Advanced financial accounting - Lecture 30: Accounting policies, changes in accounting estimates and errors

Advanced Financial
Accounting
FIN-611
Mian Ahmad Farhan
Lecture-30
Accounting Policies, Changes in Accounting
Estimates & Errors


Solution


Profit & Loss Account
2004
Sales (72,750-1,000)
Cost of sales
Gross profit (1/3 of sales)
Operating Expenses
Income tax @ 30%
Profit after tax

2004
Rs.
71,750
(47,833)
23,917
(7,750)
16,167
(4,850)
11,317

Working (2004)
Gross profit = 717,50 x 1/3 = 23,917
Cost of goods sold = 71,750 – 23,917 = 47,833
Income tax = 16,167 x 30% = 4,850


Profit & Loss Account
2005
Sales (75,000+1,000-1,500)
Cost of sales
Gross profit (1/3 of sales)
Operating Expenses
Income tax @ 30%
Profit after tax

2005
Rs.
74,500
(49,667)
24,833
(7,500)
17,333
(5,200)
12,133


Working (2005)
Gross profit = 74,500 x 1/3 = 24,833
Cost of goods sold = 74,500 – 24,833 = 49,667

Income tax = 17,333 x 30% = 5,200


Statement of Retained Earnings
2004
2004
.
Opening Balance
Add Profit for the year
Less Closing Balance

Rs.
4,800
11,317
16,117
8,050
8,067


Statement of Retained Earnings
2005
2005
.
Opening Balance
Add Profit for the year
Less Closing Balance

Rs.
8,067
12,133

20,200
10,250
9,950


Working (2005)
Gross profit = 717,50 x 1/3 = 23,917
Cost of goods sold = 72,750 – 23,917 = 47,833
Income tax = 16,167 x 305 = 4,850


Prospective Application
Prospective application of a change in accounting
policy and of recognizing the effect of change in an
accounting estimate respectively are:
a). Applying the new accounting policy to transactions,
other events and conditions occurring after the date
as at which the policy is changed.
b). Recognizing the effect of the change in the
accounting estimates in the current and future
affected by the change.


Question
Idrees Sports Private Limited purchased an assets with followings
details:
Cost price = Rs. 2,500,000
Estimated useful life = 10 years
Estimated residual value = Rs. 100,000
In third year, the company estimates the useful life of its assets at six

years with residual value Rs. 220,000. The company depreciates its
asset on straight line method.
Required: Account for the above Accounting Estimates in the Financial
Statement of Idrees Sports Private Limited in the third year.


Solution
Straight line method
Depreciation Rate = 1 / Useful life x 100
Depreciation Rate = 1 / 10 x 100 = 10%
First year depreciation = 2,500,000 – 100,000
= 2,400,000 x 10% = 240,000
Second year depreciation = 2,500,000 – 100,000
= 2,400,000 x 10% = 240,000
Third year depreciation = 2,500,000 – 480,000 = 2,020,000
Amount of depreciation = 2,020,000 – 220,000 = 1,800,000
= 1,800,000 / 6 = 300,000
OR
Depreciation rate = 1 / 6 x 100 = 16.666%
Depreciation expense = 1,800,000 x 16.666 / 100 = 300,000


Prior Period Error


Retrospective Restatements
Retrospective Restatements is correcting
the recognitions, measurement and
disclosure of amounts of elements of
financial statements as if a prior period

error had never occurred i.e. correction of
error is to be made by restating the
previous income statement and opening
balance of previous periods’ retained
earnings.


Question
During 2008, Saleem Co. discovered that some products that hade
been sold during 2007 were incorrectly included in inventory at 31
December 2007 at Rs. 6,500
Saleem Co. accounting record for 2008 show sales of Rs. 104,000,
cost of goods sold of Rs. 86,500 (including Rs. 6,500) for the error
in opening inventory and income taxes of Rs. 5,250.


Question
2007
Rs.
Sales

73,500

Less Cost of goods sold

53,500

Profit before income taxes

20,000

Less Income taxes
Profit

6,000
14,000


Question
2007 opening retained earning was Rs. 20,000 and closing
retained earning was Rs. 34,000.
Saleem Co. income tax rate was 30% for 2008 and 2007. It
had no other income or expenses.
Saleem Co. had Rs. 50,000 of share capital through out
and no other components of equity except for retained
Earning.


Solution
2008
Sales

2007
104,000

73,500

Less Cost of goods
sold

80,000

60,000

Profit before income
taxes

24,000

13,500

7,200

4,050

16,800

9,450

Less Income taxes
Profit


Working (2007)
Reported cost of goods sold
Add Overstated closing stock

53,500
6,500
60,000

Working (2008)
Reported cost of goods sold
Less Overstated closing stock

86,500
6,500
80,000


Statement of Change in Equity
2008
Rs.
Opening retained profit

2007
Rs.
34,000

Adjustment in opening
retained profit
6,500
Less Income
tax effect (30%) 1,950

20,000

----(4,550)

Adjusted opening
retained profit
Add Profit after tax

29,450
16,800

---9,450

46,250

29,450