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Chapter 22: Question 6 (page 1305)

Define a change in estimate and provide an illustration. When is a change in accounting estimate effected by a change in accounting principle?

Short Answer

Expert verified

An accounting estimate is a simple change in the realizability of an asset or liability. The second part occurs when the change in accounting estimates is inseparable from the effect of related change in principle.

Step by step solution

01

Definition of change in estimate

The change in estimate is defined as a simple change in how an individual perceives the realizability of an asset or liability—for example, changes in estimates of warranty costs.

02

Change in accounting estimate affected by the change in accounting principle

This situation occurs when the change in accounting estimates is inseparable from the effect of a related change in accounting principle.

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Most popular questions from this chapter

Taveras Co. decides at the beginning of 2017 to adopt the FIFO method of inventory valuation. Taveras had used the LIFO method for financial reporting since its inception on January 1, 2015, and had maintained records adequate to apply the FIFO method retrospectively. Taveras concluded that FIFO is the preferable inventory method because it reflects the current cost of inventory on the balance sheet. The following table presents the effects of the change in accounting principles on inventory and cost of goods sold. Inventory Determined by Cost of Goods Sold Determined by Date LIFO Method FIFO Method LIFO Method FIFO Method January 1, 2015 \( 0 \) 0 \( 0 \) 0 December 31, 2015 100 80 800 820 December 31, 2016 200 240 1,000 940 December 31, 2017 320 390 1,130 1,100 Other information: 1. For each year presented, sales are \(3,000 and operating expenses are \)1,000. 2. Taveras provides two years of financial statements. Earnings per share information is not required. Instructions (a) Prepare income statements under LIFO and FIFO for 2015, 2016, and 2017. (b) Prepare income statements reflecting the retrospective application of the accounting change from the LIFO method to the FIFO method for 2017 and 2016. (c) Prepare the note to the financial statements describing the change in method of inventory valuation. In the note, indicate the income statement line items for 2017 and 2016 that were affected by the change in accounting principle. (d) Prepare comparative retained earnings statements for 2016 and 2017 under FIFO. Retained earnings reported under LIFO are as follows: Retained Earnings Balance December 31, 2015 $1,200 December 31, 2016 2,200 December 31, 2017 3,070

Simmons Corporation owns stock of Armstrong, Inc. Prior to 2017, the investment was accounted for using the equity method. In early 2017, Simmons sold part of its investment in Armstrong, and began using the fair value method. In 2017, Armstrong earned net income of \(80,000 and paid dividends of \)95,000. Prepare Simmons’s entries related to Armstrong’s net income and dividends, assuming Simmons now owns 10% of Armstrong’s stock.

(Change in Estimate) Mike Crane is an audit senior of a large public accounting firm who has just been assigned to the Frost Corporation’s annual audit engagement. Frost has been a client of Crane’s firm for many years. Frost is a fastgrowing business in the commercial construction industry. In reviewing the fixed asset ledger, Crane discovered a series of unusual accounting changes, in which the useful lives of assets, depreciated using the straight-line method, were substantially lowered near the midpoint of the original estimate. For example, the useful life of one dump truck was changed from 10 to 6 years during its fifth year of service. Upon further investigation, Mike was told by Kevin James, Frost’s accounting manager, “I don’t really see your problem. After all, it’s perfectly legal to change an accounting estimate. Besides, our CEO likes to see big earnings!”

Instructions Answer the following questions.

(a) What are the ethical issues concerning Frost’s practice of changing the useful lives of fixed assets?

(b) Who could be harmed by Frost’s unusual accounting changes?

(c) What should Crane do in this situation?

The management of Utrillo Instrument Company had concluded, with the concurrence of its independent auditors, that results of operations would be more fairly presented if Utrillo changed its method of pricing inventory from last-in, first-out (LIFO) to average-cost in 2017. Given below is the 5-year summary of income under LIFO and a schedule of what the inventories would be if stated on the average-cost method.

UTRILLO INSTRUMENT COMPANY STATEMENT OF INCOME AND RETAINED EARNINGS FOR THE YEARS ENDED MAY 31 2013 2014 2015 2016 2017 Sales—net \(13,964 \)15,506 \(16,673 \)18,221 \(18,898 Cost of goods sold Beginning inventory 1,000 1,100 1,000 1,115 1,237 Purchases 13,000 13,900 15,000 15,900 17,100 Ending inventory (1,100) (1,000) (1,115) (1,237) (1,369) Total 12,900 14,000 14,885 15,778 16,968 Gross profi t 1,064 1,506 1,788 2,443 1,930 Administrative expenses 700 763 832 907 989 Income before taxes 364 743 956 1,536 941 Income taxes (50%) 182 372 478 768 471 Net income 182 371 478 768 470 Retained earnings—beginning 1,206 1,388 1,759 2,237 3,005 Retained earnings—ending \) 1,388 \( 1,759 \) 2,237 \( 3,005 \) 3,475 Earnings per share \(1.82 \)3.71 \(4.78 \)7.68 \(4.70 SCHEDULE OF INVENTORY BALANCES USING AVERAGE-COST METHOD FOR THE YEARS ENDED MAY 31 2012 2013 2014 2015 2016 2017 \)1,010 \(1,124 \)1,101 \(1,270 \)1,500 $1,720

Instructions Prepare comparative statements for the 5 years, assuming that Utrillo changed its method of inventory pricing to average-cost. Indicate the effects on net income and earnings per share for the years involved. Utrillo Instruments started business in 2012. (All amounts except EPS are rounded up to the nearest dollar.)

You have been assigned to examine the financial statements of Zarle Company for the year ended December 31, 2017. You discover the following situations.

1. Depreciation of \(3,200 for 2017 on delivery vehicles was not recorded.

2. The physical inventory count on December 31, 2016, improperly excluded merchandise costing \)19,000 that had been temporarily stored in a public warehouse. Zarle uses a periodic inventory system.

3. A collection of \(5,600 on account from a customer received on December 31, 2017, was not recorded until January 2, 2018.

4. In 2017, the company sold for \)3,700 fully depreciated equipment that originally cost \(25,000. The company credited the proceeds from the sale to the Equipment account.

5. During November 2017, a competitor company filed a patent-infringement suit against Zarle claiming damages of \)220,000. The company’s legal counsel has indicated that an unfavorable verdict is probable and a reasonable estimate of the court’s award to the competitor is \(125,000. The company has not reflected or disclosed this situation in the financial statements.

6. Zarle has a portfolio of trading investments. No entry has been made to adjust to market. Information on cost and fair value is as follows. Cost Fair Value December 31, 2016 \)95,000 \(95,000 December 31, 2017 \)84,000 \(82,000

7. At December 31, 2017, an analysis of payroll information shows accrued salaries of \)12,200. The Salaries and Wages Payable account had a balance of \(16,000 at December 31, 2017, which was unchanged from its balance at December 31, 2016.

8. A large piece of equipment was purchased on January 3, 2017, for \)40,000 and was charged to Maintenance and Repairs Expense. The equipment is estimated to have a service life of 8 years and no residual value. Zarle normally uses the straight-line depreciation method for this type of equipment.

9. A \(12,000 insurance premium paid on July 1, 2016, for a policy that expires on June 30, 2019, was charged to insurance expense.

10. A trademark was acquired at the beginning of 2016 for \)50,000. No amortization has been recorded since its acquisition. The maximum allowable amortization period is 10 years.

Instructions

Assume the trial balance has been prepared but the books have not been closed for 2017. Assuming all amounts are material, prepare journal entries showing the adjustments that are required. (Ignore income tax considerations.)
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