Intermediate accounting 17e by kieso ch22

Intermediate Accounting
Seventeenth Edition

Kieso ● Weygandt ● Warfield

Chapter 22
Accounting Changes and Error Analysis

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Learning Objectives

After studying this chapter, you should be able to:

1.

Discuss types of accounting changes and understand the accounting for changes in accounting principles.

2.

Describe the accounting for changes in estimates and changes in the reporting entity.

3.

Describe the accounting for correction of errors.

4.

Analyze the effect of errors.

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Preview of Chapter 22 (1 of 2)

Accounting Changes and Error Analysis
Accounting Changes

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Background

•

Changes in accounting principle

•

Impracticability

Other Changes

•

Changes in accounting estimates

•

Changes in reporting entity

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Preview of Chapter 22 (2 of 2)

Accounting Errors

•

Example

•

Summary

Error Analysis

•

Balance sheet errors

•

Income statement errors

•

Balance sheet and income statement errors

•

Comprehensive example

•

Preparation of statements with error corrections

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Learning Objective 1
Discuss the Types of Accounting Changes and the Accounting for
Changes in Accounting Principles

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Accounting Changes
Accounting Alternatives:

•

Diminish the comparability of financial information.

•

Obscure useful historical trend data.

Types of Accounting Changes:

1.

Change in Accounting Principal.

2.

Change in Accounting Estimate.

3.

Change in Reporting Entity.

Errors are not considered an accounting change.

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Changes in Accounting Principle

Change from one accepted accounting policy to another. Examples include:

•

Average cost to LIFO.

•

Completed-contract to percentage-of-completion method.

Adoption of a new principle in recognition of events that have occurred for the first time or that
were previously immaterial is not an accounting change.

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Changes in Accounting Principle
Approaches

Three approaches for reporting changes:

1)

Currently.

2)

Retrospectively.

3)

Prospectively (in the future).

FASB requires use of the retrospective approach.
Rationale - Users can then better compare results from one period to the next.

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What Do the Numbers Mean?: Quite a Change

The cumulative-effect approach results in a loss of comparability. Also, reporting the cumulative adjustment in the period of the change
can significantly affect net income, resulting in a misleading income for example, at one time Chrysler Corporation changed its inventory
accounting from LIFO to FIFO. If Chrysler had used the cumulative-effect approach, it would have reported a $53,500,000 adjustment to
net income. That adjustment would have resulted in net income of $45,900,000, instead of a net loss of $7,600,000.
A second case: In the early 1980s, the railroad industry switched from the retirement-replacement method of depreciating railroad
equipment to more generally used methods such as straight-line depreciation. Using cumulative treatment, railroad companies would
have made substantial adjustments to income in the period of change. Many in the industry argued that including such large cumulativeeffect adjustments in the current year would distort the information and make it less useful. Such situations lend support to retrospective
application so that comparability is maintained.

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Changes in Accounting Principle

Retrospective Accounting Change Approach
Company reporting the change

1)

Adjusts its financial statements for each prior period presented to the same basis as the new
accounting principle.

2)

Adjusts the carrying amounts of assets and liabilities as of the beginning of the first year
presented, plus the opening balance of retained earnings.

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Changes in Accounting Principle Retrospective Accounting Change: Long-Term
Contracts

Illustration: Denson Company has accounted for its income from long-term construction contracts
using the completed-contract method. In 2020, the company changed to the percentage-ofcompletion method. Management believes this approach provides a more appropriate measure of
the income earned. For tax purposes, the company uses the completed-contract method and plans
to continue doing so in the future. (Assume a 20 percent enacted tax rate.)

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Changes in Accounting Principle Completed-Contract Method vs. Percentageof-completion Method

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Changes in Accounting Principle
Retrospective Change

Data for Retrospective Change

Journal entry beginning of

2020

Construction in Process
Deferred Tax Liability
Retained Earnings

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220,000
44,000
176,000

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What Do the Numbers Mean?: Change Management (1 of 2)

Halliburton offers a case study in the importance of good reporting of an accounting change. Note that Halliburton uses percentage-ofcompletion accounting for its long-term construction-services contracts. The SEC questioned the company about its change in accounting
for disputed claims. Prior to the year of the change, Halliburton took a very conservative approach to its accounting for disputed claims.
That is, the company waited until all disputes were resolved before recognizing associated revenues. In contrast, in the year of the change,
the company recognized revenue for disputed claims before their resolution, using estimates of amounts expected to be recovered. Such
revenue and its related profit are more tentative and subject to possible later adjustment. The accounting method adopted is more
aggressive than the company’s former policy but is within the boundaries of G AAP. It appears that the problem with Halliburton’s
accounting stems more from how the company handled its accounting change than from the new method itself. That is, Halliburton did
not provide in its annual report in the year of the change an explicit reference to its change in accounting method.

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What Do the Numbers Mean?: Change Management (2 of 2)

In fact, rather than stating its new policy, the company simply deleted the sentence that described how it accounted for disputed claims.
Then later, in its next year’s annual report, the company stated its new accounting policy. Similar transparency concerns have been raised
when companies, like Hawthorn Bancshares, did not provide sufficient explanation about their changes to fair value accounting for their
mortgage servicing rights. When companies make such changes in accounting, investors need to be informed about the change and about
its effects on the financial results. With such information, investors and analysts can compare current results with those of prior periods
and can make a more informed assessment about the company’s future prospects.
Sources: Adapted from “Accounting Ace Charles Mulford Answers Accounting Questions,” Wall Street Journal Online (June 7, 2002); and J.
Arnold, B. Blisard, and J. Duggan, “Dealing with the Implications of Accounting Change,” FEI Magazine (November 2012).

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Changes in Accounting Principle
Reporting a Change in Principle

Major disclosure requirements are as follows.

1.

Nature of the change in accounting principle.

2.

The method of applying the change, and:
a. A description of the prior period information that has been retrospectively adjusted, if any.
b. The effect of the change on income from continuing operations, net income (or other appropriate captions of changes
in net assets or performance indicators), any other affected line item.
c. The cumulative effect of the change on retained earnings or other components of equity or net assets in the balance
sheet as of the beginning of the earliest period presented.

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Changes in Accounting Principle
Note Disclosure

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Changes in Accounting Principle
Retained Earnings Adjustment

Retained earnings balance is $1,360,000 at the beginning of 2018.

Before Change

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Changes in Accounting Principle

Retained Earnings Adjustment Continued

After Change

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Changes in Accounting Principle
Inventory Methods

Illustration (Change in Principle—Inventory Methods): Assume that Lancer Company has accounted for its
inventory using the LIFO method. In 2020, the company changes to the FIFO method because management

believes this approach provides a more appropriate reporting of its inventory costs.

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Changes in Accounting Principle
Lancer Company Information

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Changes in Accounting Principle
Lancer Company Information Continued

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Changes in Accounting Principle

Journal Entry – Change to FIFO

The entry to record the change to the FIFO method at the beginning of 2020:

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Changes in Accounting Principle Comparative Info

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Changes in Accounting Principle

Retained Earnings Adjustment – Inventory Methods
Retained Earnings Statements (LIFO)

Retained Earnings balances FIFO vs. LIFO

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