Book cover for Intermediate Accounting

Intermediate Accounting

Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield

ISBN #9780470374948

13th Edition

695 Questions

Group icon
7,109 Students Helped

Homework Questions

Right arrow
Summary
Learning Objectives
Key Concepts
Example Problems
Explanations
Common Mistakes

Summary

This chapter examines the accounting treatment for changes in accounting principles, estimates, reporting entities, and corrections of errors, emphasizing that voluntary changes in accounting principles require retrospective application for comparability, while changes in estimates are applied prospectively. It underscores the critical role of proper disclosure in financial reporting to maintain transparency and ensure that financial statements accurately reflect the true financial performance and position of an entity.

Learning Objectives

1

Differentiate between changes in accounting principles, changes in estimates, changes in reporting entities, and corrections of errors.

2

Explain the retrospective application required for accounting principle changes versus the prospective approach for estimate changes.

3

Understand the importance of consistency, comparability, and full disclosure in financial reporting.

4

Analyze the implications of voluntary changes versus corrections of past misstatements in financial statements.

Key Concepts

CONCEPT

DEFINITION

Change in Accounting Principle

A voluntary change in the methods or assumptions used in preparing financial statements, typically requiring retrospective application to maintain comparability.

Change in Accounting Estimate

An adjustment of the carrying amount of an asset or liability due to new information or developments; applied prospectively.

Change in Reporting Entity

A modification in the composition of the group of entities that are covered by consolidated financial statements.

Correction of Errors

Restatements to fix past misstatements in financial reports, which are treated differently from voluntary changes in accounting principles.

Retrospective Application

The process of restating prior period financial statements as if the new accounting principle had always been applied, typically used for changes in accounting principles.

Prospective Application

The approach of applying a change or estimate only to events occurring after the change, commonly used for changes in accounting estimates.

Disclosure

Detailed explanations in the financial statements that provide transparency about changes, estimates, and errors affecting financial reporting.

Example Problems

Example 1

What are the major lessor groups in the United States? What advantage does a captive have in a leasing arrangement?

Example 2

Bradley Co. is expanding its operations and is in the process of selecting the method of financing this program. After some investigation, the company determines that it may (1) issue bonds and with the proceeds purchase the needed assets or (2) lease the assets on a long-term basis. Without knowing the comparative costs involved, answer these questions: (a) What might be the advantages of leasing the assets instead of owning them? (b) What might be the disadvantages of leasing the assets instead of owning them? (c) In what way will the balance sheet be differently affected by leasing the assets as opposed to issuing bonds and purchasing the assets?

Example 3

Identify the two recognized lease-accounting methods for lessees and distinguish between them.

Example 4

Ballard Company rents a warehouse on a month-to-month basis for the storage of its excess inventory. The company periodically must rent space whenever its production greatly exceeds actual sales. For several years the company officials have discussed building their own storage facility, but this enthusiasm wavers when sales increase sufficiently to absorb the excess inventory. What is the nature of this type of lease arrangement, and what accounting treatment should be accorded it?

Example 5

Distinguish between minimum rental payments and minimum lease payments, and indicate what is included in minimum lease payments.
Scroll left
Scroll right

Step-by-Step Explanations

QUESTION

How should a company account for a voluntary change in accounting principle, such as switching inventory valuation methods?

STEP-BY-STEP ANSWER:

Step 1: Identify the change in the accounting principle and determine that it is a voluntary change rather than a correction of an error.
Step 2: Review the previous financial statements to understand how the old principle was applied.
Step 3: Apply the new accounting principle retrospectively, adjusting prior period financial statements for consistency and comparability.
Step 4: Provide detailed disclosures in the current financial statements explaining the nature of the change, the impact on prior periods, and the reason for the change.
Final Answer: The company should restate prior period statements using the new accounting principle and disclose all relevant information to ensure transparency and comparability.

Retrospective Application for Accounting Principle Changes

QUESTION

How should a company handle a change in an accounting estimate like useful life of an asset?

STEP-BY-STEP ANSWER:

Step 1: Identify that the change is an estimate revision rather than a change in principle or a correction of error.
Step 2: Calculate the updated estimate for the asset and determine the period over which the change applies.
Step 3: Apply the updated estimate prospectively, meaning that the new estimation affects only future periods.
Step 4: Disclose the nature of the change and the impact on current and future financial statements, if material.
Final Answer: The company should use the revised accounting estimate prospectively in its future depreciation calculations, with clear disclosure in financial reports.

Prospective Application for Changes in Estimates

Scroll left
Scroll right

Common Mistakes

  • Confusing retrospective application (for changes in accounting principles) with prospective application (for changes in accounting estimates).
  • Mixing up voluntary changes with corrections of errors, leading to improper adjustments in financial statements.
  • Failing to provide adequate disclosure, which can compromise the transparency and comparability of financial information.
  • Overlooking the impact of changes in reporting entities on consolidated financial statements.