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Flashcards in Accounting Changes Deck (27):
1

The cumulative effect of a change in accounting principle should be recorded as an adjustment to retained earnings, when the change is:

  1. Cash basis of accounting for vacation pay to the accrual basis.
  2. Straight-line method of depreciation for previously recorded assets to the double-declining-balance method.
  3. Longer useful life of equipment to shorter useful life.
  4. Completed-contract method of accounting for long-term construction-type contracts to the percentage-of-completion method.

Completed-contract method of accounting for long-term construction-type contracts to the percentage-of-completion method.

Accounting-principle changes such as this one are recorded by retroactively restating prior-year financial statements. The entry to record the change results in an adjustment to the beginning balance of retained earnings in the year of the change.

2

In 2005, Brighton Co. changed from the individual-item approach to the aggregate approach in applying the lower of FIFO cost or market to inventories.

The cumulative effect of this change should be reported in Brighton's financial statements as a

  1. Prior period adjustment, with separate disclosure.
  2. Component of income from continuing operations, with separate disclosure.
  3. Component of income from continuing operations, without separate disclosure.
  4. Cumulative-effect adjustment to retained earnings, with separate disclosure.

Cumulative-effect adjustment to retained earnings, with separate disclosure.

This accounting change is a change in the application of an accounting principle, which merits the reporting of a cumulative effect of accounting principle change.

Accounting-principle changes, as well as changes in the application of principles, are accounted for using the retrospective approach, which recognizes the effect of the change on all prior years affected as an adjustment to retained earnings at the beginning of the year of change.

3

The effect of a change in accounting principle that is inseparable from the effect of a change in accounting estimate should be reported

  1. By restating the financial statements of all prior periods presented.
  2. As a correction of an error.
  3. As a component of income from continuing operations, in the period of change and future periods if the change affects both.
  4. As a separate disclosure after income from continuing operations, in the period of change and future periods if the change affects both.

As a component of income from continuing operations, in the period of change and future periods if the change affects both.

When an accounting principle change cannot be distinguished from an estimate change, it is accounted for as an estimate change. Changes in accounting estimate are accounted for currently and prospectively and are reported in income from continuing operations. The relevant accounts affected by the change are adjusted for the current and future years. The change is not retroactively applied.

4

For 2003, Pac Co. estimates its two-year equipment warranty costs based on $100 per unit sold in 2003. Experience during 2004 indicates that the estimate should have been based on $110 per unit.

The effect of this $10 difference from the estimate is reported

  1. In 2004 income from continuing operations.
  2. As an accounting change, net of tax, below 2004 income from continuing operations.
  3. As an accounting change requiring 2003 financial statements to be restated.
  4. As a correction of an error requiring 2003 financial statements to be restated.

In 2004 income from continuing operations.

This is a change in accounting estimate, because experience in the current period implies that a different estimate should be used. This new information does not invalidate the good-faith estimate made in 2003, because the new information was not known at that time. These changes are treated currently and prospectively; that is, in the current and future periods, if affected. They are not applied retroactively.

In this instance, the $10 increase in warranty costs per unit is recognized as an increase in warranty expense of 2004. Therefore, income from continuing operations will reflect this increase.

5

Matt Co. included a foreign subsidiary in its 2008 consolidated financial statements. 
The subsidiary was acquired in 2002 and was excluded from previous consolidations. The change was caused by the elimination of foreign-exchange controls.

Including the subsidiary in the 2008 consolidated financial statements results in an accounting change that should be reported

  1. By footnote disclosure only.
  2. Currently and prospectively.
  3. Currently with footnote disclosure of pro forma effects of retroactive application.
  4. By restating the financial statements of all prior periods presented.

By restating the financial statements of all prior periods presented.

The elimination of foreign-currency controls would legitimately change the status of the foreign sub from non-consolidated to consolidated.

This causes a change in the reporting entity, since both companies must now be reported together. A change in reporting entity utilizes the retrospective method.

6

On January 2, 2002, Union Co. purchases a machine for $264,000 and depreciated it by the straight-line method, using an estimated useful life of eight years with no salvage value.

On January 2, 2005, Union determines that the machine has a useful life of six years from the date of acquisition and will have a salvage value of $24,000. An accounting change was made in 2005 to reflect the additional data.

The accumulated depreciation for this machine should have a balance at December 31, 2005, of

  1. $176,000
  2. $160,000
  3. $154,000
  4. $146,000

$146,000

  • Book value, January 2, 2005, date of accounting change: $264,000(5/8 years) = (as of January 2, 2005, five years of useful life remain) $165,000
  • Accumulated depreciation January 2, 2005, date of accounting change: $264,000(3/8 years) = (as of January 2, 2005, three years of the asset's life have been used) $99,000
  • Plus 2005 depreciation: ($165,000 - $24,000)/(6 - 3 years) = $47,000
  • Equals accumulated depreciation balance, December 31, 2005 $146,000

As of January 2, 2005, the equipment has been used for three years. The new estimate of total life is six years. Therefore, 6-3 = three years remain. This remaining number of years is the basis for depreciating the asset, as well as the remaining book value at the beginning of the year of the accounting change ($165,000).

7

Mellow Co. depreciates a $12,000 asset over five years, using the straight-line method with no salvage value. At the beginning of the fifth year, it is determined that the asset will last another four years.

What amount should Mellow report as depreciation expense for year five?

  1. $600
  2. $900
  3. $1,500
  4. $2,400

$600

The book value at the beginning of the year of the change in estimated useful life is used as the base for subsequent depreciation. After four years, the book value remaining is one-fifth of its original cost, because there is no salvage value and the firm uses SL depreciation.

That remaining book value is spread equally over four more years, yielding $600 of depreciation in each of those years. Book value at the beginning of year five = $12,000 - 4($12,000/5) = $2,400. Depreciation expense for year five = $2,400/4 = $600. The four years remaining include year five.

8

Which of the following statements is correct as it relates to changes in accounting estimates?

  1. Most changes in accounting estimates are accounted for retrospectively.
  2. Whenever it is impossible to determine whether a change in an estimate or a change in accounting principle occurred, the change should be considered a change in principle.
  3. Whenever it is impossible to determine whether a change in accounting estimate or a change in accounting principle has occurred, the change should be considered a change in estimate.
  4. It is easier to differentiate between a change in accounting estimate and a change in accounting principle than it is to differentiate between a change in accounting estimate and a correction of an error.

Whenever it is impossible to determine whether a change in accounting estimate or a change in accounting principle has occurred, the change should be considered a change in estimate.

When it is impossible to determine whether the change is an estimate or a change in accounting principle, the change should be considered a change in estimate and accounted for prospectively.

9

On January 1, 2004, Taft Co. purchases a patent for $714,000. The patent is being amortized over its remaining legal life of 15 years, expiring on January 1, 2019. 
During 2007, Taft determined that the economic benefits of the patent would not last longer than ten years from the date of acquisition.

What amount should be reported in the balance sheet for the patent, net of accumulated amortization, at December 31, 2007?

  1. $428,400
  2. $489,600
  3. $504,000
  4. $523,600

$489,600

This is a change in accounting estimate. The beginning 2007 patent balance is $714,000(12/15) = $571,200, because three years of amortization would have been recorded as of that date, based on 15 years. Amortization in 2007, therefore, is $571,200(1/7) = $81,600.
As of the beginning of 2007, only seven years remain in the useful life, because the total useful life as of that date was changed to ten years, and the patent had been used for three years as of that date.

Therefore, the ending net balance in the patent is $571,200 - $81,600 = $489,600.

10

During 2005, Krey Co. increased the estimated quantity of copper recoverable from its mine. Krey uses the units-of-production-depletion method.

Which of the following statements correctly describes the appropriate accounting for this change?

  1. Accumulated depletion is recalculated back to the date of acquiring the mine and the depletion for each period included in the annual report will reflect the new estimate.
  2. The effect of the change on all prior years is treated as a catch-up adjustment in the 2005 income statement.
  3. The change in estimate is applied as of the beginning of 2005 for current and future periods.
  4. The retained-earnings balance at the beginning of 2005 is adjusted for the effect of the change on prior years.

The change in estimate is applied as of the beginning of 2005 for current and future periods.

This is an accounting-estimate change. These accounting changes are handled currently and prospectively by applying the new estimate to the current and future periods, if affected. The effect of the change on prior years' earnings is not computed, because the new information causing the estimate change was not known at that time.

Cumulative effects are reported for accounting principle changes, not estimate changes, because the effect of the change on prior years is computed and reported for accounting principle changes only.

11

On January 1, 2003, Warren Co. purchases a $600,000 machine, with a five-year useful life and no salvage value.

The machine is depreciated by the accelerated method for book and tax purposes. The machine's carrying amount is $240,000 on December 31, 2004. On January 1, 2005, Warren changes to the straight-line method for financial-statement purposes. Warren can justify the change. Warren's income tax rate is 30%.

In its 2005 financial statements, what amount should Warren report as the cumulative effect of this change?

  1. $120,000
  2. $84,000
  3. $36,000
  4. $0

$0

A change in depreciation method is treated as a change in estimate with the remaining book value at the beginning of the year of change being subject to the new method for the remainder of the asset's life. No cumulative effect is reported.

12

At December 31, 2004, Off-Line Co. changes its method of accounting for demo costs from writing off the costs over two years to expensing the costs immediately.

Off-Line makes the change in recognition of an increasing number of demos placed with customers that did not result in sales. Off-Line has deferred demo costs of $500,000 at December 31, 2003, $300,000 of which were to be written off in 2004 and the remainder in 2005.

Off-Line's income tax rate is 30%. In its 2004 retained-earnings statement, what amount should Off-Line report as cumulative effect of change in accounting principle?

  1. $0
  2. $200,000
  3. $350,000
  4. $500,000

$0

The change in accounting principle is indistinguishable from a change in accounting estimate. This change can be effected by changing the useful life of the demo costs to zero - a change in estimate. The firm should write off the remaining unamortized costs at the beginning of the year of change. Earnings in 2004 will be reduced by $500,000 before tax as a result.

13

When a company changes the expected service life of an asset because additional information has been obtained, which of the following should be reported?

  • Cumulative effect of accounting principle change    
  • Deferred income tax adjustment

  • Cumulative effect of accounting principle change = NO
  • Deferred income tax adjustment = NO

The change in expected service life is an accounting-estimate change. These are handled currently and prospectively. No attempt is made to compute the effect of the change on prior years' income, because the new information was not available at that time.

With no catch-up adjustment, there is no change in deferred taxes, because future differences between book and tax depreciation have not been changed.

14

On December 31, year 2, Foster, Inc. appropriately changed to the FIFO cost method from the weighted-average cost method for financial statement and income tax purposes. The change will result in a $150,000 increase in the beginning inventory at January 1, year 3. Assuming a 30% income tax rate, the period-specific effect of this accounting change for the year ended December 31, year 2, is

  1. $0
  2. $45,000
  3. $105,000
  4. $150,000

$105,000

The change results in a $150,000 increase in the inventory valuation for ending inventory at December 31, year 2, which means the before-tax effect on income in year 2 is also $150,000. Since the period-specific effects must be reported net of year 2 effects, the tax effect is $45,000 (30% × $150,000) and must be subtracted to leave a period-specific effect of $105,000 ($150,000 – $45,000). The $150,000 increase in inventory should be added to the balance in inventory on the year 2 comparative balance sheet, $105,000 is the increase in net income, and the income tax payable account will increase by $45,000.

15

A change in the salvage value of an asset depreciated on a straight-line basis, arising because additional information has been obtained, is

  1. An accounting change that should be reflected in the period of change and future periods if the change affects both.
  2. An accounting change that should be reported by restating the financial statements of all prior periods presented.
  3. A correction of an error.
  4. Not an accounting change.

An accounting change that should be reflected in the period of change and future periods if the change affects both.

A change in the salvage value of an asset is a change in accounting estimate. ASC 250-10-45-17 states that a change in accounting estimate should be accounted for in the period of change and future periods if the change affects both.

16

A change in the salvage value of an asset depreciated on a straight-line basis, arising because additional information has been obtained, is

  1. An accounting change that should be reflected in the period of change and future periods if the change affects both.
  2. An accounting change that should be reported by restating the financial statements of all prior periods presented.
  3. A correction of an error.
  4. Not an accounting change.

An accounting change that should be reflected in the period of change and future periods if the change affects both.

According to ASC Topic 250. A change in the salvage value of an asset is a change in accounting estimate. ASC 250-10-45-17 states that a change in accounting estimate should be accounted for in the period of change and future periods if the change affects both.

17

Which of the following describes a change in reporting entity?

  1. A company presents consolidated financial statements in place of individual company financial statements.
  2. A manufacturing company expands its market from regional to nationwide.
  3. A company acquires additional shares of an investee and changes to the equity method of accounting.
  4. A company discontinues a product line in one of their factories.

A company presents consolidated financial statements in place of individual company financial statements.

When there is a change in reporting entity, the change is retrospectively applied to the financial statements of all prior periods presented.  Previously issued interim statements are also presented on a retrospective basis. Footnote disclosures for change in reporting entity include the nature and reason for the change, net income, other comprehensive income, and any related per-share amounts for all periods presented.

18

A change in the periods benefited by a deferred cost because additional information has been obtained is

  1. A correction of an error.
  2. An accounting change that should be reported by restating the financial statements of all prior periods presented.
  3. An accounting change that should be reported in the period of change and future periods if the change affects both.
  4. Not an accounting change.

An accounting change that should be reported in the period of change and future periods if the change affects both.

ASC Topic 250 states that a change in the periods benefited by a deferred cost should be treated as a change in accounting estimate. Changes in accounting estimates are accounted for in the period of change and future periods if the change affects both.

19

A company changes from an accounting principle that is not generally accepted to one that is generally accepted. The effect of the change should be reported, net of applicable income taxes, in the current

  1. Income statement after income from continuing operations and before extraordinary items.
  2. Income statement after extraordinary items.
  3. Retained earnings statement as an adjustment of the opening balance.
  4. Retained earnings statement after net income but before dividends.

Retained earnings statement as an adjustment of the opening balance.

ASC Topic 250 states that a change from an accounting principle that is not generally accepted to one that is generally accepted should be treated in the same manner as a correction of an error. A correction of an error should be reported as a prior period adjustment. This means that the cumulative effect at the beginning of the period of change is entered directly as an adjustment to the opening balance of retained earnings. When comparative statements are presented, prior years’ statements are retroactively restated. 

20

The year 1 financial statements of Bice Company reported net income for the year ended December 31, year 1, of $2,000,000. On July 1, year 2, subsequent to the issuance of the year 1 financial statements, Bice changed from an accounting principle that is not generally accepted to one that is generally accepted. If the generally accepted accounting principle had been used in year 1, net income for the year ended December 31, year 1, would have been decreased $1,000,000. On August 1, year 2, Bice discovered a mathematical error relating to its year 1 financial statements. If this error had been discovered in year 1, net income for the year ended December 31, year 1, would have been increased $500,000. What amount, if any, should be included in net income for the year ended December 31, year 2, because of the items noted above?

  1. $0.
  2. $ 500,000 decrease.
  3. $ 500,000 increase.
  4. $1,000,000 decrease.

$0.

The change from an unacceptable accounting principle to an acceptable accounting principle is considered a correction of an error per ASC Topic 250. Thus both of these items are corrections of errors and as such are reported as prior period adjustments. Prior period adjustments are reported in the retained earnings statement and not in the income statement. Thus, year 2 earnings are not affected by the aforementioned items.

21

Cory Company acquired some machinery on January 2, year 2. Cory was using straight-line depreciation with an estimated life of 15 years with no salvage value for this machinery. On January 2, year 6, Cory estimated that the remaining life of this machinery was 6 years with no salvage value. How should this change be accounted for by Cory?

  1. Making a prior period adjustment and changing to an accelerated depreciation method that will compensate for under-depreciation in prior years.
  2. Estimating the effect of the change on each year’s net earnings, but maintaining the method of depreciation as originally determined.
  3. Revising future depreciation per year to equal the book value on January 2, year 6, divided by 6.
  4. Revising future depreciation per year to equal the original cost divided by 6.

Revising future depreciation per year to equal the book value on January 2, year 6, divided by 6.

Cory Company’s change of depreciation is considered a change in estimate. A change in estimate is treated prospectively by revising the remaining years’ depreciation expense. Book value of the asset at the time of change should be divided by 6, the estimated remaining life.

22

A change in accounting principle that would require retrospective application to all prior periods would be a change

  1. From using the percentage-of-completion method of accounting for long-term construction contracts to the completed contract method.
  2. In the salvage value of a depreciable asset.
  3. From the straight-line method of depreciation to the double-declining balance method.
  4. From reporting revenues on a cash basis to reporting on an accrual basis.

From using the percentage-of-completion method of accounting for long-term construction contracts to the completed contract method.

Per ASC Topic 250, an entity shall report a change in accounting principle through retrospective application of the new accounting principle to all prior periods, unless it is impracticable to do so.

23

On January 1, year 2, Belmont Company changed its inventory cost flow method to the FIFO cost method from the LIFO cost method. Belmont can justify the change, which was made for both financial statement and income tax reporting purposes. Belmont’s inventories aggregated $4,000,000 on the LIFO basis at December 31, year 1. Supplementary records maintained by Belmont showed that the inventories would have totaled $4,800,000 at December 31, year 1, on the FIFO basis. Belmont does not have sufficient information to calculate the effect of the change in inventories for years prior to year 1. Ignoring income taxes, the adjustment for the effect of changing to the FIFO method from the LIFO method should be reported by Belmont

  1. In the year 2 income statement as an $800,000 loss from cumulative effect of change in accounting principle.
  2. In the year 1 retained earnings statement as an $800,000 debit adjustment to the beginning balance.
  3. As an adjustment to the balances of inventory, and a retrospective application to cost of goods sold, net income, and retained earnings in the year 1 comparative financial statements.
  4. In the year 2 retained earnings statement as an $800,000 credit adjustment to the beginning balance.

As an adjustment to the balances of inventory, and a retrospective application to cost of goods sold, net income, and retained earnings in the year 1 comparative financial statements.

Per ASC Topic 250, retrospective application requires the changes to be reflected in the carrying amounts of assets and liabilities of the first period presented. The financial statements for each individual prior period are adjusted to reflect the period-specific effects of applying the new accounting principle if it can be determined.

24

On January 1, year 2, an intangible asset with a 35-year estimated useful life was acquired. On January 1, year 6, a review was made of the estimated useful life, and it was determined that the intangible asset had an estimated useful life of 45 more years. As a result of the review

  1. The original cost at January 1, year 2, should be amortized over a 50-year life.
  2. The original cost at January 1, year 2, should be amortized over the remaining 30-year life.
  3. The unamortized cost at January 1, year 6, should be amortized over a 40-year life.
  4. The unamortized cost at January 1, year 6, should be amortized over a 45-year life.

The unamortized cost at January 1, year 6, should be amortized over a 45-year life.

The estimated useful life of an intangible asset is revised, the unamortized cost should be allocated over the remaining periods of the new useful life.

25

In which of the following situations should a company report a prior period adjustment?

  1. A change in the estimated useful lives of fixed assets purchased in prior years.
  2. The correction of a mathematical error in the calculation of prior years’ depreciation.
  3. A switch from the straight-line to double-declining balance method of depreciation.
  4. The scrapping of an asset prior to the end of its expected useful life.

The correction of a mathematical error in the calculation of prior years’ depreciation.

A correction of an error in previously issued financial statements requires a prior period adjustment by restating the financial statements.  Prior period adjustments are covered in the previous section of this module.

26

Presenting consolidated financial statements this year when statements of individual companies were presented last year is

  1. A correction of an error.
  2. An accounting change that should be reported prospectively.
  3. An accounting change that should be reported by restating the financial statements of all prior periods presented.
  4. Not an accounting change.

An accounting change that should be reported by restating the financial statements of all prior periods presented.

Per ASC Topic 250, accounting changes that result from a change in the business entity should be reflected in financial statements that are restated.

27

On December 31, year 2, Rapp Co. changed inventory cost methods to FIFO from LIFO for financial statement and income tax purposes. The change will result in a $175,000 increase in the beginning inventory at January 1, year 3. Rapp does not maintain records to identify the effect of the change on years prior to year 1. Assuming a 30% income tax rate, the cumulative effect of this accounting change reported in the income statement for the year ended December 31, year 3, is

  1. $175,000
  2. $122,500
  3. $ 52,500
  4. $0

$0

ASC Topic 250 requires changes in accounting principle to be given retrospective application, and the cumulative effects of the change reflected in the carrying value of assets and period-specific effects on the financial statements for each period presented.