comparative information for a three-year period Use of the shorter comparative data period must be addressed before U.S companies can adopt IFRS 22-79 LO 11 IFRS SELF-TEST QUESTION 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 22-80 LO 11 IFRS SELF-TEST QUESTION 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 22-81 LO 11 IFRS SELF-TEST QUESTION 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 22-82 LO 11 Copyright Copyright © 2013 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein 22-83 ...PREVIEW OF CHAPTER 22 Intermediate Accounting 15th Edition Kieso Weygandt Warfield 22- 2 22 Accounting Changes and Error Analysis LEARNING OBJECTIVES After studying this chapter, you should... next 22- 7 LO 22- 8 LO 22 Accounting Changes and Error Analysis LEARNING OBJECTIVES After studying this chapter, you should be able to: Identify the types of accounting changes Describe the accounting. .. 2012 Illustration 22- 4 Before Change 22- 17 LO Changes in Accounting Principle Retained Earnings Adjustment Illustration 22- 5 22- 18 After Change LO Changes in Accounting Principle E22-1 (Change in