Financial Reporting Paper 11

(c) A change in inventory method no longer receives cumulative effect treatment on the income statement. The accounting change is given retrospective application to the earliest period presented, if practicable.

(a) The requirement is to indicate how a change in accounting principle from the completed-contract method to the percentage-of-completion method should be reported. A change in the method of accounting for long-term contracts requires retrospective application to the earliest year practicable. This results in a $180,000 increase in income for year 2. The assets would be adjusted for the earliest period affected, and construction- in-progress would increase by $180,000. Net income for year 2 would increase by $108,000 ($180,000 less 40% tax ef310 fects), and the deferred tax liability account would increase in year 2 by $72,000.

(c) The effect of a change in accounting principle which is inseparable from the effect of a change in accounting estimate should be accounted for as a change in accounting estimate. Changes in estimate should be accounted for in the period of change and also in any affected future periods as a component of income from continuing operations. Financial statements are only restated for changes due to an error. Errors include mathematical mistakes, mistakes in applying accounting principles, oversights or misuse of available facts, and changes from unacceptable accounting principles to GAAP. The situation described in this question does not meet the description of an error.

(a) Deferred taxes is a direct effect from the change in accounting principle, and its effects should be recorded in the earliest period presented, if practicable. Profit sharing and royalty payments are indirect effects and should be reported in the period of the change.

(c) Indirect effects of a change in accounting principle should be reported in the period in which the accounting change occurs. Direct effects are reported retrospectively to the earliest period presented, if practicable. Answers (b) and (d) are incorrect since accounting changes are no longer treated as cumulative effect changes or prior period adjustments.

(b) If it is impracticable to determine the cumulative effect of an accounting change to any of the prior periods, the accounting change should be accounted for on a prospective basis. Answer (a) is incorrect because accounting changes are no longer treated as prior period adjustments. Answer (c) is incorrect because accounting changes are no longer treated as cumulative effect changes on the income statement. Answer (d) is incorrect because the change would not be to retained earnings in the first period presented.

(d) If the cumulative effect of applying an accounting change can be determined, but the period-specific effects on all periods cannot be determined, the cumulative effect of the change should be applied to the carrying value of the assets and liabilities at the beginning of the earliest period to which it can be determined.

(b) This situation is a change in accounting estimate and should be accounted for currently and prospectively. From 1/1/Y1 to 12/31/Y3, patent amortization was recorded using a fifteen-year life. Yearly amortization was $47,600 ($714,000 ÷ 15), accumulated amortization at 12/31/Y3 was $142,800 ($47,600 × 3), and the book value of the patent at 12/31/Y3 was $571,200 ($714,000 – $142,800). Beginning in year 4, this book value must be amortized over its remaining useful life of 7 years (10 years – 3 years). Therefore, year 4 amortization is $81,600 ($571,200 ÷ 7) and the 12/31/Y4 book value is $489,600 ($571,200 – $81,600).

(a) From 1/1/01 to 12/31/Y3, depreciation was recorded using an eight-year life. Yearly depreciation was $66,000 ($528,000 ÷ 8), and accumulated depreciation at 12/31/Y1 was $198,000 (3 × $66,000). In year 4, the estimated useful life was changed to six years total with a salvage value of $48,000. Therefore, the 12/31/Y3 book value ($528,000 – $198,000 = $330,000) is depreciated down to the $48,000 salvage value over a remaining useful life of three years (six years total – three years already recorded). Depreciation expense for year 4 is $94,000 [($330,000 – $48,000) ÷ 3], increasing accumulated depreciation to $292,000 ($198,000 + $94,000).

(d) Changes in accounting estimate are to be accounted for in the period of change and in future periods if the change affects both (i.e., prospectively). Pro forma amounts are presented for changes in accounting principle accounted for using the current (cumulative effect) approach. Answers (a) and (c) are incorrect because they apply to retroactive-type changes in principle and error correction, respectively.