Q22–12 How should consolidated financial statements be reported this
year when statements of individual companies were presented last year?
Where individual company statements were reported in prior years and
consolid
...
Q22–12 How should consolidated financial statements be reported this
year when statements of individual companies were presented last year?
Where individual company statements were reported in prior years and
consolidated financial statements are to be prepared this year, the
following reporting and disclosure practices should be implemented:
1. The financial statements of all prior periods presented should be
restated to show the financial information for the new reporting entity
for all periods.
2. The financial statements of the year in which the change in reporting
entity is made should describe the nature of the change and the
reason for it.
3. The effect of the change on income before extraordinary items, net
income, and earnings per share amounts should be disclosed for all
periods presented.
Correction of Errors
Types of Accounting Errors:
• A change from an accounting principle that is not
generally accepted to an accounting policy that is
acceptable.
• Mathematical mistakes.
• Changes in estimates that occur because a company did
not prepare the estimates in good faith.
• Failure to accrue or defer certain expenses or revenues.
• Misuse of facts.
• Incorrect classification of a cost as an expense instead of
an asset, and vice versa.
Correction of Errors
• All material errors must be corrected.
• Record corrections of errors from prior periods as an
adjustment to the beginning balance of retained earnings
in the current period.
• Such corrections are called prior period adjustments.
• For comparative statements, a company should restate
the prior statements affected, to correct for the error.
Balance sheet errors affect only the presentation of an asset,
liability, or stockholders’ equity account.
u Current year error - reclassify item to its proper position.
u Prior year error - restate the balance sheet of the prior year
for comparative purposes.
Error Analysis
Income Statement errors cause the improper classification of
revenues or expenses.
u Current year error - reclassify item to its proper position.
u Prior year error - restate the income statement of the prior
year for comparative purposes.
Will be offset or corrected over two periods.
If company has closed the books:
a. If the error is already counterbalanced, no entry is necessary.
b. If the error is not yet counterbalanced, make entry to adjust the
present balance of retained earnings.
For comparative purposes, restatement is necessary even if a
correcting journal entry is not required.
Counterbalancing Errors
If company has not closed the books:
a. If error already counterbalanced, make entry to correct the
error in the current period and to adjust the beginning balance
of Retained Earnings.
b. If error not yet counterbalanced, make entry to adjust the
beginning balance of Retained Earnings.
Correction of Accounting Errors
Four-step process
1. Prepare a journal entry to correct any balances.
2. Retrospectively restate prior years’ financial statements
that were incorrect.
3. Report correction as a prior period adjustment if
retained earnings is one of the incorrect accounts
affected.
4. Include a disclosure note.
Example 5
Goddard Company has used the FIFO method of inventory
valuation since it began operations in 2008. Goddard decided to
change to the average cost method for determining inventory
costs at the beginning of 2011. The following schedule shows
year-end inventory balances under the FIFO and average cost
methods:
Year FIFO Average Cost
2008 $45,000 $54,000
2009 78,000 71,000
2010 83,000 78,000
Ignoring income taxes, prepare the 2011 journal entry to adjust
the accounts to reflect the average cost method.
How much higher or lower would cost of goods sold be in the
2010 revised income statement?
Example 5: Continued
2008 2009 2010
+9
Example 5: Continued
2008 2009 2010
0 0
0
+9
Example 5: Continued
2008 2009 2010
0 0
0
+9 –9
Example 5: Continued
2008 2009 2010
0 0 +9 0
0
+9 –9
Example 5: Continued
2008 2009 2010
0 0 +9 0
0 +9
+9 –9 –7
Example 5: Continued
2008 2009 2010
0 0 +9 0
0 +9
+9 –9 –7 +16
Example 5: Continued
2008 2009 2010
0 0 +9 0 –7 0
0 +9 –7
+9 –9 –7 +16
Example 5: Continued
2008 2009 2010
0 0 +9 0 –7 0
0 +9 –7
+9 –9 –7 +16 –5
Example 5: Continued
2008 2009 2010
0 0 +9 0 –7 0
0 +9 –7
+9 –9 –7 +16 –5 –2
Ignoring income taxes, prepare the 2011 journal entry to adjust the accounts to
reflect the average cost method.
Retained earnings 5,000
Inventory ($83,000 – 78,000) 5,000
How much higher or lower would cost of goods sold be in the 2010 revised
income statement?
$2,000 lower
Example 6: Classifying Accounting Changes
Type of Change Reporting Approach
P. Change in accounting principle R. Retrospective approach
E. Change in accounting estimate P. Prospective approach
EP. Change in estimate resulting from a change in principle
X. Correction of an error
N. Neither an accounting change nor an accounting error.
1. Wagner changed its method of depreciating computer equipment
from the DDB method to the straight-line method.
2. Wagner determined that a liability insurance premium it both paid
and expensed in 2010 covered the 2010–2012 period.
Example 6: Classifying Accounting Changes
Type of Change Reporting Approach
P. Change in accounting principle R. Retrospective approach
E. Change in accounting estimate P. Prospective approach
EP. Change in estimate resulting from a change in principle
X. Correction of an error
N. Neither an accounting change nor an accounting error.
3. Wagner custom-manufactures farming equipment on a contract
basis. Wagner switched its accounting for these long-term
contracts from the completed-contract method to the percentageof-completion method.
4. Due to an unexpected relocation, Wagner determined that its office
building, previously depreciated using a 45-year life, should be
depreciated using an 18-year life.
5. Wagner offers a three-year warranty on the farming equipment it
sells. Manufacturing efficiencies caused Wagner to reduce its
expectation of warranty costs from 2% of sales to 1% of sales.
Example 6: Classifying Accounting Changes
Type of Change Reporting Approach
P. Change in accounting principle R. Retrospective approach
E. Change in accounting estimate P. Prospective approach
EP. Change in estimate resulting from a change in principle
X. Correction of an error
N. Neither an accounting change nor an accounting error.
6. Wagner changed from LIFO to FIFO to account for its materials
and work-in-process inventories.
7. Wagner changed from FIFO to average cost to account for its
equipment inventory.
8. Wagner sells extended service contracts on some of its equipment
sold. Wagner performs services related to these contracts over
several years, so in 2011 Wagner changed from recognizing
revenue from these service contracts on a cash basis to the
accrual basis.
Example 7: Error Analysis
You have been hired as the new controller for the Ralston Company.
Shortly after joining the company in 2011, you discover the following errors
related to the 2009 and 2010 financial statements:
a. Inventory at 12/31/09 was understated by $6,000.
b. Inventory at 12/31/10 was overstated by $9,000.
c. On 12/31/10, inventory was purchased for $3,000. The company did
not record the purchase until the inventory was paid for early in 2011.
At that time, the purchase was recorded by a debit to purchases and a
credit to cash. The company uses a periodic inventory system.
Required:
1. Assuming that the errors were discovered after the 2010 financial
statements were issued, analyze the effect of the errors on 2010 and
2009 cost of goods sold, net income, and retained earnings. ( Ignore
income taxes.)
2. Prepare a journal entry to correct the errors.
3. What other step( s) would be taken in connection with the error?
Example 7: Error Analysis
2009 2010
–3,000
–6,000 +9,000
Example 7: Error Analysis
2009 2010
0 0 –3,000
0
–6,000 +6,000 +9,000
Example 7: Error Analysis
Retained earnings 12,000
Inventory 9,000
Purchases 3,000
The financial statements that were incorrect as a result of both errors
(effect of one error in 2009 and effect of three errors in 2010) would be
retrospectively restated to report the correct inventory amounts, cost of
goods sold, income, and retained earnings when those statements are
reported again for comparative purposes in the 2011 annual report. A
prior period adjustment to retained earnings would be reported, and a
disclosure note should describe the nature of the error and the impact
of its correction on each year’s net income, income before
extraordinary items, and earnings per share.
2009 2010
0 0 –6,000 –3,000
0 –9,000
–6,000 +6,000 +9,000 –18,000
Summary of Accounting Ch
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