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Chapter 22: Question 4 (page 1305)
Identify and describe the approach the FASB requires for reporting changes in accounting principles.
FASB is an organization that regulates the accounting standards, and they believe that the best approach is retrospective.
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Botticelli Inc. was organized in late 2015 to manufacture and sell hosiery. At the end of its fourth year of operation, the company has been fairly successful, as indicated by the following reported net incomes.
2015 \(140,000a 2017 \)205,000
2016 160,000b 2018 276,000
a Includes a \(10,000 increase because of change in bad debt experience rate.
bIncludes a gain of \)30,000.
The company has decided to expand operations and has applied for a sizable bank loan. The bank officer has indicated that the records should be audited and presented in comparative statements to facilitate analysis by the bank. Botticelli Inc. therefore hired the auditing firm of Check & Doublecheck Co. and has provided the following additional information.
1. In early 2016, Botticelli Inc. changed its estimate from 2% of sales to 1% on the amount of bad debt expense to be charged to operations. Bad debt expense for 2015, if a 1% rate had been used, would have been \(10,000. The company therefore restated its net income for 2015.
2. In 2018, the auditor discovered that the company had changed its method of inventory pricing from LIFO to FIFO. The effect on the income statements for the previous years is as follows.
2015 2016 2017 2018
Net income unadjusted—LIFO basis \)140,000 \(160,000 \)205,000 \(276,000
Net income unadjusted—FIFO basis 155,000 165,000 215,000 260,000
\) 15,000 \( 5,000 \) 10,000 \( (16,000)
3. In 2018, the auditor discovered that:
(a) The company incorrectly overstated the ending inventory (under both LIFO and FIFO) by \)14,000 in 2017.
(b) A dispute developed in 2016 with the Internal Revenue Service over the deductibility of entertainment expenses. In 2015, the company was not permitted these deductions, but a tax settlement was reached in 2018 that allowed these expenses. As a result of the court’s finding, tax expenses in 2018 were reduced by $60,000.
Instructions
(a) Indicate how each of these changes or corrections should be handled in the accounting records. (Ignore income tax considerations.)
(b) Present net income as reported in comparative income statements for the years 2015 to 2018
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.
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?
Taveras Co. decides at the beginning of 2017 to adopt the FIFO method of inventory valuation. Taveras had used the LIFO method for financial reporting since its inception on January 1, 2015, and had maintained records adequate to apply the FIFO method retrospectively. Taveras concluded that FIFO is the preferable inventory method because it reflects the current cost of inventory on the balance sheet. The following table presents the effects of the change in accounting principles on inventory and cost of goods sold. Inventory Determined by Cost of Goods Sold Determined by Date LIFO Method FIFO Method LIFO Method FIFO Method January 1, 2015 \( 0 \) 0 \( 0 \) 0 December 31, 2015 100 80 800 820 December 31, 2016 200 240 1,000 940 December 31, 2017 320 390 1,130 1,100 Other information: 1. For each year presented, sales are \(3,000 and operating expenses are \)1,000. 2. Taveras provides two years of financial statements. Earnings per share information is not required. Instructions (a) Prepare income statements under LIFO and FIFO for 2015, 2016, and 2017. (b) Prepare income statements reflecting the retrospective application of the accounting change from the LIFO method to the FIFO method for 2017 and 2016. (c) Prepare the note to the financial statements describing the change in method of inventory valuation. In the note, indicate the income statement line items for 2017 and 2016 that were affected by the change in accounting principle. (d) Prepare comparative retained earnings statements for 2016 and 2017 under FIFO. Retained earnings reported under LIFO are as follows: Retained Earnings Balance December 31, 2015 $1,200 December 31, 2016 2,200 December 31, 2017 3,070
A partial trial balance of Julie Hartsack Corporation is as follows on December 31, 2018.
Dr. Cr.
Supplies \( 2,700
Salaries and wages payable \) 1,500
Interest receivable 5,100
Prepaid insurance 90,000
Unearned rent –0–
Interest payable 15,000
Additional adjusting data:
1. A physical count of supplies on hand on December 31, 2018, totaled \(1,100.
2. Through oversight, the Salaries and Wages Payable account was not changed during 2018. Accrued salaries and wages on December 31, 2018, amounted to \)4,400.
3. The Interest Receivable account was also left unchanged during 2018. Accrued interest on investments amounts to \(4,350 on December 31, 2018.
4. The unexpired portions of the insurance policies totaled \)65,000 as of December 31, 2018.
5. \(28,000 was received on January 1, 2018, for the rent of a building for both 2018 and 2019. The entire amount was credited to rent revenue.
6. Depreciation on equipment for the year was erroneously recorded as \)5,000 rather than the correct figure of \(50,000.
7. A further review of depreciation calculations of prior years revealed that equipment depreciation of \)7,200 was not recorded. It was decided that this oversight should be corrected by a prior period adjustment.
Instructions
(a) Assuming that the books have not been closed, what are the adjusting entries necessary at December 31, 2018? (Ignore income tax considerations.)
(b) Assuming that the books have been closed, what are the adjusting entries necessary at December 31, 2018? (Ignore income tax considerations.)
(c) Repeat the requirements for items 6 and 7, taking into account income tax effects (40% tax rate) and assuming that the books have been closed.
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