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Accounting Changes and Error Analysis: Understanding GAAP Principle Shifts and Corrections, Slides of Business Accounting

This document, from Bob Anderson's UCSB Accounting course, covers various aspects of accounting changes, focusing on changes in accounting principles and estimates. the importance of materiality, the difference between changes in principle and estimates, and the required disclosures for each. It also includes examples and exercises to help students understand the concepts.

What you will learn

  • What is the difference between a change in accounting principle and a change in accounting estimate?
  • How should a company report a change in accounting principle?
  • What disclosures are required when a company makes an accounting change?

Typology: Slides

2021/2022

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08:35
22-1
Bob Anderson- UCSB
Accounting Changes and
Error Analysis
Chapter
22
22-2
Bob Anderson- UCSB
MATERIALITY!!!!
Everything ever must be material to matter.
Consequently, remember that for this whole
class, we assume the items we discuss are
material to the Company.
22-3
Bob Anderson- UCSB
Accounting Changes - APBO No. 20
Classifications:
a. Change in Accounting Principle --
- GAAP to GAAP change
»NEW literature: FASB Statement No.154.
b. Change in Accounting Estimate --
- Example = useful lives of fixed assets
c. Change in Reporting Entity --
- Example = changing specific subsidiaries in
consolidated financial statements.
22-4
Bob Anderson- UCSB
Change in Principle
Change from one GAAP to another GAAP
A change is NOT considered to result when a new
principle is adopt in recognition of events that have
occurred for the first time or that were were
previously immaterial.
Change from non GAAP to GAAP is not an
accounting changes but rather considered a
Correction of an Error
NOTE: When it is difficult to determine if it is a change
in estimate or a change in principle (such as change in
depreciation method), GAAP requires that it be treated
as a change in estimate (Current & Forward).
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22- Bob Anderson- UCSB

Accounting Changes and

Error Analysis

Chapter

22- Bob Anderson- UCSB

MATERIALITY!!!!

Everything ever must be material to matter.

Consequently, remember that for this whole

class, we assume the items we discuss are

material to the Company.

22-

Accounting Changes - APBO No. 20

Classifications: a. Change in Accounting Principle --

  • GAAP to GAAP change » NEW literature: FASB Statement No.154. b. Change in Accounting Estimate --
  • Example = useful lives of fixed assets c. Change in Reporting Entity --
  • Example = changing specific subsidiaries in consolidated financial statements.

22-

Change in Principle

 Change from one GAAP to another GAAP  A change is NOT considered to result when a new principle is adopt in recognition of events that have occurred for the first time or that were were previously immaterial.  Change from non GAAP to GAAP is not an accounting changes but rather considered a Correction of an Error  NOTE: When it is difficult to determine if it is a change in estimate or a change in principle (such as change in depreciation method), GAAP requires that it be treated as a change in estimate (Current & Forward).

22- Bob Anderson- UCSB

Enterprise must demonstrate that the new GAAP is preferable to the existing one. Three POSSIBLE Approaches for Reporting Changes:  Retroactive (adjust prior years)

 Currently (adjust current year)

 Prospective (adjust current and future years)

Change in Principle

22- Bob Anderson- UCSB

WHICH DO WE USE?

For years and years, we used the “Cumulative effect” method, but that recently changed (Due to IAS “Convergence”. GAAP requires the retrospective approach, which is WHAT YOU LEARNED IN 136A!!!!!  Report each year presented as if the new principle had always been in place  For the very first year presented, make sure to adjust the balance sheet accounts (including retained earnings) for the cumulative effect up to that point!

22-

CHANGE IN Recorded (FIFO) If used Wtd Average ACCOUNTING 2003 10,000 11, PRINCIPLE 2004 12,000 13, EXAMPLE 2005 18,000 15, 20062007 15,00016,000 18,00012, 2008 10,000 15, CUMULATIVE EFFECT 81,000 84, 2009 17,000 15, TOTAL THRU 09' 98,000 99, COGS recorded through end of 2008COGS if using wtd average over the same period 81,00084, Cumulative effect through 12/31/08 3, TO GET BEGINNING BALANCES RIGHT (Catch-up 2003-2008): Beginning retained earningsTax effect 1,9501, Inventory 3, AMOUNT TO RECORD IN 2009 AND THEREAFTER IS DETERMINED WITH NEW PRINCIPLE 2009 entry COGS (^) Inventory 15,000 15, RECAP. WHAT WE JUST DID: COGS recorded before we started messing with it:Cumulative effect adjustment 81,0003, 2009 COGS reported 15, 99,

COGS

changes their inventoryIn 2009, the company costing principle fromFIFO to weighted average. They have a35% effective tax rate and began business in2003. Assume they COGS for 2009 yet.have not recorded

Hmmm, isnt that the total we would have if we were using the new method all along!! 22-

CHANGE IN PRINCIPLE, REQUIRED DISCLOSURES:

 The Nature of and reason for the change  Method of applying the change (i.e retrospective)

  • Description of items that changed and by how much
  • The effect on the following items: » Income from continuing op’s » Net income » Any other significant measure, including per share
  • The cumulative effect on retained earnings.

22- Bob Anderson- UCSB

Change in Reporting Entity

Requires restating the financial statements of all prior periods presented (Retroactively).

Footnotes should describe the nature of the change and the reason for it.

22- Bob Anderson- UCSB

Correction of an Error

APBO No. 20 requires:

(a) treated as prior period adjustments,

(b) recorded in the year in which the error was

discovered, and

(c) reported in the F/S’s as an adjustment to the

beginning balance of Retained Earnings

If comparative statements are presented, the

prior statements affected should be restated to

correct the error.

22-

Errors

Can result from:

 Mathematical mistakes, improper estimates,

misapplication of accounting principles, etc.

Once discovered, the accountant must

determine:

(a) What type of error is involved?

(b) What entries are needed to correct the error?

(c) How are the F/S’s to be restated?

Does the error affect B/S, I/S, or both?

22-

ERRORS & RESTATEMENTS

In 1997, there were 116 restatements. In 2002 there were 330 and 323 in 2003!!!!!!!  Prevalence clearly growing!

  • Many argue that this is a one-time issue of fixing old problems.
  • I disagree. The Public Company Accounting Oversight Board (PCAOB) is closely reviewing public companies and have an OBVIOUS goal: Identify restatements  Top two causes: #1 reserves and contingencies, # Revenue recognition– say hello chapter 18 to the REAL WORLD!!!

22- Bob Anderson- UCSB

ERROR EXAMPLE

Company Eye Dunnonada, Inc. was not properly reporting revenue from a pool of notes receivable they owned. This had been going on since 1972. Their effective tax rate is 35%. Their analysis is:

Tax rate 35%

Pretax effect of errors Tax effect Tax effected Prior to 2002 100,000 35,000 65, 2002 10,000 3,500 6, 2003 (5,000) (1,750) (3,250) 2004 (5,000) (1,750) (3,250)

Overstated/ (Understated)

22- Bob Anderson- UCSB

ERROR EXAMPLE

 What are the journal entries for 2004, 2003 and 2002, respectively to properly fix the error? (assume that the basis in the note pool is the location of the problem on the balance sheet and interest income is the location of the problem on the income statement)  Based on recording the proper adjustments and including this impact in the tax provision, proper net income in 2004, 2003 and 2002 is $275,000, $200, and $280,000, respectively.  Present the 3 year statement of retained earnings assuming that the retained earnings at the beginning of 2002 (prior to any restatements) was $1,275,000.

22-

ERROR EXAMPLE SOLUTION

Tax rate 35% Pretax effect of errors Tax effect Tax effected Prior to 2002 2002 100,00010,000 35,0003,500 65,0006, 2003 (5,000) (1,750) (3,250) 2004 (5,000) (1,750) (3,250) 2002 ENTRY TO FIX BEGINNING RETAINED EARNINGS Beginning retained earnings 65, Notes receivable 100, Deferred taxes 35, 2002 ENTRY TO RECORD PROPERLY* Interest income 10, Notes receivable 10, 2003 ENTRY TO RECORD PROPERLY* Notes receivable 5, Interest income 5, 2004 ENTRY TO RECORD PROPERLY* Notes receivable 5, Interest income 5,

  • NOTE that as the "fix" occurs in the income statement before the income tax provision, these entries do not need to be tax effected- the tax provision will take this into account automatically.

Overstated/ (Understated)

22-

ERROR EXAMPLE- RETAINED EARNINGS

PRESENTATION

Retained earnings as of January 1, 2002, as previously reported 1,275, Correction of an error, see note X, net of $35, tax effect (65,000) Retained earnings as of January 1, 2002, as RESTATED 1,210,

Net income 2002 280, Retained eanrings at December 31, 2002 (^) 1,490,

Net income 2003 200, Retained earnings at December 31, 2003 (^) 1,690,

Net income 2004 (^) 275, Retained earnings at December 31, 2004 1,965,

Idunnonada, Inc. Statements of Retained Earnings

Restated, see note x

Restated, see note x