F2 M2 - Accounting Changes and Error Corrections (2 counts)

Question 1

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

A.	As a component of income from continuing operations.

B.	By restating the financial statements of all prior periods presented.

C.	As a correction of an error.

D.	By footnote disclosure only.

Answer 1

Choice “A” is correct. When the effect of a change in accounting principle is inseparable from the effect of a change in accounting estimate, the reporting treatment for the overall effect is as a change in estimate. Thus, the effect is reported prospectively as a component of income from continuing operations.

Choice “B” is incorrect. Restatement of all prior periods is the retroactive accounting treatment that is applied to the correction of an error and the retrospective accounting treatment given to changes in accounting principle. However, a change in accounting principle that is inseparable from the effect of a change in accounting estimate is now treated as a change in accounting estimate.

Choice “C” is incorrect. Correction of an error is given retroactive treatment as a prior period adjustment to retained earnings with restatement of prior periods. This is not the treatment appropriate for the effect of a change in accounting principle that is inseparable from the effect of a change in accounting estimate.

Choice “D” is incorrect. While footnote disclosure is always appropriate for an accounting change, such disclosure alone is never the appropriate accounting treatment.

Question 2

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

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

B.	Prior period adjustment resulting from the change in accounting principle.

C.	Component of income from continuing operations.

D.	Component of income from continuing operations, net of tax.

Answer 2

Choice “A” is correct. The cash basis for financial reporting is not a generally accepted accounting basis of accounting (GAAP); therefore, it is an error. Correction of an error from a prior period is a reported as prior period adjustment to retained earnings.

Choice “B” is incorrect. Cash basis reporting is not an accounting principle under accrual accounting principles. Thus, the change from cash basis is not reported as a change in accounting principle. In addition, changes in accounting principle are not prior period adjustments; instead, they are treated retrospectively.

Choices “C” and “D” are incorrect. Correction of prior period errors has no effect on the current year’s income statement.

Question 3

Tack, Inc. reported a retained earnings balance of $150,000 at December 31, Year 1. In June Year 2, Tack discovered that merchandise costing $40,000 had not been included in inventory in its Year 1 financial statements. Tack has a 30% tax rate. What amount should Tack report as adjusted beginning retained earnings in its statement of retained earnings at December 31, Year 2?

A.	$190,000

B.	$178,000

C.	$150,000

D.	$122,000

Answer 3

Question 4

On January 2, Year 4, Raft Corp. discovered that it had incorrectly expensed a $210,000 machine purchased on January 2, Year 1. Raft estimated the machine’s original useful life to be 10 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, Year 4, financial statements, what amount should Raft report as a prior period adjustment?

A.	$102,900

B.	$105,000

C.	$165,900

D.	$168,000

Answer 4

Question 5

On January 1, year 1, Newport Corp. purchased a machine for $100,000. The machine was depreciated using the straight-line method over a 10-year period with no residual value. Because of a bookkeeping error, no depreciation was recognized in Newport’s year 1 financial statements, resulting in a $10,000 overstatement of the book value of the machine on December 31, year 1. The oversight was discovered during the preparation of Newport’s year 2 financial statements. What amount should Newport report for depreciation expense on the machine in the year 2 financial statements?

A.	$9,000

B.	$10,000

C.	$11,000

D.	$20,000

Answer 5

Choice “B” is correct. This error should be corrected by restating the opening balance of retained earnings by $10,000 for Year 2, if only Year 2 financial statements are being presented. If Year 1 financial statements are being presented, then they should be corrected to reflect the proper Year 1 depreciation expense. In either case, this would have NO effect on the Year 2 depreciation expense, which is $10,000.

Choices “A”, “C”, and “D” are incorrect. An error is not correct by spreading the difference into future years or by double-counting the error in the following year. The error is corrected by adjusting beginning retained earnings if the year of the error is not presented, or by correcting the error in the year of the error if that year is presented. Year 2 depreciation expense should be shown as if the error did not occur.

Question 6

Holt 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 20 percent. How should Holt report the correction of error in the current year?

A.	As an increase in accumulated depreciation of $32,000.

B.	As an increase in accumulated depreciation of $40,000.

C.	As an increase in depreciation expense of $32,000.

D.	As an increase of depreciation expense of $40,000.

Answer 6