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Flashcards in Accounting Restatements & IFRS Contingencie Deck (15):
1

How should the effect of a change in accounting estimate be accounted for?
A. By restating amounts reported in financial statements of prior periods.
B. By reporting pro forma amounts for prior periods.
C. As a Prior period adjustment to beginning retained earnings.
D. In the period of change and future periods if the change affects both.

D. In the period of change and future periods if the change affects both.

Accounting-estimate changes are treated currently and prospectively (in the future).
If the change affects only the current period, then only current-period earnings is affected. More frequently, though, the change affects future periods as well. Then, current and future earnings are affected.

An estimate change is never treated retroactively. Prior-year earnings are never adjusted for a change in estimate, because the information giving rise to the change could not have been known in prior periods.

2

Cuthbert Industrials, Inc. prepares three-year comparative financial statements. In year 3, Cuthbert discovered an error in the previously issued financial statements for year 1. The error affects the financial statements that were issued in years 1 and 2. How should the company report the error?
A. The financial statements for years 1 and 2 should be restated; an offsetting adjustment to the cumulative effect of the error should be made to the comprehensive income in the year 3 financial statements.
B. The financial statements for years 1 and 2 should not be restated; financial statements for year 3 should disclose the fact that the error was made in prior years.
C. The financial statements for years 1 and 2 should not be restated; the cumulative effect of the error on years 1 and 2 should be reflected in the carrying amounts of assets and liabilities as of the beginning of year 3.
D. The financial statements for years 1 and 2 should be restated; the cumulative effect of the error on years 1 and 2 should be reflected in the carrying amounts of assets and liabilities as of the beginning of year 3.

D. The financial statements for years 1 and 2 should be restated; the cumulative effect of the error on years 1 and 2 should be reflected in the carrying amounts of assets and liabilities as of the beginning of year 3

When there is an error in prior period financial statements and those statements are presented with the current year, the error should be corrected in years 1 and 2 so they are comparative to year 3. The effect of the error should be reflected in the year 3 beginning balances of the appropriate asset and liabilities

3

The senior accountant for Carlton Co., a public company with a complex capital structure, has just finished preparing Carlton's income statement for the current fiscal year. While reviewing the income statement, Carlton's finance director noticed that the earnings-per-share data have been omitted. What changes will have to be made to Carlton's income statement as a result of the omission of the earnings-per-share data?
A. No changes will have to be made to Carlton 's income statement. The income statement is complete without the earnings-per-share data.
B. Carlton's income statement will have to be revised to include the earnings-per-share data.
C. Carlton's income statement will only have to be revised to include the earnings-per-share data if Carlton's market capitalization is greater than $5mn.
D. Carlton's income statement will only have to be revised to include the earnings-per-share data if Carlton's net income for the past two years is greater than $5mn.

B. Carlton's income statement will have to be revised to include the earnings-per-share data

All publicly traded companies are required to report EPS information. However, only the current year is affected. Restatement of prior-year statements is not required.

4

In which of the following situations should a company report a Prior period adjustment?
A. A change in the estimated useful lives of fixed assets purchased in prior years.
B. The correction of a mathematical error in the calculation of prior years' depreciation.
C. A switch from the straight-line to double-declining-balance method of depreciation.
D. The scrapping of an asset prior to the end of its expected useful life.

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

Only errors get adjusted to prior periods not accounting principal changes

5

In single period statements, which of the following should be reflected as an adjustment to the opening balance of retained earnings?
A. Effect of a failure to provide for uncollectible accounts in the previous period.
B. Effect of a decrease in the estimated useful life of depreciable equipment.
C. Adoption of a new accounting method for transactions that in the past had an immaterial effect on the financial statements.
D. Cumulative effect of a change from an accelerated method to straight-line depreciation.

A. Effect of a failure to provide for uncollectible accounts in the previous period.

Only errors get adjusted to prior periods not accounting principal changes

This is an error correction. The correction of an error affecting the income of prior periods is accounted for as a Prior period adjustment. This adjustment corrects the beginning retained earnings balance in the period the error was discovered, thereby correcting the retained earnings carried forward from earlier periods.

6

On January 2, 2003, Raft Corp. discovers that it had incorrectly expensed a $210,000 machine purchased on January 2, 2000. Raft estimates the machine's original useful life to be ten years and its salvage value at $10,000. Raft uses the straight-line method of depreciation and is subject to a 30% tax rate. In its December 31, 2003, financial statements, what amount should Raft report as a Prior period adjustment?

A.
$102,900

B.
$105,000

C.
$165,900

D.
$168,000

B.
$105,000

210-10=200
200/10=20
20*3(years)=60 total dep

210-60=150 (asset current value)

150*.7= 105,000

The after-tax understatement is .70 x $150,000 = $105,000. Prior period adjustments are recorded as of the beginning of the year in which the error is discovered

7

Miller Co. discovers that in the prior year, it failed to report $40,000 of depreciation related to a newly constructed building. The depreciation was computed correctly for tax purposes. The tax rate for the current year is 40%.
What was the impact of the error on Miller's financial statements for the prior year?

A. Understatement of accumulated depreciation of $24,000.
B. Understatement of accumulated depreciation of $40,000.
C. Understatement of depreciation expense of $24,000.
D. Understatement of net income of $24,000.

B. Understatement of accumulated depreciation of $40,000.

Accumulated depreciation is a pre-tax amount. The journal entry omitted in the past is:
dr. Depreciation expense, $40,000;
cr. Accumulated depreciation, $40,000.
The beginning balance of accumulated depreciation in the year the error was discovered is understated by $40,000 because that amount was not recorded in a prior year.

8

On January 2, 2005, Air, Inc. agrees to pay its former president $300,000 under a deferred-compensation arrangement.
Air should have recorded this expense in 2004, but did not do so. Air's reported income tax expense would have been $70,000 lower in 2004 had it properly accrued this deferred compensation.

In its December 31, 2005 financial statements, Air should adjust the beginning balance of its retained earnings by a

A. $230,000 credit.
B. $230,000 debit.
C. $300,000 credit.
D. $370,000 debit.

B. $230,000 debit.

The after-tax amount of the overstatement of 2004 earnings is $230,000 ($300,000 - $70,000 tax effect).
2004 income is overstated by this amount, because the expense and tax effect were not recorded. Ending 2004 retained earnings is overstated by $230,000. Therefore, beginning 2005 retained earnings must be decreased (debited) $230,000. This is accomplished by adjusting the beginning 2005 retained earnings balance with a Prior period adjustment of $230,000 (debit).

9

At the end of 2003, Ritzcar Co. fails to accrue sales commissions earned during 2003, but paid in 2004. The error is not repeated in 2004.
What was the effect of this error on 2003 ending working capital and on the 2004 ending retained earnings balance?

2003 ending working capital 20x4 ending retained earnings
Overstated Overstated
No effect Overstated
No effect No effect
Overstated No effect

Overstated No effect

The entry that should have been accrued at the end of 2003 is:

dr. Commission expense xxx
cr. Commission payable xxx
Working capital (current assets, less current liabilities) is overstated, because current liabilities (via unrecorded commission payable) are understated. By the end of 2004, the error has counterbalanced. The commission expense attributable to 2003 (in the above entry) would have been recognized as expense upon payment in 2004. Although earnings of both years are in error, the ending retained earnings balance for 2004 is correct.

10

Conn Co. reports a retained-earnings balance of $400,000 at December 31, 2004.
In August 2005, Conn determines that insurance premiums of $60,000 for the three-year period beginning January 1, 2004 had been paid and fully expensed in 2004. Conn has a 30% income tax rate.

What amount should Conn report as adjusted beginning retained earnings in its 2005 statement of retained earnings?

A. $420,000
B. $428,000
C. $440,000
D. $442,000

B. $428,000

The 2005 statement of retained earnings must disclose a Prior period adjustment to the beginning retained-earnings balance for the amount required to correct prior-year net income.
2004 insurance expense actually recognized (in error) $60,000
Less 2004 correct insurance expense - the amount that should have been recognized ($60,000/3 - a three-year policy) (20,000)
Equals the error in pre-tax income before 2005(income understated) $40,000
Times (1 - tax rate) to determine after-tax error x .70
Equals the error correction, the amount by which retained earnings at January 1, 2005 must be increased(the Prior period adjustment) $28,000
Plus unadjusted retained earnings at January 1, 2005 $400,000
Equals adjusted retained earnings at January 1, 2005 $428,000

11

A firm considers its regular warranty liability to be an existing liability of uncertain amount. At year-end, the firm estimates that the amount required to extinguish its warranty liability in the future is in the range of $20 to $60 million, with no amount more likely than any other. Under the two sets of standards, what amount will be recognized?

International U.S.
40 40
40 20
20 20
0 40

40 20

International accounting standards recognize the midpoint, whereas U.S. standards recognize the low point

12

Choose the correct statement about international accounting standards as they relate to contingent liabilities and similar items.
A. A provision that has a reasonably possible chance of requiring the outflow of benefits is treated as a contingent liability.
B. Provisions are recognized only when there is greater than a 90% probability of an outflow of benefits occurring.
C. A recognized provision is a contingent liability.
D. A provision for which it is probable that an outflow of benefits will be required is recognized, even if it is not of estimable amount.

A. A provision that has a reasonably possible chance of requiring the outflow of benefits is treated as a contingent liability.

A provision is a present obligation. This is one of the ways a liability can be treated as a contingent liability under international standards. If the provision involved a probable outflow, then it would be recognized, but would not be a contingent liability.

13

Which of the following is a recognized liability for both international accounting standards and U.S. standards?
A. Regular warranty liability, 60% probability of occurring.
B. Obligation to provide rebates to customers, 90% probability of occurring.
C. Possible loss due to lawsuit, 60% probability of occurring.
D. Possible loss due to lawsuit, 40% probability of occurring.

B. Obligation to provide rebates to customers, 90% probability of occurring.

For international accounting standards, this is a recognized provision. For U.S. standards, it is a recognized contingent liability.

14

Which of the following is not a contingent liability under international accounting standards?
A. A provision with a 60% chance of requiring an outflow of benefits, amount is estimable.
B. A provision with a 40% chance of requiring an outflow of benefits, amount is estimable.
C. A provision with a 90% chance of requiring an outflow of benefits, amount not estimable.
D. A possible obligation.

A. A provision with a 60% chance of requiring an outflow of benefits, amount is estimable.

A probable (< 50%) outflow of benefits is implied, and the amount is estimable. This is a recognized liability for international accounting standards, not a contingent liability.

15

Choose the correct statement regarding international accounting standards and U.S. standards as they relate to contingent liabilities and similar items.
A. All provisions under international accounting standards are contingent liabilities under U.S. standards.
B. Both sets of standards require discounting of estimated liabilities.
C. A possible obligation that requires a future event for confirmation is treated as a contingent liability under both sets of standards.
D. Both sets of standards are essentially the same with regard to recognition of contingent assets.

C. A possible obligation that requires a future event for confirmation is treated as a contingent liability under both sets of standards.

This is the one situation where both sets of standards agree with respect to classifying contingent liabilities. For international accounting standards, there are other situations calling for the reporting of a contingent liability.