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Chapter 22: Q1CRC (page 1326)

As part of the year-end accounting process and review of operating policies, Cullen Co. is considering a change in the accounting for its equipment from the straight-line method to an accelerated method. Your supervisor wonders how the company will report this change in principle. He read in a newspaper article that the FASB has issued a standard in this area and has changed GAAP for a “change in estimate that is effected by a change in accounting principle.” (Thus, the accounting may be different from what he learned in intermediate accounting.) Your supervisor wants you to research the authoritative guidance on a change in accounting principle related to depreciation methods.

Instructions

(a) What are the accounting and reporting guidelines for a change in accounting principle related to depreciation methods?

(b) What are the conditions that justify a change in depreciation method, as contemplated by Cullen Co.?

(c) What guidance does the SEC provide concerning the impact that recently issued accounting standards will have on the financial statements in a future period?

Short Answer

Expert verified

The change in accounting principles is related to depreciation methods.

Step by step solution

01

Accounting and reporting guidelines

The guideline for reporting the change in accounting principle is related to the depreciation methods which can be found in IAS 8, paragraphs 32-38 under the heading of changes in accounting estimates.

02

Conditions that justify a change in depreciation methods

According to paragraph 14, the business entity shall change an accounting policy only if the change:

1. Is required by an IFRS or

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

03

Guidance provided by the SEC

If the cost of sales or operating expenses exclude charges for depreciation, depletion, and amortization of property, plant, and equipment, the description of the line item should read somewhat as follows: “Cost of goods sold (exclusive of items shown separately below)” or “Cost of goods sold (exclusive of depreciation shown separately below).” To avoid placing undue emphasis on “cash flow,” depreciation, depletion, and amortization should not be positioned in the income statement in a manner that results in reporting a figure for income before depreciation.

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Most popular questions from this chapter

Below is the net income of Anita Ferreri Instrument Co., a private corporation, computed under the three inventory methods using a periodic system. FIFO Average-Cost LIFO 2015 \(26,000 \)24,000 $20,000 2016 30,000 25,000 21,000 2017 28,000 27,000 24,000 2018 34,000 30,000 26,000

Instructions (Ignore tax considerations.) (a) Assume that in 2018 Ferreri decided to change from the FIFO method to the average-cost method of pricing inventories. Prepare the journal entry necessary for the change that took place during 2018, and show net income reported for 2015, 2016, 2017, and 2018.

(b) Assume that in 2018 Ferreri, which had been using the LIFO method since incorporation in 2015, changed to the FIFO method of pricing inventories. Prepare the journal entry necessary to record the change in 2018 and show net income reported for 2015, 2016, 2017, and 2018

(Analysis of Various Accounting Changes and Errors) Mathys Inc. has recently hired a new independent auditor, Karen Ogleby, who says she wants “to get everything straightened out.” Consequently, she has proposed the following accounting changes in connection with Mathys Inc.’s 2017 financial statements.

1. At December 31, 2016, the client had a receivable of \(820,000 from Hendricks Inc. on its balance sheet. Hendricks Inc. has gone bankrupt, and no recovery is expected. The client proposes to write off the receivable as a prior period item.

2. The client proposes the following changes in depreciation policies.

(a) For office furniture and fixtures, it proposes to change from a 10-year useful life to an 8-year life. If this change had been made in prior years, retained earnings at December 31, 2016, would have been \)250,000 less. The effect of the change on 2017 income alone is a reduction of \(60,000.

(b) For its new equipment in the leasing division, the client proposes to adopt the sum-of-the-years’-digits depreciation method. The client had never used SYD before. The first year the client operated a leasing division was 2017. If straight-line depreciation were used, 2017 income would be \)110,000 greater.

3. In preparing its 2016 statements, one of the client’s bookkeepers overstated ending inventory by \(235,000 because of a mathematical error. The client proposes to treat this item as a prior period adjustment.

4. In the past, the client has spread preproduction costs in its furniture division over 5 years. Because its latest furniture is of the “fad” type, it appears that the largest volume of sales will occur during the first 2 years after introduction. Consequently, the client proposes to amortize preproduction costs on a per-unit basis, which will result in expensing most of such costs during the first 2 years after the furniture’s introduction. If the new accounting method had been used prior to 2017, retained earnings at December 31, 2016, would have been \)375,000 less.

5. For the nursery division, the client proposes to switch from FIFO to LIFO inventories because it believes that LIFO will provide a better matching of current costs with revenues. The effect of making this change on 2017 earnings will be an increase of \(320,000. The client says that the effect of the change on December 31, 2016, retained earnings cannot be determined.

6. To achieve an appropriate recognition of revenues and expenses in its building construction division, the client proposes to switch from the completed-contract method of accounting to the percentage-of-completion method. Had the percentage-of-completion method been employed in all prior years, retained earnings at December 31, 2016, would have been \)1,075,000 greater.

Instructions

(a) For each of the changes described above, decide whether:

(1) The change involves an accounting principle, accounting estimate, or correction of an error.

(2) Restatement of opening retained earnings is required.

(b) What would be the proper adjustment to the December 31, 2016, retained earnings?

(Change from Fair Value to Equity) On January 1, 2017, Beyonce Co. purchased 25,000 shares (a 10% interest) in Elton John Corp. for \(1,400,000.

At the time, the book value and the fair value of John’s net assets were \)13,000,000. On July 1, 2018, Beyonce paid \(3,040,000 for 50,000 additional shares of John common stock, which represented a 20% investment in John. The fair value of John’s identifiable assets net of liabilities was equal to their carrying amount of \)14,200,000. As a result of this transaction, Beyonce owns 30% of John and can exercise significant influence over John’s operating and financial policies.

John reported the following net income and declared and paid the following dividends.

Net Income Dividend per Share

Year ended 12/31/17 \(700,000 None

Six months ended 6/30/18 500,000 None

Six months ended 12/31/18 815,000 \)1.55

Instructions

(Any excess fair value is attributed to goodwill.) Determine the ending balance that Beyonce Co. should report as its investment in John Corp. at the end of 2018

Simmons Corporation owns stock of Armstrong, Inc. Prior to 2017, the investment was accounted for using the equity method. In early 2017, Simmons sold part of its investment in Armstrong, and began using the fair value method. In 2017, Armstrong earned net income of \(80,000 and paid dividends of \)95,000. Prepare Simmons’s entries related to Armstrong’s net income and dividends, assuming Simmons now owns 10% of Armstrong’s stock.

In recent years, the Wall Street Journal has indicated that many companies have changed their accounting principles. What are the major reasons why companies change accounting methods?
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