Ch 22 - Quiz

Question 1

Miller Co. discovered 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 was 40%. What was the impact of the error on Miller’s financial statements for the prior year?

A.) Understatement of accumulated depreciation of $40,000.

B.) Understatement of net income of $24,000.

C.) Understatement of accumulated depreciation of $24,000.

D.) Understatement of depreciation expense of $24,000.

Answer 1

A.) Understatement of accumulated depreciation of $40,000.

The result of this error would have been an understatement of depreciation by $40,000 and understatement of accumulated depreciation by $40,000 and an overstatement of net income by $24,000.

[$40,000 × (1 − 0.4)]

Question 2

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

A.) Overstated —— No Effect

B.) No effect —— No effect

C.) No effect —— Overstated

D.) Overstated —— Overstated

Answer 2

A.) 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.

Question 3

On January 1, Year 3, a company changed its inventory costing method from LIFO to FIFO. The company’s Year 3 financial statements contain comparative information for Year 2. How should the company present the Year 1 effect of the change in accounting principle in its Year 3 comparative financial statements?

A.) As an adjustment to the beginning Year 2 inventory balance with an offsetting adjustment to beginning Year 2 retained earnings

B.) As an extraordinary item in the Year 2 income statement

C.) As part of income from continuing operations in the Year 2 income statement

D.) As a note disclosure only

Answer 3

A.) As an adjustment to the beginning Year 2 inventory balance with an offsetting adjustment to beginning Year 2 retained earnings

Changes in accounting principles are applied retrospectively. Therefore, the beginning inventory of the earliest year presented is adjusted as if FIFO had always been applied. The earliest year presented is Year 2. Therefore, the beginning inventory and beginning retained earnings of Year 2 would be adjusted for the cumulative effect of the principle change.

Question 4

Changes in accounting principle are generally accounted for:

A.) prospectively.

B.) retrospectively.

C.) consistently.

D.) currently.

Answer 4

B.) retrospectively.

Question 5

A change from an accelerated method to the straight-line method of depreciation requires an adjustment to the beginning balance of retained earnings.

A.) True

B.) False

Answer 5

B.) False

A change in the depreciation method used is a change in accounting estimate and is accounted for in the current and future periods. It is not a change in accounting principle. Retained Earnings is not adjusted.

Question 6

Corrections of errors from prior periods are reported:

A.) between discontinued operations and net income on the income statement.

B.) as adjustments of beginning retained earnings of the earliest year presented.

C.) as a discontinued operation.

D.) as adjustments to the current year’s beginning retained earnings.

Answer 6

D.) as adjustments to the current year’s beginning retained earnings.

Question 7

A company fails to record accrued wages for the current year. Which of the following statement is true?

A.) Net income for the current year is understated.

B.) Retained earnings for the current year is understated.

C.) Net income for the current year is correct.

D.) Retained earnings for the current year is overstated.

Answer 7

D.) Retained earnings for the current year is overstated.

If a company fails to record accrued wages for the current year, then expenses for the current year are understated; therefore net income and retained earnings for the current year are overstated.

Question 8

On January 1, 2017, Columbia Corp. changed its inventory method to FIFO from LIFO for both financial reporting purposes. The change resulted in an increase in the Inventory account. The net of tax amount of the increase was $2,320,000 on January 1, 2017 (all tax effects should be ignored). The cumulative effect of the accounting change should be reported by Columbia in its 2017:

A.) retained earnings statement as a $2,320,000 addition to the ending balance.

B.) retained earnings statement as a $2,320,000 deduction from the beginning balance.

C.) income statement as a $2,320,000 cumulative effect of accounting change.

D.) retained earnings statement as a $2,320,000 addition to the beginning balance.

Answer 8

D.) retained earnings statement as a $2,320,000 addition to the beginning balance.

The change in inventory method to FIFO from LIFO which resulted in an increase in Inventory should be reported in the retained earnings statement as a $2,320,000 addition to the beginning balance.

Question 9

Which of the following describes a change in reporting entity?

A.) A manufacturing company expands its market from regional to nationwide.

B.) A company divests itself of a European branch sales office.

C.) A company acquires 10% of the outstanding stock of a supplier.

D.) A company changes the companies included in combined financial statements.

Answer 9

D.) A company changes the companies included in combined financial statements.

Question 10

All of the following involve counterbalancing errors except the

A.) understatement of inventory.

B.) overstatement of purchases.

C.) failure to adjust for bad debts.

D.) failure to record prepaid expenses.

Answer 10

C.) failure to adjust for bad debts.

Failure to adjust for bad debts is a non-counterbalancing error.

Question 11

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

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

B.) A correction of an error.

C.) Not an accounting change.

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

Answer 11

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

Correct answer icon
This answer is correct 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.

Question 12

Lore Co. changed from the cash basis to the accrual basis of accounting during 2005. The cumulative effect of this change should be reported in Lore’s 2005 financial statements as a

A.) Prior period adjustment resulting from the correction of an error.

B.) Adjustment to retained earnings for an accounting principle change.

C.) Prior period adjustment resulting from the change in accounting principle.

D.) Component of income after extraordinary item.

Answer 12

A.) Prior period adjustment resulting from the correction of an error.

The cash basis of accounting is not acceptable under GAAP. Therefore, the change to the accrual basis is a change from an unacceptable method or basis of accounting to an acceptable method or basis. Such a change is treated as an error correction, which is reported as a Prior period adjustment. This adjustment is to the beginning balance in retained earnings for the current year.

Question 13

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

A.) In the year 2 retained earnings statement as an $800,000 credit adjustment to the beginning balance.

B.) 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.

C.) In the year 2 income statement as an $800,000 loss from cumulative effect of change in accounting principle.

D.) In the year 1 retained earnings statement as an $800,000 debit adjustment to the beginning balance.

Answer 13

B.) 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.

Question 14

Mellow Co. depreciated a $12,000 asset over five years, using the straight-line method with no salvage value. At the beginning of the fifth year, it was determined that the asset will last another four years. What amount should Mellow report as depreciation expense for year 5?

A.) $2,400

B.) $900

C.) $1,500

D.) $600

Answer 14

D.) $600

According to ASC Topic 250, a change in the estimated life of an asset is accounted for on a prospective basis. Depreciation expense in years 1 through 4 is calculated as $12,000 ÷ 5 years = $2,400 per year. At the end of year 4, the book value of the asset is $2,400 and this amount is depreciated over the newly estimated remaining life of 4 years. Therefore, the depreciation expense in year 5 would be $2,400 ÷ 4 remaining years = $600. Therefore, this answer is correct.

Question 15

Jackson Company uses IFRS to report its financial results. During the current year, the company discovered it had overstated sales in the prior year. How should the company handle this issue?

A.) Present the cumulative effect of the overstatement as an item in the current period income statement.

B.) Spread the adjustment over the current and future periods.

C.) Restate the prior year financial statements presented for comparative purposes.

D.) Adjust sales for the current period.

Answer 15

C.) Restate the prior year financial statements presented for comparative purposes.

The overstatement is an error which must be accounted for by restating the prior year financial statements.

Question 16

While preparing its year 3 financial statements, Dek Corp. discovered computational errors in its year 2 and year 1 depreciation expense. These errors resulted in overstatement of each year’s income by $25,000, net of income taxes. The following amounts were reported in the previously issued financial statements:

𝗬𝗲𝗮𝗿 𝟮
Retained Earnings, 1/1: $700,000
Net Income: $150,000
Retained Earnings, 12/31: $850,000

𝗬𝗲𝗮𝗿 𝟯
Retained Earnings, 1/1: $500,000
Net Income: $200,000
Retained Earnings, 12/31: $700,000

Dek’s year 3 income is correctly reported at $180,000. Which of the following amounts should be adjusted to retained earnings and presented for net income in Dek’s year 3 and year 2 comparative financial statements?

A.) 𝗬𝗲𝗮𝗿 𝟮
Retained Earnings: ($50,000)
Net Income: $150,000
𝗬𝗲𝗮𝗿 𝟯
Retained Earnings: -- 
Net Income: $180,000

B.) 𝗬𝗲𝗮𝗿 𝟮
Retained Earnings: ($50,000)
Net Income: $125,000
𝗬𝗲𝗮𝗿 𝟯
Retained Earnings: --
Net Income: $180,000

C.) 𝗬𝗲𝗮𝗿 𝟮
Retained Earnings: --
Net Income: $125,000
𝗬𝗲𝗮𝗿 𝟯
Retained Earnings: --
Net Income: $180,000

D.) 𝗬𝗲𝗮𝗿 𝟮
Retained Earnings: --
Net Income: $150,000
𝗬𝗲𝗮𝗿 𝟯
Retained Earnings: ($50,000)
Net Income: $180,000

Answer 16

B.) 𝗬𝗲𝗮𝗿 𝟮
Retained Earnings: ($50,000)
Net Income: $125,000
𝗬𝗲𝗮𝗿 𝟯
Retained Earnings: --
Net Income: $180,000

ASC Topic 250 requires that items of profit or loss related to the correction of an error in the financial statements of a prior period be accounted for and reported as prior period adjustments and excluded from the determination of net income for the current period. When comparative financial statements are prepared, it is necessary to adjust net income, its components, retained earnings balances, and other affected balances for all of the periods presented to reflect retroactive application of prior period adjustments. Hence, the amounts for each period must be stated in the comparative statements as if the errors had not occurred. Thus, both year 1 and year 2 net income and retained earnings would be retroactively reduced by $25,000 to reflect the correct amounts for each period. After these adjustments are made, the amounts for year 3 will be correctly stated. Note that this retroactive treatment is only used for presentation purposes in the comparative financial statements. The actual journal entry made to correct retained earnings at 1/1/Y3 is

Dr. Retained earnings…………………………………………….50,000
Cr. …………….Accumulated depreciation…………………………………………..50,000

Question 17

During year 3, Orca Corp. decided to change from the FIFO method of inventory valuation to the weighted-average method. Inventory balances under each method were as follows:

𝗝𝗮𝗻𝘂𝗮𝗿𝘆 𝟭, 𝘆𝗲𝗮𝗿 𝟯
FIFO: $71,000
Weighted-Average: $77,000

𝗗𝗲𝗰𝗲𝗺𝗯𝗲𝗿 𝟯𝟭, 𝘆𝗲𝗮𝗿 𝟯
FIFO: $79,000
Weighted-Average: $83,000

Orca’s income tax rate is 30%.

In its year 3 financial statements, what amount should Orca report as the gain or loss on the cumulative effect of this accounting change?

A.) $0

B.) $4,000

C.) $4,200

D.) $2,800

Answer 17

A.) $0

A change in inventory method no longer receives cumulative effect treatment on the income statement. Instead, the accounting change is given retrospective application to the earliest period presented, if practicable. Therefore, the answer is zero.

Question 18

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.) Under IFRS, the impracticability exception applies both to changes in accounting principles and to the correction of errors.

C.) The accounting for changes in estimates is similar between GAAP and IFRS.

D.) GAAP has detailed guidance on the accounting and reporting of indirect effects; IFRS does not.

Answer 18

A.) GAAP and IFRS have the same absolute standard regarding the reporting of error corrections in previously issued financial statements.

Question 19

The cumulative effect of an accounting change is not computed for a change:

A.) from the LIFO method to the FIFO method.

B.) to the percentage-of-completion method from the completed-contract method.

C.) to the LIFO method from the FIFO method.

D.) All of these answer choices are correct.

Answer 19

C.) to the LIFO method from the FIFO method.

The cumulative effect of accounting change is computed for all of the options except a change from the FIFO method to the LIFO method.

Question 20

When converting to the equity method of accounting, retrospective application is required.

A.) True

B.) False

Answer 20

A.) True

When converting to the equity method, the carrying amount of the investment, results of current and prior operations, and retained earnings are all adjusted as if the equity method had been used for all the previous periods for which the investment was held.