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Accounting Changes Chapter 20

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Chapter 20 Accounting Changes True/False Questions 1. Most, but not all, changes in accounting principle are reported using the retrospective approach. 2. All changes in estimate are acco... unted for retrospectively. 3. Both changes in reporting entities and material error corrections are reported prospectively. 4. Most changes in accounting principle require a disclosure justifying the change in the first set of financial statements after the change is made. 5. Error corrections require restatement of all the affected prior year financial statements reported in comparative financial statements. 6. A change to the LIFO method of valuing inventory requires use of the retrospective method. 7. Prior years' financial statements are restated when the prospective approach is used. 8. The after-tax cumulative effect on income is no longer required for changes in accounting principles. 9. All changes reported using the retrospective approach require prior period adjustments. 10. A change in reporting entity requires footnote disclosure in all subsequent financial statements prepared for the new entity. 79 Chapter 20 Accounting Changes Matching Pair Questions Use the following to answer questions 11-20: 11-20. Indicate the nature of each of the situations described below using the following three-letter code. CODE DESCRIPTION CPR: Change in principle reported retrospectively CPP: Change in principle reported prospectively CES: Change in estimate CRE: Change in reporting entity PPA: Prior period adjustment required 11. ____ Technological advance that renders worthless a patent with an unamortized cost of $45,000. 12. ____ Change from LIFO inventory costing to average inventory costing. 13. ____ Including in the consolidated financial statements a subsidiary acquired several years earlier that was appropriately not included in previous years. 14. ____ Change from FIFO inventory method to LIFO. 15. ____ Pension plan assets for a defined benefit pension plan achieving a rate of return in excess of the amount anticipated. 16. ____ Change from the direct write-off method to the allowance method for recording bad debt expense. (Assume bad debts are material in this case and have always been material.) 17. ____ Change from declining balance depreciation to straight-line. 18. ____ Change from determining lower of cost or market for inventories by the individual item approach to the aggregate approach. 19. ____ Settling a lawsuit for less than the amount accrued previously as a loss contingency. 20. ____ Change in the estimated useful life of office equipment. 80 Chapter 20 Accounting Changes Use the following to answer questions 21-30: 21-30. Indicate the nature of each of the situations described below using the following three-letter code. CODE DESCRIPTION CPR: Change in principle reported retrospectively CPP: Change in principle reported prospectively CES: Change in estimate CRE: Change in reporting entity PPA: Prior period adjustment required 21. ____ Change from FIFO inventory costing to LIFO inventory costing. 22. ____ Change from LIFO inventory costing to FIFO inventory costing. 23. ____ Change in the composition of a group of firms reporting on a consolidated basis. 24. ____ Change to the installment method of accounting for receivables. 25. ____ Change in actuarial assumptions for a defined benefit pension plan. 26. ____ Change from sum-of-the-years' digits depreciation to straight-line. 27. ____ Change from expensing extraordinary repairs to capitalizing the expenditures. 28. ____ Change in the percentage used to determine bad debts. 29. ____ Change from reporting postretirement benefits according to the provisions of Accounting Principles Board Opinion to reporting the benefits according to the provisions of SFAS 109. 30. ____ Change in the residual value of machinery. Use the following to answer questions 31-35: 31-35. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase. Terms: A. Changes in accounting estimates B. Changes in accounting principle C. Changes in inventory supplier D. Changes in reporting entity E. Disclosure note F. Estimates of future EPS G. Error corrections H. Immaterial changes I. Prior period adjustment J. Prospective approach Phrases: 31. ____ Required for all material changes and error corrections. 32. ____ The approach now used for changes in depreciation methods. 33. ____ Most are handled under the retrospective approach. 34. ____ Involves consolidated financial statements. 35. ____ Always handled retrospectively. 81 Chapter 20 Accounting Changes Use the following to answer questions 36-40: 36-40. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase. Terms: A. Changes in accounting estimates B. Changes in accounting principle C. Changes in reporting entity D. Current period adjustment to income statement only E. Error corrections F. Prior period adjustment G. Pro forma disclosure H. Prospective approach I. Retrospective approach J. Simulation techniques Phrases: 36. ____ No longer used for changes in accounting principles. 37. ____ Adjustment to retained earnings of earliest year reported. 38. ____ No journal entry needed, but disclosure is required. 39. ____ Handled prospectively. 40. ____ "As if" amounts for net income and Multiple Choice Questions 41. Which of the following accounting changes should not be accounted for prospectively? A) The correction of an error. B) A change from declining balance to straight-line depreciation. C) A change from straight-line to declining balance depreciation. D) A change in the expected salvage value of a depreciable asset. 42. Which of the following changes should be accounted for using the retrospective approach? A) A change in the estimated life of a depreciable asset. B) A change from straight-line to declining balance depreciation. C) A change to the LIFO method of costing inventories. D) A change from the completed-contract method of accounting for long-term construction contracts. 82 Chapter 20 Accounting Changes 43. Which of the following changes would not be accounted for using the prospective approach? A) A change to LIFO from average costing for inventories. B) A change from the individual application of the LCM rule to aggregate approach. C) A change from straight-line to double-declining balance depreciation. D) A change from double-declining balance to straight-line depreciation. 44. Which of the following would not be accounted for using the retrospective approach? A) A change from LIFO to FIFO inventory costing. B) A change from the completed contract method to the percent-of-completion method for long-term construction contracts. C) A change in depreciation methods. D) A change from the full cost method in the oil industry. 45. Which of the following would not be accounted for using the prospective approach? A) A change to LIFO from FIFO for inventory costing. B) A change in price indexes used under the LIFO method of inventory costing. C) Amortization of the transition amount under SFAS 109. D) A change from the cash basis to accrual accounting. 46. Which of the following changes should be accounted for using the retrospective approach? A) A change in the estimated useful life of a depreciable asset. B) A change from straight-line to double-declining-balance depreciation. C) A change from percentage-of-completion to the completed contract method. D) A change to LIFO from FIFO inventory costing. 47. How many acceptable approaches are there for changes in accounting principles? A) One B) Two C) Three D) Four 48. Which of the following is an example of a change in accounting principle? A) A change in depreciation methods. B) A change in the estimated useful life of a depreciable asset. C) A change in the actuarial life expectancies of employees under a pension plan. D) Consolidating a new subsidiary. 83 Chapter 20 Accounting Changes 49. Which of the following is not an example of a change in accounting principle? A) A change in the useful life of a depreciable asset. B) A change from LIFO to FIFO for inventory costing. C) A change to the full costing method in the extractive industries. D) A change from the cost method to the equity method of accounting for investments. 50. Which of the following is a change in estimate? A) A change from the full costing method in the extractive industries. B) A change from percentage-of-completion to the completed contract method. C) Consolidating a subsidiary for the first time. D) A change in the termination rate of employees under a pension plan. 51. Which of the following is not a change in estimate? A) A change in the life of a depreciable asset. B) A change in the mortality rate used for pension computations. C) A change from the cost to the equity method in accounting for investments. D) A change in the bad debt percentage. 52. Which of the following is a change in reporting entity? A) A change to the full cost method in the extractive industries. B) Switching to the completed contract method. C) A change from the cost to the equity method. D) Consolidating a subsidiary not previously included in consolidated financial statements. 53. Which of the following is not a change in reporting entity? A) Reporting using comparative financial statements for the first time. B) Changing the companies that comprise a consolidated group. C) Presenting consolidated financial statements for the first time. D) All are changes in reporting entity. 54. A change in the residual value of equipment is treated? A) currently. B) prospectively. C) retrospectively. D) None of the above.. Answer: B Learning Objective: 4 Level of Learning: 2 84 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition Chapter 20 Accounting Changes 55. When the retrospective approach is used for a change to the FIFO method, which of the following accounts is usually not adjusted? A) Deferred Income Taxes B) Inventory C) Retained Earnings D) All of the above usually are adjusted 56. Prior years' financial statements are restated under the: A) Current approach. B) Prospective approach. C) Retrospective approach. D) None of the above 57. Which of the following is not one of the approaches for reporting accounting changes? A) The change approach. B) The retrospective approach. C) The prospective approach. D) All three of the above are approaches for reporting accounting changes. 58. A change that uses the prospective approach is accounted for by: A) Implementing it in the current year. B) Reporting pro forma data. C) Retrospective restatement of all prior financial statements in a comparative annual report. D) Giving current recognition of the past effect of the change. 59. An accounting change that is reported by the prospective approach is reflected in the financial statements of: A) Prior years only. B) Prior years plus the current year. C) The current year only. D) Current and future years. 60. When a change in accounting principle is reported, what is sometimes sacrificed? A) Relevance. B) Consistency. C) Conservatism. D) Reliability. Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 85 Chapter 20 Accounting Changes 61. Accounting changes occur for which of the following reasons? A) Management is being fair and consistent in financial reporting. B) Management compensation is affected. C) Debt agreements are impacted. D) All of the above. 62. The cumulative effect of a change in accounting principle is reported: A) On the income statement between extraordinary items and net income. B) On the income statement after income before income tax. C) On the income statement between discontinued operations and extraordinary items. D) In the balance sheet accounts affected. 63. National Hoopla Company switches from sum-of-the-years' digits depreciation to straight-line depreciation. As a result: A) Current income tax payable increases. B) Current tax expense decreases. C) The deferred portion of tax expense increases. D) None of the above. 64. Companies should report the cumulative effect of an accounting change: A) In the quarter in which the change is made. B) In the annual financial statements only. C) In the first quarter of the fiscal year in which the change is made. D) Never. 65. If a change is made from straight-line to SYD depreciation, one should record the effects by a journal entry including: A) A credit to deferred tax liability. B) A credit to accumulated depreciation. C) A debit to depreciation expense. D) No journal entry is required. 66. An item that should be reported as a prior period adjustment is the: A) Correction of an error in depreciation from last year. B) Payment of taxes due to a tax audit of last year's tax return. C) Collection of a previously written off bad debt. D) Receipt of the proceeds of a note receivable that was due last year. Chapter 20 Accounting Changes 67. Disclosure notes related to a change in accounting principle under the retrospective approach should include: A) The effect of the change on executive compensation. B) The auditor's approval of the change. C) The SEC's permission to change. D) Justification for the change. 68. When an accounting change is reported under the retrospective approach, prior years' financial statements are: A) Restated to reflect the use of the new principle. B) Reported as previously prepared. C) Left unchanged. D) Adjusted using prior period adjustment procedures. 69. When an accounting change is reported under the retrospective approach, account balances in the general ledger: A) Are not adjusted. B) Are closed out and then updated. C) Are adjusted net of the tax effect. D) Are adjusted to what they would have been had the new method been used in previous years. 70. Regardless of the type of accounting change that occurs, the most important responsibility is: A) To properly determine the tax effect. B) To communicate that a change has occurred. C) To compute the correct amount of the change. D) None of the above. 71. Cooper Inc. took physical inventory at the end of 2005. Purchases that were acquired FOB destination were in transit, so they were not included in the physical count. A) Cooper needs to correct an accounting error. B) Cooper has made a change in accounting principle, requiring retrospective adjustment. C) Cooper is required to adjust a change in accounting estimate prospectively. D) Cooper is not required to make any accounting adjustments. Rationale: This inventory should be excluded because it had not yet reached its destination, where title passes. 87 Chapter 20 Accounting Changes 72. Washburn Co. spent $10 million to purchase a new patented technology, debiting an intangible asset and crediting cash. A) Washburn is not required to make any accounting adjustments. B) Washburn is required to adjust a change in accounting estimate prospectively. C) Washburn has made a change in accounting principle, requiring retrospective adjustment. D) Washburn needs to correct an accounting error. 73. Gore Inc. recorded a liability in 2006 for probable litigation losses of $2 million. Ultimately, $5 million in legitimate warranty claims were filed by Clifton's customers. A) Gore has made a change in accounting principle, requiring retrospective adjustment. B) Gore needs to correct an accounting error. C) Gore is required to adjust a change in accounting estimate prospectively. D) Gore is not required to make any accounting adjustments. 74. During 2006, Hoffman Co. uses FIFO to account for its inventory transactions. Previously, it had used LIFO. A) Hoffman is not required to make any accounting adjustments. B) Hoffman has made a change in accounting principle, requiring retrospective adjustment. C) Hoffman is required to adjust a change in accounting principle prospectively. D) Hoffman needs to correct an accounting error. 75. In December 2006, Kojak Insurance Co. received $500,000 in premiums for a two-year property insurance policy. The company recorded the transaction by debiting cash and crediting insurance premium revenue for the full amount. An internal audit conducted in early 2007 flagged this transaction. A) Kojak needs to correct an accounting error. B) Kojak has made a change in accounting principle, requiring retrospective adjustment. C) Kojak is required to adjust a change in accounting estimate prospectively. D) Kojak is not required to make any accounting adjustments. Use the following to answer questions 76-78: Berkshire Inc. uses a periodic inventory system. At the end of 2005, it missed counting some inventory items, resulting in an inventory understatement by $600,000. Assume that Berkshire has a 30% income tax rate and that this was the only error it made. 76. What is the effect of this error on Berkshire's 12/31/05 balance sheet? A) Assets understated by $600,000 and shareholders' equity understated by $600,000. B) Assets understated by $420,000 and shareholders' equity understated by $420,000. C) Assets understated by $600,000, liabilities understated by $180,000 and shareholders' equity understated by $420,000. D) None of the above is correct. Chapter 20 Accounting Changes 77. What is the effect of the error on Berkshire's 2006 income statement? A) Net income is understated by $420,000 B) Cost of goods sold is understated by $420,000. C) There are no errors in the 2006 income statement. D) None of the above is correct. 78. What is the effect of the error on Berkshire's 12/31/06 balance sheet? A) There are no errors in the 12/31/06 balance sheet. B) Assets understated by $600,000 and shareholders' equity understated by $600,000. C) Assets understated by $420,000 and shareholders' equity understated by $420,000. D) Liabilities understated by $180,000 and shareholders' equity overstated by $420,000. 79. Mobic Inc. acquired some manufacturing equipment in January 2003 for $400,000 and depreciated it $40,000 each year for three years on a straight-line basis. During 2006, the manufacturer announced a new technology for this type of equipment that will make the old models obsolete by the end of 2009. As a result, Mobic will plan to replace the equipment at that time, effectively reducing the asset's life from ten to seven years. In its financial statements for 2006, Mobic should: A) Charge $280,000 in depreciation expense. B) Report the book value of the equipment on its12/31/06 balance sheet at $210,000. C) Make an adjustment to retained earnings for the error in measuring depreciation during 2003-2005. D) None of the above is correct. Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 89 Chapter 20 Accounting Changes 80. Prior to 2006, Trapper John Inc. used sum-of-the-years'-digits depreciation on its store equipment. Beginning in 2006, Trapper John decided to use straight-line depreciation for these assets. The equipment cost $3 million when it was purchased at the beginning of 2004, had an estimated useful life of five years and no estimated residual value. To account for the change in 2006, Trapper John: A) Would retrospectively report $600,000 in depreciation expense annually for 2004 and 2005, and report $600,000 in depreciation expense for 2006. B) Would adjust accumulated depreciation and retained earnings for the excess charges made in 2004 and 2005, C) Would report depreciation expense of $400,000 in its 2006 income statement. D) None of the above is correct. 81. On January 2, 2006, the company's records included prepaid expense in the amount of $150,000. The appropriate tax rate is 40%. The separately reported change in 2006 earnings for this change is: A) $ 0. B) $ 60,000. C) $150,000. D) $90,000. 82. On January 2, 2006, Tobias Company began using straight-line depreciation for a certain class of assets. In the past, the company had used double-declining-balance depreciation for these assets. As of January 2, 2006, the amount of the change in accumulated depreciation is $40,000. The appropriate tax rate is 40%. The separately reported change in 2006 earnings is: A) An increase of $40,000. B) A decrease of $40,000. C) An increase of $24,000. D) None of the above Chapter 20 Accounting Changes 83. Hepburn Company bought a copyright for $90,000 on January 1, 2003, at which time the copyright had an estimated useful life of 15 years. On January 5, 2006, the company determined that the copyright would expire at the end of 20011. How much should Hepburn record as amortization expense for this copyright for 2006? A) $14,400. B) $7,200. C) $8,000. D) $12,000. 84. Goosen Company bought a copyright for $90,000 on January 1, 2003, at which time the copyright had an estimated useful life of 15 years. On January 5, 2006, the company determined that the copyright would expire at the end of 2011. How much should Goosen record retroactively as the effect of change in accounting principle? A) $ 0. B) $12,000. C) $8,000. D) $14,400. 85. Moonland Company's income statement contained the following errors: Ending inventory, December 31, 2006, understated by $6,000 Depreciation expense for 2006 overstated by $1,000 What is the effect of the errors on 2006 net income before taxes? A) Overstated by $5,000. B) Understated by $5,000. C) Understated by $7,000. D) Overstated by $7,000. Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 91 Chapter 20 Accounting Changes 86. Popeye Company purchased a machine for $300,000 on January 1, 2005. Popeye depreciates machines of this type by the straight-line method over a five-year period using no salvage value. Due to an error, no depreciation was taken on this machine in 2005. Popeye discovered the error in 2006. What amount should Popeye record as depreciation expense for 2006? The tax rate is 40%. A) $120,000. B) $60,000. C) $36,000. D) $72,000. 87. Lundholm Company purchased a machine for $100,000 on January 1, 2004. Lundholm depreciates machines of this type by the straight-line method over a ten-year period using no salvage value. Due to a change in sales patterns, on January 1, 2006, management determines the useful life of the machine to be a total of five years. What amount should Lundholm record for depreciation expense for 2006? The tax rate is 40%. A) $20,000. B) $16,000. C) $17,778. D) $26,667. 88. Powell Company had the following errors over the last two years: 2004: Ending inventory was overstated by $30,000 while depreciation expense was overstated by $24,000. 2005: Ending inventory was understated by $5,000 while depreciation expense was understated by $4,000. By how much should retained earnings be adjusted on January 1, 2006? (Ignore taxes) A) Increase by $15,000. B) Decrease by $25,000. C) Decrease by $6,000. D) Increase by $25,000. 92 Chapter 20 Accounting Changes 89. Due to an error in computing depreciation expense, Prewitt Corporation overstated accumulated depreciation by $20 million as of December 31, 2006. Prewitt has a tax rate of 30%. Prewitt's retained earnings as of December 31, 2006, would be: A) Overstated by $14 million. B) Understated by $14 million. C) Overstated by $6 million. D) Understated by $6 million. 90. Due to an error in computing depreciation expense, Crote Corporation understated accumulated depreciation by $60 million as of December 31, 2006. Crote has a tax rate of 40%. Crote's retained earnings as of December 31, 2006, would be: A) Overstated by $36 million. B) Understated by $36 million. C) Overstated by $24 million. D) Understated by $24 million. 91. In 2006, due to a change in marketing forecasts, Barney Corporation reduced the projected life of its patent for producing round dice. The cumulative patent amortization prior to 2006 would have been $10 million higher had the new life been used. Barney's tax rate is 30%. Shaw's retained earnings as of December 31, 2006, would be: A) Overstated by $7 million. B) Overstated by $3 million. C) Overstated by $10 million. D) Unaffected. 92. A company failed to record unrealized gains of $20 million on its available for sale security investments. Its tax rate is 30%. As a result of this error, comprehensive income would be: A) Understated by $14 million. B) Understated by $6 million. C) Understated by $20 million D) Unaffected. 93 Chapter 20 Accounting Changes 93. A company failed to record unrealized gains of $20 million on its trading security investments. Its tax rate is 30%. As a result of this error, total shareholders' equity would be: A) Understated by $14 million. B) Understated by $7 million. C) Understated by $20 million D) Unaffected. 94. A company uses the aging method to estimate bad debt expense. Its tax rate is 30%. After issuing its 2006 financial statements, the firm discovered that it failed to write off $50,000 in receivables that were determined to be uncollectible in 2006. As a result of this error, net income was: A) Overstated by $35,000. B) Overstated by an undetermined amount. C) Understated by an undetermined amount. D) Unaffected. 95. A company uses the percentage of sales method to estimate bad debt expense. Its tax rate is 30%. After issuing its 2006 financial statements, the firm discovered that it failed to write off $50,000 in receivables that were determined to be uncollectible in 2006. As a result of this error, net income was: A) Overstated by $35,000. B) Overstated by an undetermined amount. C) Understated by an undetermined amount. D) Unaffected. 96. After issuing its financial statements, a company discovered that its beginning inventory was overstated by $100,000. Its tax rate is 30%. As a result of this error, net income was: A) Understated by $70,000. B) Overstated by $70,000. C) Understated by $30,000. D) Overstated by $30,000. Chapter 20 Accounting Changes 97. A company failed to report the $600,000 additional liability for its under funded pension plan. Its tax rate is 30%. As result of this error, retained earnings would be: A) Unaffected. B) Overstated by $600,000. C) Overstated by $420,000. D) Overstated by $180,000. 98. A company overstated its liability for warranties by $200,000. Its tax rate is 30%. As a result of this error, income tax expense is: A) Unaffected. B) Overstated by $60,000. C) Understated by $60,000. D) Understated by $140,000. 99. A company switched from the cash basis to the accrual basis for recognizing warranty expense. The unrecorded liability for warranties was $2 million at the beginning of the year. Its tax rate is 30%. The company booked a year-end warranty liability of $3 million. As a result of this change, the firm would: A) Report a prior period adjustment decreasing retained earnings by $600,000. B) Report a prior period adjustment decreasing retained earnings by $1,400,000. C) Report a current period charge decreasing net income by $600,000. D) Report a current period charge decreasing net income by $1,400,000. 100. At the end of the current year, a company overstated prepaid insurance by $80,000 and understated supplies expense by $100,000. Its effective tax rate is 40%. As a result of this error, net income is: A) Overstated by $108,000. B) Overstated by $12,000. C) Understated by $108,000. D) Understated by $12,000. 95 Chapter 20 Accounting Changes 101. At the end of the current year, a company failed to accrue interest of $500,000 on its investments in municipal bonds. Its tax rate is 30%. As a result of this error, net income is: A) Unaffected. B) Understated by $350,000. C) Understated by $500,000. D) Understated by $150,000. 102. A broadcasting company failed to make a year-end accrual of $400,000 for fines due to a violation of FCC rules. Its tax rate is 30%. As a result of this error, net income was: A) Unaffected. B) Overstated by $400,000. C) Overstated by $280,000. D) Overstated by $120,000. . 103. In the previous year, a firm failed to record premium amortization of $40,000 and $30,000, respectively, on its bonds payable and held to maturity bond investments. These errors affect both income before tax and taxable income. The firm's tax rate is 30%. As a result of this error, net income was: A) Understated by $7,000. B) Overstated by $7,000. C) Understated by $33,000. D) Overstated by $33,000. Chapter 20 Accounting Changes Problems 104. Albatross Company purchased a piece of machinery for $60,000 on January 1, 2004, and has been depreciating the machine using the sum-of-the-years'-digits method based on a five-year estimated useful life and no salvage value. On January 1, 2006, Albatross decided to switch to the straight-line method of depreciation. The salvage value is still zero and the estimated useful life did not change. Ignore income taxes. Required: (1.) Prepare the appropriate journal entry, if any, to record the accounting change. (2.) Prepare the journal entry to record depreciation for 2006. Therefore, remaining depreciation for years 2006 and following would be: ($60,000 - $36,000) = $24,000 over three years. The journal entry for 2006 would be: 105. Lugar Company purchased a piece of machinery for $30,000 on January 1, 2004, and has been depreciating the machine using the sum-of-the-years'-digits method based on a five-year estimated useful life and no salvage value. On January 1, 2006, Lugar decided to switch to the straight-line method of depreciation. The salvage value is still zero and the estimated useful life is changed to a total of six years from the date of purchase. Ignore income taxes. Required: (1.) Prepare the appropriate journal entry, if any, to record the accounting change. (2.) Prepare the journal entry to record depreciation for 2006. 97 Chapter 20 Accounting Changes 106. Max Industries changed its method of accounting for bad debts from the direct write-off method to the allowance method on January 1, 2006. The company's accountant determined that an appropriate allowance of $90,000 should be established. Ignore income taxes. Required: Prepare the journal entry to record the accounting change. Answer: This is a change from an unacceptable accounting principle to a principle in compliance with GAAP. Therefore, this is a correction of an error (prior period adjustment). 107. Nash Industries changed its method of accounting for warranties from the cash basis to the accrual basis on January 1, 2006. The company's accountant determined that a liability of $70,000 should be established. Ignore income taxes. Required: Prepare the journal entry to record the accounting change. Chapter 20 Accounting Changes 108. Buckeye Company purchased a machine on January 1, 2004. The machine had a cost of $260,000 with a $10,000 residual value. The estimated useful life of the machine was 8 years. On January 1, 2006, due to technological innovations, the estimated useful life was reduced by 2 years from the original life and the residual value was cut by 50%. The company uses straight-line depreciation. Required: Prepare the journal entry to record the annual depreciation on December 31, 2006. 109. Jackson Company uses the percentage of sales method to estimate bad debts. Information relating to bad debts since the company's inception is as follows: Actual bad debts Estimated bad debts Sales 2004 $ 800 $1,400 $46,667 2005 1,900 2,200 73,333 On January 1, 2006, Jackson decided to change their bad debt estimate from 3% of sales to 2% of sales. Sales for the year were $100,000 and actual bad debts were $1,550. Required: (1.) Prepare the journal entry to record bad debt expense for 2006. (2.) What is the balance in allowance for uncollectible accounts on December 31, 2006, after the adjusting entry is made? 99 Chapter 20 Accounting Changes 110. Colorado Consulting Company has been using the sum-of-the-years'-digits depreciation method to depreciate some office equipment that was acquired at the beginning of 2004. At the beginning of 2006, Colorado Consulting decided to change to the straight-line method. The equipment cost $120,000 and is expected to have no salvage value. The estimated useful life of the equipment is 5 years. The tax rate is 30%. Required: Prepare the journal entry, if any, to record the accounting change. 111. Pinnacle Corporation has been using the straight-line depreciation method to depreciate some office equipment that was acquired at the beginning of 2003. At the beginning of 2006, Pinnacle decided to change to the sum-of-the-years'-digits method. The equipment cost $120,000 and is expected to have no salvage value. The estimated useful life of the equipment is 5 years. The tax rate is 30%. Required: Prepare the journal entry, if any, to record the accounting change. 112. On January 1, 2006, Bubba Construction decided to change from the completed contract method of accounting for long-term construction contracts to the percentage-of-completion method. The company will continue to use the completed contract method for tax purposes. The tax rate is 30%. The following are all relevant data concerning the change. Income Before Income Tax Year % of Completion Completed Contract Before 2005 $500,000 $300,000 2005 400,000 250,000 2006 450,000 400,000 Required: Prepare the journal entry to record the accounting change. Chapter 20 Accounting Changes 113. On January 1, 2006, Randall Construction decided to change from the completed contract method of accounting for long-term construction contracts to the percentage-of-completion method. The company will continue to use the completed contract method for tax purposes. The tax rate is 30%. The following are all relevant data concerning the change. Income Before Income Tax Year % of Completion Completed Contract Before 2005 $500,000 $300,000 2005 400,000 250,000 2006 450,000 400,000 Required: (1.) Prepare the journal entry to record the accounting change. (2.) Determine the net income to be reported in the 2006-2005 comparative income statements. 114. Annual depreciation expense on equipment purchased a few years ago (using the straight-line method) is $5,000. The cost of the equipment was $100,000. The current book value of the equipment (January 1, 2006) is $85,000. At the time of purchase, the asset was estimated to have a zero salvage value. On January 1, 2006, the company decided to reduce the original useful life by 25% and to establish a salvage value of $5,000. The firm also decided double-declining-balance depreciation was more appropriate. Ignore tax effects. Required: (1.) Record the journal entry, if any, to report the accounting change. (2.) Record the annual depreciation for 2006. 101 Chapter 20 Accounting Changes 115. Johnson Company receives royalties on a patent it developed several years ago. Royalties are 5% of net sales, receivable on September 30 for sales from January through June and receivable on March 31 for sales from July through December. The patent rights were distributed on July 1, 2005, and Johnson accrued royalty revenue of $50,000 on December 31, 2005, as follows: Receivable - royalty revenue 50,000 Royalty revenue 50,000 Johnson received royalties of $65,000 on March 31, 2006, and $90,000 on September 30, 2006. The patent user indicated to Johnson that sales subject to royalties for the second half of 2006 should be $600,000. Required: Prepare any journal entries Johnson should record during 2006 related to the royalty revenue. 102 Chapter 20 Accounting Changes 116. Mattson Company receives royalties on a patent it developed several years ago. Royalties are 5% of net sales, receivable on September 30 for sales from January through June and receivable on March 31 for sales from July through December. The patent rights were distributed on July 1, 2005, and Mattson accrued royalty revenue of $60,000 on December 31, 2005, as follows: Receivable - royalty revenue 60,000 Royalty revenue 60,000 Mattson received royalties of $65,000 on March 31, 2006, and $80,000 on September 30, 2006. The patent user indicated to Mattson that sales subject to royalties for the second half of 2006 should be $800,000. Required: (1.) Prepare any journal entries Mattson should record during 2006 related to the royalty revenue. (2.) What changes should be made to retained earnings relative to these royalties? 117. Cherokee Company's auditor discovered some errors. No errors were corrected during 2005. The errors are described as follows: (1.) Beginning inventory on January 1, 2005, was understated by $5,000. (2.) A two-year insurance policy purchased on April 30, 2005, in the amount of $24,000 was debited to Prepaid Insurance. No adjustment was made on December 31, 2005, or on December 31, 2006. Required: Prepare appropriate journal entries (assume the 2006 books have not been closed). Ignore income taxes. 103 Chapter 20 Accounting Changes 118. Lindy Company's auditor discovered two errors. No errors were corrected during 2005. The errors are described as follows: (1.) Merchandise costing $4,000 was sold to a customer for $9,000 on December 31, 2005, but it was recorded as a sale on January 2, 2006. The merchandise was properly excluded from the 2005 ending inventory. Assume the periodic inventory system is used. (2.) A machine with a 5-year life was purchased on January 1, 2005. The machine cost $20,000 and has no expected salvage value. No depreciation was taken in 2005 or 2006. Assume the straight-line method for depreciation. Required: Prepare appropriate journal entries (assume the 2006 books have not been closed). Ignore income taxes. 119. Macintosh Inc. changed from LIFO to the FIFO inventory costing method on January 1, 2006. Inventory values at the end of each year since the inception of the company are as follows: FIFO LIFO 2004 $200,000 $180,000 2005 400,000 360,000 Required: Ignoring income tax considerations, prepare the entry to report this accounting change. 104 Chapter 20 Accounting Changes 120. Novell Inc. disclosed the following footnote in its 2001 Annual Report to Shareholders: NOTE Q: CHANGE IN ACCOUNTING PRINCIPLE -- REVENUE RECOGNITION The Company previously recognized revenue related to product sales to distribution channel partners upon shipment to the partner and provided a reserve for contractual return obligations and other estimated product returns. Effective November 1, 2000, the Company changed its method of accounting for revenue related to these product sales to recognize such revenues upon the sell-through of the respective product from the distribution channel partner to the reseller or end user. The Company believes the change in accounting principle is preferable based on guidance provided in SAB 101. The $11 million ($0.03 per share) charge for the cumulative effect of the change (after reduction for income taxes of $6 million) was included in income in the first quarter of fiscal 2001. Also, during the three months ended January 31, 2001, the Company recognized $7 million in revenue that was included in the cumulative effect adjustment at November 1, 2000. The effect of that revenue on the first quarter was to increase net income by $5 million ($0.01 per share). Had the Company reported under its previous method of accounting for revenue recognition, the effect on earnings without consideration of the cumulative effect of the change would be a decrease in earnings of approximately $10 million, or $0.03 per share, during fiscal 2001. The pro forma amounts presented in the consolidated statements of income were calculated assuming the accounting change was made retrospectively to prior periods. Explain the rationale for the accounting change, disclosed by Novell in the footnote. Answer: Prior to the SEC issuing Staff Accounting Bulletin 101, ………………………………………………………………………………………………………………………………………………………….. Learning Objective: 2 Level of Learning: 2 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 105 Chapter 20 Accounting Changes Essay Instructions: The following answers point out the key phrases that should appear in students' answers. They are not intended to be examples of complete student responses. It might be helpful to provide detailed instructions to students on how brief or in-depth you want their answers to be. 121. A company changes depreciation methods. Briefly describe the steps the company should take to report this accounting change in its current comparative financial statements. Answer: Under a recent FASB pronouncement, such a change is now treated as a change in estimate, that is, prospectively. No changes are made retrospectively. The depreciation for the current and future periods reflects the remaining depreciation, computed on the new basis. A disclosure note should describe the effect of a change in estimate on income before extraordinary items, net income, and related per share amounts for the current period. Learning Objective: 2 Level of Learning: 2 122. Name and briefly describe the three categories of accounting changes. Learning Objective: 1 Level of Learning: 1 123. Describe the approaches of reporting changes in accounting principles. Learning Objective: 1 Level of Learning: 1 124. There is not always a clear-cut distinction between a change in estimate and a change in principle. How are these accounted for? Chapter 20 Accounting Changes 125. What situations are deemed to be a change in reporting entity? 126. If inventory is understated at the end of 2005 and the error is not discovered, how will net income be affected in 2006? 127. How may accounting changes detract from accounting information? 128. How are accounting errors treated? 129. What are the changes in accounting principle that require the prospective approach? Chapter 20 Accounting Changes [Note: The following question pertains to a time period prior to the recent FASB pronouncement on accounting changes. Although the accounting for it is no longer used, it was at the time. The question still has value in making the student analyze the validity of the change made.] 130. Sears Roebuck and Co. reported the following information in its report to shareholders for the 3rd quarter of 2002. NOTE 8 - CHANGE IN ACCOUNTING POLICY AND IMPLEMENTATION OF NEW ACCOUNTING STANDARDS Change in Accounting Policy In the second quarter of 2002, the Company adopted a change in accounting policy related to its method used to determine the allowance for uncollectible accounts. In accordance with Accounting Principles Board Opinion No. 20, "Accounting Changes", the cumulative effect of this change in accounting policy has been recorded as of the beginning of fiscal 2002. The Company periodically reviews its accounting practices to ensure that its adopted policies appropriately reflect changes in its businesses, the industries it operates in, and the regulatory and political environments. During the second quarter, the Company compared its methodology for computing the allowance for uncollectible accounts to the methodologies of participants in the bank card industry. The Company felt that a comparison to bank card issuers was appropriate given the growth of the Sears Gold MasterCard product (approximately $8.5 billion in balances at the end of the second quarter of 2002) and the recent changes to the Sears Card product that are meant to provide a wider range of services to the Sears Card holder (e.g., balance transfers, convenience checks, broader acceptance, etc.) The Company determined that practice in the industry was diverse and evolving, particularly in the areas of providing allowances for current accounts, finance charges and credit card fees. The Company's previous policy for determining the allowance for uncollectible accounts provided an allowance for principal and finance charges on past due accounts but not for current accounts or credit card fees. Based on its comparison, the Company has changed its methodology to provide an allowance for principal and finance charge balances on current and past due accounts as well as for credit card fee balances. The Company believes that this new methodology for determining its allowance is preferable, as it is consistent with more conservative industry practices in this area. The cumulative effect of the accounting change as of December 30, 2001, was to decrease net income for the quarter ended March 30, 2002, by $191 million, net of tax, or $0.59 per share. There was no impact on income before cumulative effect of accounting changes as a result of adopting the new methodology. Required: Do you agree with Sears' treatment of the new allowance for uncollectible accounts method as a change in accounting principle? Briefly explain your position. [Show More]

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