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54 views25 pagesChapter 9 (With Problems)
valix vol 3
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Abigail PadillaCopyright
© © All Rights Reserved
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/ 25
CHAPTER 9
ACCOUNTING CHANGES
Change in accounting policy
Prior period errors
TECHNICAL KNOWLEDGE
To understand the concept of a change in accounting policy.
To know the recognition and reporting of a change in
accounting policy. :
To know the guideline when selecting accounting policy in.
the absence of an accounting standard.
To understand the concept of prior period errors.
To know the recognition and reporting of prior period
errors.
230 ACCOUNTING POLICIES
Accounting Policies are ¢
conventions, rules and pr
preparing and presenting
he specific principles, bases,
‘actices applied by an entity in
financial statements.
Accounting policies
Are essential for a proper understandin;
of the information fanat 6
contained in the financial statements.
An entity is required to outline ail significant accounting
policies applied in preparing financial statements
Under accounting standards,
‘ alternative treatments are
possible.
In this case, it becomes all the more important for an entity
to clearly state the accounting policies used in preparing
financial statements, *
The entity shall select and apply the same accounting policies
each period in order to achieve comparability of financial
statements or to identify trends in the financial position,
performance and cash flows of the entity.
Change in accounting policy
Once selected, accounting policies must be applied
consistently for similar transactions and events.
‘A change in accounting policy shall be made only when:
a. Required by an accounting standard or an interpretatiqn
of the standard.
b. The change will result in more relevant and faithfully
represented information about the financial position,
financial performance and cash flows of the entity. i olicy
Examples of change in accounting P!
7 i ises when an entity ado
A change in accounting policy On 1. hich is different fron
generally accepted accounting principle w' from,
the one previously used by the entity.
Examples of change in accounting policy are:
a. Change in the method of inventory pricing from the Firo
to weighted average method.
7 ting for long ter,
b. Change in the method of accoun i
construction contract from cost recovery method ty
percentage of completion method.
initi i i ts at revalued
¢. The initial adoption of policy to carty, asset 1
amount is a change in accounting policy to be dealt with
as revaluation in accordance with PAS 16.
d. Change from cost model to fair value model in measuring
investment property.
e. Change to a new policy resulting from the requirement
of a new PFRS.
The following are not changes in accounting policy:
a. The application of an accounting policy for events or
transactions that differ in substance from previously
occurring events or transactions.
b. The application of a new accounting policy for events or
transactions which did not occur previously or that were
immaterial.,
How to report a change in accounting policy
A change in accounting policy required by a standard or 4°
interpretation shall be applied in accordance with the
transitional provisions therein.
If the standard or interpretation contains no transition®!
provisions or if an accounting policy is changed voluntarily:
the change shall be, applied restropectively or retroactivel)’
232 yr
Retrospective application
Rt one ae tion is applying a new accounting policy
” Tr event: fae * .
jad always been applied, ‘8 and conditions as if that policy
PAS 8, paragraph 22, provides that a just the
opening balance of each affected colafouont ot auuicr ie the
ae ea presented and the comparative amounts
jisclos Prior period : i
fig always been appliod, presented as if the new policy
Simply stated, retrospective application means that any
resulting adjustment from the change in accounting policy
shall be reported as an adjustment to the opening balance of
retained earnings.
The amount of the adjustment is determined as of the
beginning of the year of change.
However, the adjustment may be made to another component
of equity, not retained earnings, in order to comply with
another standard.
If comparative information is presented, the financial
statements of the prior period presented shall be restated
to conform with the new accounting policy.
The impact of the new policy on the retained earnings prior to
the earliest period presented shall be adjusted against the
opening balance of retained earnings.
‘Tilustration
An entity has used the FIFO method of inventory valuation
since it began operations in 2019. The entity decided to change
to the weighted average method for determining inventory
cost at the beginning of 2020.
FIFO Weighted average
December 31, 2019 1,000,000 750,000
December 31, 2020 1,500,000 1,200,000
FIFO inventory - January 1, 2020 1,000,000
Weighted average inventory - January 1, 2020 750,000
Decrease in beginning inventory 250,000
233 in peginning inventory
decrease
fthe 950,000
Adjustment o!
Retained earnings 250,009
Inventory - January 1
ost of goods gold for 2020 woulg
The c tation of the © 00 and i
then Show beginning inventory at Ee reehie snding
inventory at P1,200,000 to conform wit mee
method. ‘
i " i ity for the year endeq
The statement of changes 19 equity
December 31, 2020 would show the effect of the change of
P250,000 net of tax as a deduction from the beginning balance
of retained earnings.
Limitation of retrospective application
ge in accounting policy is
Restropective application of a chant e y
determine the cumulative
not required if it is impracticable to
effect of the change.
Applying a requirement of a standard is impracticable when
the entity cannot apply it after making every effort to do so.
For a particular prior period, it is impracticable to apply a
change in an accounting policy when:
1. The effects of the retrospective application are not
determinable.
2. Theretrospective application requires assumptions about
what management's intentions would have been at that
time.
3. The retrospective application requires significant
estimate, and it is impossible to distinguish objectively
information about the estimate that:
a. Provides evidence of circu: :
i msta: dat
that time, and mces that existe
b. Would have been available at that time.
284 prospective application
Prospective application means that the new accounting policy
is applied to events and transactio; i
at which the policy is changed,’ Curing after the date
When it is impracticable for an entity to apply a new
accounting policy retrospectively because it. cannot
determine the cumulative effect of applying the policy to all
prior periods, the entity shall apply the new policy
prospectively from the earliest Period practicable.
In other words, if the amount of thé adjustment on the
opening balance of retained earnings cannot be reasonably
determined, the change in accounting policy shall be applied
prospectively.
No adjustments relating to prior periods are made either to
the opening balance of retained earnings or other component
of equity because existing balances are not recalculated.
Change in reporting entity
A change in reporting entity is a change whereby entities
change their nature and report their operations in such a way
that the financial statements are in effect those of a different
reporting entity.
For example, this accounting change may result from
changing the specific subsidiaries comprising the group of
entities for which consolidated financial statements are
vresented,
Achange in reporting entity is actually a change in accounting
Policy and therefore shall be ‘treated retrospectively or
retroactively to disclose what the statements would have
looked like if the current entity had been-existence in the ,
Prior year.
In other words, the financial statements of all prior periods
Presented shall be restated to show financial information
for the new reporting entity.
235 ‘ d
Absence of accounting standar
i bs
PAS 8, paragraph 10, provides that Sere =a of an
accounting standard that epee th a selecting
t, agement shal us Baa is
eats ae pooeunting policy that arene that
is relevant to the economic decision ™! ‘ing Userg
and faithfully represented.
Paragraphs 11 and 12 specify the following hierarchy i
guidance which management may Ane - selecting
accounting policies in such circumstances:
a. Requirements of current standards dealing with similar
matters.
b. Definition, recognition criteria and measurement
concepts for assets, liabilities, income and expenses in
the Conceptual Framework for Financial Reporting.
c. Most recent pronouncements of other standard-setting
bodies that use a similar Conceptual Framework, other
accounting literature and accepted industry practices.
Prior period errors
Prior period errors are omissions and misstatements in the
financial statements for one or more periods arising from &
failure to use or misuse of reliable information that:
a, Was available when financial statements for those periods
were authorized for issue.
b. cou reasonably be expected to have been obtained and
taken into account in the preparati tio”
of those financial statements,” eae
Hick may occur as a result of mathematical mistak**
mistakes in applying accounting policies, misinte’ retatio?
of facts, fraud or oversight. , misinterp’
236 ee
How to treat prior period errors
Prior period errors shall be corrected retrospectively by
adjusting the opening balances of retained earnings and
affected assets and liabilities.
If comparative statements are presented, the financial
statements of the prior period shall be restated so as to reflect
the retroactive application of the prior period errors as a
retrospective restatement.
Retrospective restatement.means correcting the recognition,
measurement and disclosure of amounts of elements of
financial statements as if a prior period error had never
occurred.
In other words, the net income, its components, retained
earnings and other affected balances for the prior period
presented shall be adjusted accordingly.
If the error occurred before the earliest prior period
presented, the opening balances of assets, liabilities and
equity for the earliest prior period presented shall be
restated.
When it is impracticable to determine the cumulative effect
at the beginning of the current period of an error on all prior
periods, the entity shall restate the comparative information
to correct the error prospectively from the earliest date
practicable.
237 * . i rors
Disclosure of prior period er!
An entity shall disclose the following:
+ ‘ i ‘or.
a. The'nature of the prior period err
b. The amount of correction for each prior period Presenteq
to the extent practicable:
tatement line item affected,
a. For each financials I
d earnings per share.
b. For basic and dilute
c. The amount of correction at the beginning of the earlies,
prior period presented.
d. If retrospective restatement is impracticable for ,
particular prior period, the circumstances that led to the
existence of that condition and a description of how and
from when the error has been corrected.
Illustration
During 2021, an entity discovered that certain goods that
had been sold during 2020 were incorrectly included in
December 31, 2020 inventory in the amount of P300,000.
The accounting records for 2021 before adjustment revealed
sales of P5,000,000 and cost of goods sold of P3,000,000.
The adjustment on December 31, 2021 to correct the prior
period error is: f
Retained earnings 300,000
Inventory, January 1 (or cost of goods sold) 300,000
Accordingly, the partial income statement for 2021 would
appear as:
Sales
000,000
Cost of goods sold (3,000,000 - 300,000) 700,000
: Pear
Gross income 2,300,009
so
238 QUESTIONS
4, Define accounting policies.
2. Define @ change; in accounting policy.
3. Give examples of change in accounting policy.
4, When is a change in accounting policy allowed?
5. How is a change in accounting policy reported?
6. Explain the retrospective application of a change in
* accounting policy.
7. Explain the adoption of an accounting policy in the
absence of an accounting standard.
8. What is a change in reporting entity?
9. Define prior period errors.
10. Explain the treatment. of prior period errors.
239 PROBLEMS
Problem 9-1 (AICPA Adapted)
ae Z kk Company chan,
-At the beginning of current year, Blac! Bed
the inventory cost flow method to FIFO from LUFO for boy
financial statement and income tax reporting Purposes,
The change resulted in a P600,000 increase in the beginning
inventory.
Ignoring incomé tax, the accounting change should be
reported in the current year.
a. Income statement as a P600,000 debit
b. Retained earnings statement as a P600,000 debit
adjustment to the beginning balance —
c. Income statement as a P600,000 credit
d. Retained earnings statement as a P600,000 credit
adjustment to the beginning balance
Problem 9-2 (AICPA Adapted)
During the current year, Orca Company decided to change
from the FIFO method of inventory valuation to the weighted
average method. Inventory balances under each method
were as follows:
FIFO Weighted average
January 1 7,200,000 7,700,000
December 31 7,900,000 8,300,000
What amount should be reported as the pretax effect of the
accounting change in the statement of changes in equity for
the current year?
500,000 addition
500,000 deduétion
900,000 addition
900,000 deduction
Bop
240 ce.
problem 9-3 (AICPA Adapted)
Goddard Company had used the FIFO met! invento!
valuation since it began operations in 2017, The entity ‘decided
change to the weighted average method for determining
inventory cost at the beginning of 2020,
the entity provided the following year-end inventory
balances under FIFO and weighted average method:
a FIFO Weighted average
2017 4,500,000 5,400,000
au 7,800,000 7,100,000
2019 8,300,000 7,800,000
What pretax amount should be reported in the 2020 statement
of changes in equity as the cumulative effect of the change in
accounting policy?
a. 500,000 decrease
b, 300,000 decrease
c. 500,000 increase
d. 300,000 increase
Problem 9-4 (AICPA Adapted)
On January 1, 2020, Poe Construction Company changed to
the percentage of completion method from cost recovery
method of income recognition. On December 31, 2019, the
entity compiled data showing that income under the cost
recovery method aggregated P7,000,000.
If the percentage of completion method had been used, the
accumulated income through December 31, 2019 would have
been P9,000,000. The income tax rate is 30%.
The cumulative effect of the accounting change should be
reported in the 2020
a Retained earnings statement as P2,000,000 credit
adjustment to the beginning balance.
b, Income statement as P2,000,000 credit. :
©. Retained earnings statement as a P1,400,000 credit
adjustment to the beginning balance.
4. Income statement as a P1,400,000 credit.
241 Problein 9-5 (IAA)
any has used the cost TECOVey,
Banko Construction Comp: Ty
method of accounting since it bega” operations in 2017,
reasons, manage!
ion method.
g income for the past 3 year,
ment decided t
In 2020, for justifiable © adont
the percentage of completio!
The following schedule, reportini
has been prepared by the entity.
2017 2018 2019
Total revenue from
completed contracts 25,000,000 42,000,000 40,000,009
Less: Cost of completed
contracts 18,000,000- 29,000,000 28,000,000
Income from operations 7,000,000 13,000,000 | 12,000,009
om operation: 0 3 Coon
Casualty loss
Inceme 7,000,000 13,000,000 10,000,000
Analysis of the accounting records disclosed the following
income by contracts, earned in the years 2017-2019 using the
percentage of completion method.
2017 2018 2019
Contract 1 7,000,000
Contract 2 5,000,000 8,000,000
Contract 3 3,000,000 7,000,000 2,000,000
Contract 4 1,000,000 6,000,000
Contract 5 (2,000,000)
What pretax amount should be reported. as the cumulative
effect of change in accounting policy in the statement
retained earnings for 2020?
a. 6,000,000
b. 8,000,000
c. 7,000,000
da. 0
242 Problem 9-6 (IAA)
During 2020, Ruild Company changed from the cost recovery
method to the percentage of completi
is 30%. Gross profit figures ae letion method. The tax rate
2018 2019 2020
Cost recovery method 950,000 000
Percentage ofeompletion 1,600,000 Tepu'oue 10e 000
How should this accounting change be reported in 2020?
a. 1,300,000 increase in profit or loss
b. 1,300,000 increase in retained earnings
c. 910,000 increase in profit or loss
d. 910,000 increase in retained earnings
Problem 9-7 (IFRS)
Animus Company provided the following information at
year-end:
December 31, 2020 December 31, 2019
Development costs 8,160,000 5,840,000
Amortization (1,800,000) (1,200,000)
The capitalized development costs relate to a single project
that commenced in 2017. It has now been discovered that
one of the criteria for capitalization has never been met.
1. What adjustment is required to restate retained earnings
‘on January 1, 2020?
a. 6,360,000
b. 1,720,000
c. 4,640,000
d. 0 f :
2. What amount of the development costs should be
expensed in 2020?
a. 5,840,000
b. 6,360,000
e. 1,720,000
d. 0
248 N
Problem 9-8 (AICPA: Adapted)
While preparing the financial statements for 2020, Dati),
Company discovered computational errors in the 2018 a
2019 depreciation expense. fouch He
i t of each year’s inco,
‘These errors resulted in overstatement O° me
by P25,000, net of income tax. The net income for 2029 i
correctly reported at 500,000.
The following amounts were reported in the previously issueg
financial statements:
2019 2018
Retained earnings, January 1 To O00 200,
Net income Benne Rt oo
Retained earnings, December 31 850,000 700,009
== =
What is the balance of retained earnings on December 31,
2020?
a. 1,300,000
b. 1,350,000
ec. 1,400,000
d. 1,325,000
Problem 9-9 (IAA)
Effective January 1, 2020, King Company adopted the
accounting policy of expensing advertising and promotion
costs when: incurred. Previou: advertising and promotion
costs applicable to future periods were recorded in prepaid
_ expenses.
The entity can justify the change which was made for both
financial statement and income tax reporting purposes.
The prepaid advertising and promotion costs totaled P600,000
on December 31, 2019. The income tax rate is 30%,
What is the adjustment for the effect of the change it
accounting policy that should result in a net charge against
income for 2020?
nop
.
&
2
8
Ss
244 problem 9-10 (IFRS)
During the year ended D, i
events occurred at Harbor Compene? joa ine ef re
+ It was decided to write off P;
was over two years old ag
+ Sales of P1,000,000 had been omi i
rae omitt 1
tatements for the year ended Dee a Cal
What amount should be . . i
the finiancial statements for a0ae a prior period error in
a. 1,800,000
b. 1,000,000
c. 800,000
d. 200,000
P800,000 from inventory which
it was obsolete.
Problem 9-11 (IFRS)
In reviewing the draft financial statements for the year
ended December 31, 2020, Bituin Company decided that
market conditions were such that the provision for inventory
obsolescence on December 31, 2020 should be increased by
P3,000,000.
If the same basis of calculating inventory obsolescence had
been applied on December 31, 2019, the provision would have.
been P1,800,000 higher than-the amount recognized in the
statement of comprehensive income.
1. What adjustment should be made to net income of 2020?
a. 3,000,000 decrease
b. 3,000,000 increase
c. 1,200,000 decrease
d. 1,200,000 increase
2. What adjustment should be made to net income of 2019
presented as comparative figure in 2020?
1,800,000 decrease
1,800,000 increase
3,000,000 decrease
0
perp
246 Problem 9-12 (IFRS)
During the year ended December 31, 2020, Samar Company
revealed the following events: .
i inventory on December 3),
ating ie required @ reduction in the
n that date of P280,009,
+ A counting error rel :
2019 was discovered. Thi:
carrying amount of inventory ©}
ollectible accounts receivable on
300,000. During 2020, an amount
ff the December 31, 2019 accounts
+ The provision for unc
December 31, 2019 was
of P50,000 was written o}
receivable.
What pretax adjustment is required to restate retained
earnings on January 1, 2020?
a. 280,000
b. 300,000
c. - 580,000
da. 0
Problem 9-13 (PHILCPA Adapted)
After the issuance of the 2019 financial statements, Narra
Company discovered a computational error of P150,000 in
the calculation of the December 31, 2019 inventory. The error’
resulted in a P150,000 overstatement in the cost of goods
sold for the year ended December 31, 2019.
In October 2020, the entity paid the amount of P500,000 in
settlement of litigation instituted against it during 2019.
In the 2020 financial statements, what is the pretax
adjustment to retained earnings on January 1, 2020?
150,000 credit
a.
b. 350,000 debit
ce. 500,000 debit
d. 650,000 credit
246 ce
problem 9-14 (AICPA Adapted)
niversal Company failed to accru 000
u December 31, 2019. ‘e warranty cost of P100,|
In addition, a change from straight line to accelerated
depreciation made at the beginning of 2020 resulted in a
cumulative effect of P60,000 on retained earnings.
What pretax amount should be reported as prior period error
in 2020? .
a. 100,000
b. 160,000
c. 60,000
d. 0
Problem 9-15 (AICPA Adapted)
On January 1, 2020, Raven Company discovered that it had
incorrectly expensed a P2,100,000 machine purchased on
January 1, 2017.
The entity estimated the machine's original useful life to be
10 years and the residual value at P100,000.
The entity used the straight line method of depreciation and
is subject to a 30% income tax rate.
In the December 31, 2020 financial statements, what amount
should be reported as a prior period error?
a. 1,659,000
b. 1,029,000
© 1,050,000
4. 1,680,000
247 Ny
Problem 9-16 (IFRS)
Natasha Company reported net income of P700,000 for 2029
The entity declared and paid dividends of P150,000 in 2029
and P3800,000 in 2019.
ments for the year ended December
tained earnings of P1,100,009 ,,
d ret or 2019 was P600,000,
In the financial state:
2019, the entity reporte
January 1, 2019. The net income
In 2020, after the 2019 financial statements were approved
for issue, the entity discovered an error In the December 31,
2020 financial statements.
The after-tax effect of the error was a P650,000 overstatement
of net income for the year ended December 31, 2019 due to
underdepreciation.
1. What amount was reported as retained earnings on
December 31, 2019?
1,400,000
1,700,000
2,000,000
2,100,000
Bo op
2. What amount should be reported as retained earnings
on December 31, 2020?
1,300,000
2,900,000
1,650,000
1,950,000
peop
248 problem 9-17 Multiple choice (IFRS)
1, Which is the first step within the hi i
when selecting accounting ee, of guidance
. Apply a sti apis, .
a ey ronal from IFRS if it specifically relates
b. Apply the requirements i as ced
and related issue. an ee dealing with similar
e. Consider the applicability of the definitions,
recognition criteria and measurement concepts in the
Conceptual Framework,
d. Consider the most recent pronouncements of other
standard setting bodies,
2. In the absence of an accounting standard that applies
specifically to a transaction, what is the most authoritative
source in developing and applying an accounting policy?
a, The requirement and guidance in the standard or
interpretation dealing with similar and related issue.
b. The definition, recognition criteria and measurement
of asset, liability, income and expense in the Conceptual
Framework.
c. Most recent pronouncement of other standard-setting
body.
d. Accounting literature and accepted industry practice.
3. A change in accounting policy shall be made when
I. Required by law.
IL. Required by an accounting standard or an interpretation
of the standard.
Ill. The change will result in more relevant or reliable
information about the financial position, financial
performance and cash flows of the entity.
Land III only
. Il and III only
Tand II only
. I, and III
peop
249 itted to change an accounting
4. Why is an entity per™
policy?
ity to present a more
ti
a. The change would allow the en!
SOO the financial stateme,
result in 1 nts
. The ang more reliable and relevant information
about financial position, financial performance ang
h flows. ere 7
c. The change is made by the interne! auditor.
d. The change is made by the CPA.
5. A change in accounting policy requires what kind of
adjustment to the financial statements!
a. Current period adjustment
b. Prospective adjustment
c. Retrospective adjustment
d. Current and prospective adjustment
requires that the
6. A change in accounting policy re\ S
prior periods should
cumulative effect of the change for
be reported as an adjustment to
a. Beginning retained earnings for the earliest period
presented.
b. Net income for the period in which the change
occurred.
c. Comprehensive income for the earliest period
presented.
d. Shareholders’ equity for the period in which the
change occurred. ‘
7. Which of the following is accounted f in
accounting policy? for as a change »
a. Achange in the estimated i
eaicrtinens useful life of property, plant
b. Achange from cash basis to accrual basis of accounting
ae ange from expensing immaterial expenditures t
leferring and amortizing them when material
d. Achange in i
ae i inventory valuation from FIFO to averaé® |