CHAPTER 1] ACCOUNTING CHANGES Change in accountj : a in: i Prior period errors 8 policy TECHNICAL KNOWLEDGE To understand the concept of a change in accounting policy. To know the recognition and reporting of a change in accounting policy. To know the guideline when selecting accounting policy in the absence of an accounting standard. To understand the concept of prior period errors. To know the recognition and reporting of prior period errors. 205 Scanned with CamScannerACCOUNTING POLICIES ries are the specific principles, y and prac d by an en Financial statemento, dhe, Accounting polic ; ity ip conventions, rule « preparing and presenting essential for a proper understang; Accounting policies are ; 7 : inp d in the financial Statements fe of the information containe ine all significant, aceou, ; ting financial statements, “8 An entity is required to out] policies applied in preparing Under accounting standards, alternative treatment, ate possible. In this case, it becomes all the more important for an entity to clearly state the accounting policies used in Preparing financial statements. ‘The entity shall select and apply the same accounting policies cach period in order to achieve comparability of financial statements or to identify trends in the financial position, performance and cash flows of the entity. , Change in accounting policy Once selected, accounting policies must be applied consistently for similar transactions and events. A change in accounting policy shall be made only when: a. Required-by an accounting standard or an interpretation of the standard. b. The change will result in more relevant and faithfully : represented information about the financial position, financial performance and cash flows of the entity. 206 Scanned with CamScanneryr amples of change in accounting policy i ting policy ari: qhange account icy arises w i feral accepted accounting principle hen an entity adopts a fig one previously used by the entity, is different from mples of change in accounting policy are: px change, in the method of inve ici a Coeighte aeaverage feeds pricing from the FIFO change in the method of accountin; b. (onstruction contract from cost pe meth od to percentage of completion method. a ‘phe initial adoption of policy to carry assets at revalued unt is a change in accounting policy to be dealt with as revaluation in accordance with PAS 16. 4. Change from cost model to fair value model in measuring jnvestment property. . Change to 2 new policy resulting from the requirement of anew The following are not changes in accounting policy: icy for events or jon of an accounting polit from previously that differ in substance transactions. , The applicati transactions occurring events or eeounting policy for events or if a new at reviously or that were b, The application 0! h did not occur pr transactions whicl immaterial. How to report a change in ting policy required I be applied in ace s therein. accounting policy Achange in account by a standard or an interpretation shal ‘ordance with the transitional provision! Ifthe standard or interpretatio® contains no transitional provisions or if an accounting policy is changed voluntarily, the change shall be applied vestropectively OT tetroactively. 207 Scanned with CamScannerRetrospective application ication is ing a new accountin, r tive application 1s applying a né unting Retrospect Peter events and. conditions as if ty had always been applied. rovi tan entity shall adj ragraph 22, provides tha adjust» pee clare! of each affected component of equity fo, ie op iod presented and the comparative Amount, earliest prior period | t E disclosed for each prior period presented as if the new Pali had always been applied. i retros| i lication means th; Simply stated, retrospective app: c ‘that an, eniGne adjustment from the change in accounting Poligy shall be reported as an adjustment to the opening balance a. retained earnings. : The amount of the adjustment is determined as of the beginning of the year of change. However, the adjustment may be made to another component of equity, not retained earnings, in order to comply with another standard. Polie at Policy If comparative information is presented, the financial statements of the prior period presented shall be restated to conform with the new accounting policy. ‘The impact of the new policy on the retained earnings prior to the earliest period presented shall be adjusted against the opening balance of retained earnings. Illustration An entity has used the FIFO method of inventory valuation since it began operations in 2018. The entity decided to change to the weighted average method for determining inventory cost at the beginning of 2019. FIFO Weighted average December 31, 2018 1,000,000 750,000 December 31, 2019 1,500,000 1,200,000 FIFO inventory - January 1, 2019 1,000,000 Weighted average inventory - January 1, 2019 750,000 Decrease in beginning in 30,000 ginning inventory 250,009 208 Scanned with CamScanner| justment of th Adi © decrease in bg etained earnings ng inv, Inventory - January 1 250,000 entory ginnii the computation of the cost 250,000 cee of ‘ then show eae inventory’ Sold for 2019 w jeventory at P1,200,000 t at P750,000 and ends ending 0 conf metho de ‘orm with the weighted aver rage The statement of changes i, 2 n equity for Deven 2, 2019 would show teeta ote eed 250,000 net of tax as a deduction from the pein ee of retained earnings. ie beginning balance Limitation of retrospective applicatioi nm Restropective application of a ch : ; a seaaar te hange in accounti1 8 not required if it is impracticable to eer policy is cumulative effect of the change. rmine the Applying a requirement of a standard is impracticable when the entity cannot apply it after making every effort to do so. For a particular prior period, it is impracticable to apply a change in an accounting policy when: 1 The effects of the retrospective application are not determinable. plication requires assumptions about: 2, The retrospective ap intentions would have been at that what management's time. ‘ 3. The retrospective application requires significant estimate, and it is impossible to distinguish objectively information about the estimate that: a. Provides evidence of circumstances that existed at that time, and b. Would have been available at that Pani t time. 209 Scanned with CamScanner| Prospective application i icatit ns that the new accountin, Prospective application meai hens oboe oe lig is applied to events and ee eda at which the policy is changed. When it is impracticable for an oe to apply a a accounting policy retrospective. a ae 1 cannot determine the cumulative effect of eae fie Policy to all ior periods, the entity shall ap: DEW Dolig prospectively from the earliest period practicable" In other words, if the amount of the adjustment on the opening balance of retained earnings cannot be Teasonably determined, the change in accounting policy shall be applieg prospectively. No adjustments relating to prior periods are made either to the opening balance of retained earnings or other component of equity because existing balances are not recalculated, Change in reporting entity A change in reporting entity is a change whereby entities change their nature and report their operations in such a way that the financial statements are in effect those of a different reporting entity. For example, this accounting change may result from changing the specific subsidiaries comprising the group of entities for which consolidated financial statements are presented. A-change in reporting entity is actually a change in accounting policy and therefore shall be treated retrospectively or retroactively to disclose what the statements would have looked like if the current entity had been existence in the prior year, 210 Scanned with CamScannerVv absence of accounting standard h 10, i as 8, paragrap , provides that i , re ; Peounting standard that specifically aie absence of an reverts management shall use Judgment inva transaction applying an eee policy that results j in selecting and aaejevant to the economic decision Rene ea aare tore and faithfully represented. ing needs of users 11 and 12 ‘ paragraphs 1 specify the following hi ‘jdance which management eee hierarchy of accounting policies in such circumstances: Ce Requirements of current oe, matters. nt standards dealing with similar p. Definition, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Conceptual Framework for Financial Reporting. Most recent pronouncements of other standard-setting bodies that use a similar Conceptual Framework, other accounting literature and accepted industry pra | prior period errors Prior period errors are omissions and misstatements in the financial statements for one or more periods arising from a failure to use of misuse of reliable information that: a. Was available when financial statements for those periods were authorized for issue to have been obtained and b. Could reasonably be expected and presentation taken into account in the preparation of those financial statements. hematical mistakes, of matt pretation Errors may occur as @ result of mat tic nistakes in applying accounting policies, misinter of facts, fraud or oversight. 211 Scanned with CamScannerHow to treat prior period errors all be corrected retrospectively s sh ea . of retained earnin, 8. ang Prior period error’ adjusting the opening balance: affected assets and liabilities. are presented, the finang hall be restated so as to re ri he prior period errors pee a If comparative statements statements of the prior period 8 the retroactive application of # retrospective restatement. eans correcting the recognitio re of amounts of elements a period error had neve T Retrospective restatement m' measurement and disclosu: financial statements as if a prior occurred. In other words, the net income, its components, retained earnings and other affected balances for the prior periog presented shall be adjusted ‘accordingly. If the error occurred before the earliest prior period presented, the opening balances of assets, liabilities and equity for the earliest prior period presented shall be restated. When it is impracticable to determine the cumulative effect at the beginning of the current period of an error on all prior aad the a shall restate the comparative information ‘o correct the error prospectively from i ee ly the earliest date Scanned with CamScannerpiselosure of prior poriod err, b PreOnn y shall dinclone the follows owing anenll pho nature of the prior poviod ory yrvow p, Tho amount of correction for onch * ¢o the extent practicable; Prior period presented, For each financial atate ab i i pment Line ite For basic and diluted aaATeaT Pa ee BY per abare The amount. of correction at the | " \ » boy of & rior period presented, Winning of the earliest P a if eee nee restatoment is impracticable for cular prior period, the circumstances that led to the ription of how and arti Pistonce of that condition and a des from when the error has been corrected [Ilustration During 2020, an entity discovered that certain goods that had been sold during 2019 were incorrectly included in December 31, 2019 inventory in the amount of P300,000. s for 2020 before adjustment revealed ‘old of P3,000,000. ng record: ‘The accountil 10,000 and cost of goods s sales of P5,00' the prior The adjustment on December 31, 2020 to corre period error is: Retained earnings 300,000 Inventory, January 1 (or cost of goods sold) 300,000 Accordingly, the partial income statement for 2020 would appear as: 5,000,000 Sales 8,0 000,000 - 300,000) 2, 00,000 Cost of goods sold (3, 2,300,000 Gross income 213 Scanned with CamScannerQUESTIONS 1. Define accounting policies. 2. Define a change in accounting policy. 3. Give examples of change in accounting policy. 4, When is a change in accounting policy allowed? 5. How is a change in accounting policy reported? 6. Explain the retrospective application of a change in accounting policy. 7. Explain the adoption of an accounting policy in the absence of an accounting standard. 8. What is a change in reporting entity? 9. Define prior period errors. 10. Explain the treatment of prior period errors. aii Scanned with CamScanner 4pROBLEMS problem 11-1 (AICPA Adapted) ‘Om| ‘ost flow method to FIFO f Pany changed tes saement and income ta repo bth Send Purposes, on January 1, 2019, Black ¢ TO) ‘The change resulted in a P60 . gaventory on January 1, 2979 "000 increase in the beginning Jgnoring income tax, the ; jeported in the 2019, Accounting change should be Income statement as a P, a. : nt as a P600,000 debi p. Retained earnings statement ce, P600,000 debi adjustment to the beginning balance mee debit c. Income statement as a P600,000 credit d. Retained earnings statement as i adjustment to the beginning balance F600,000 credit Problem 11-2 (AICPA Adapted) During 2019, Orca Company decided to change from the FIFO method of inventory. valuation to the weighted average method. Inventory balances under each method were as follows: FIFO Weighted average January 1 7,200,000 7,700,000 7,900,000 8,300,000 December 31 What amount should be reported as the pretax effect i the acounting change in the statement of changes in equity 20199 & 500,000 addition 4. 500,000 deduction q, 200,000 addition ' 900,000 deduction B15 Scanned with CamScanner3 (AICPA Adapted) : PIF hod of inv d the FIFO met ' invento used ns in 2016. The entity decigey rage method for determinin of 2019. The entity Provide nces under FIFQ ea problem 11 Goddard Compa valuation since it began oe i to change to the weighte Me inventory cost at the beginning © Ee the following year-end ae weighted average method: FIFO Weighted average 5,400,000 2017 ‘on000 #'100,000 5300, 7,800,000 2017 2018 8,300,000 any ha Year ted in the 2019 statement Id be repor on of the change in What pretax amount sh rt of tenes in equity as the cumulative effect accounting policy? a. 500,000 decrease b. 300,000 decrease c. 500,000 increase d. 300,000 increase Problem 11-4 (AICPA Adapted) On January 1, 2019, Poe Construction Company changed to the percentage of completion method from cost recovery method of income recognition. On December 31, 2018, the entity compiled data showing that income under the cost recovery method aggregated P7,000,000. If the percentage of completion method had been used, the accumulated income through December 31, 2018 would have been P9,000,000. The income tax rate is 30%. The cumulative effect of the ac i d be reported in the 2019. ete ae show a. Retained earnings statement area b easement to the beginning Salanee 000,000 B ne statement as P2,000,000 credit. F : Betaing earnings statement as a P1,400,000 credit AG justment to the beginning balance ' ; - Income statement as a P1,400,000 credit. 216 Scanned with CamScannerproblem 11-5 (IAA) anko Construction Compan: a ‘od of accounting since ir) 288 meth oe ing Since it began open the cost recovery 2019, for justifiable reasons erations in 2016, the percentage of completion mery gm method. rt “ecided to adopt pe following schedule, reporting j pas been prepared by the entity “come for the past 3 years, 2016 otal revenue from 2017 2018 completed contracts 25,000,000 es: Cost of completed 42,000,000 40,000,000 contracts . ; 18,000,000 29,000,000 28,000,000 Jncome from operations 7,000,000 1 aa ney Nene oa Income _ 2,000,000 18,000,000 10,000,000 Analysis of the accounting records disclosed the following income by contracts, earned in the years 2016-2018 using the percentage of completion method. 2016 2017 2018 Contract 1 7,000,000 Contract 2 5,000,000 8,000,000 Contract 3 3,000,000 7,000,000 2,000,000 Contract 4 1,000,000 6,000,000 Contract 5 (1,000,000) What pretax amount should be reported as the eu effect of change in accounting policy in the statement 0 retained earnings for 2019? a 6,000,000 b. 8,000,000 ¢ — 7,000,000 d 0 217 Scanned with CamScannerpted) pA Adal Os statements for 2019, py, Problem 11-6 * i a ‘le preparing the financia While repirored computation® 1 errors in the 2or7 al ; iati nse. 2018 depreciation expel settee: resulted in overstatement of each year's co These errors rest e tax. The net income for 201g 000, net of incom by P25, arfectly, reported at P500,000. : ‘The following amounts were reported in the previously ina, i ial statements: financial stat soma _ 700,000 500,01 i ings, January 1 a ener ee 150,000 200,009 850,000 700,000 Retained earnings, December 31 What is the balance of retained earnings on December 31, 2019? a. 1,300,000 b. 1,350,006 c. 1,400,000 d. 1,325,000 Problem 11-7 (IAA) Effective January 1, 2019, King Company adopted the accounting policy of expensing advertising and promotion costs when incurred. Previously, advertising and promotion costs applicable to future periods were recorded in prepaid expenses. The entity can justify the change which was made for both financial statement and income tax reporting purposes. The prepaid advertising and promotion costs totaled P600,000 on December 31, 2018. The income tax rate is 30%. What is the adjustment for the effect of the change it accounting policy that pues ing policy at should result in a net charge agains! a. 600,000 b. 180,000 ¢. 420,000 idiba: 0° "Scanned with CamScanner Jproblem 11-8 (IFRS) ang the year end petit counted at Harbor Got 31, 2018, the 4 " : pany: ’ 2919, the following as decided to wri 6 1 Tew as or tWO Years olde 800.000 fi was rs old as it Was ob; rom inventory which solete, ales of P1,000,000 had been om; statements for the year ended p itted from the financial ecembey yhat amount should be reported ag a 31, 2018, he financial statements for 29197" PMO period error in 1,800,000 & 3'900,000 300,000 200,000 problem 11-9 (IFRS) in reviewing the draft financial statement ; ¢ ts fe ended December 31,2019, Bituin Company ade that market one were 4 that the provision for inventory gbsolescence on December 31, 2019 shoul iner alee ould be increased by If the same basis of calculating inventory obsolescence had heen applied on December 31, 2018, the provision would have been P1,800,000 higher than the amount recognized in the statement of comprehensive income. 1, What adjustment should be made to net income of 2019? a. 3,000,000 decrease b. 3,000,000 increase c. 1,200,000 decrease d. 1,200,000 increase 2. What adjustment should be made to net income of 2018 presented as comparative figure in 2019? a. 1,800,000 decrease b. 1,800,000 increase A 3,000,000 decrease . 0 219 Scanned with CamScanner0 (IFRS) fad 1 ed the following informatio, problem 11- . Animus Company prov! iM aed: December j ‘year-end December 81, 2019 ° a 201g 8,160,000 '200'009 Development costs 1,800,000) 7209,000) Amortization . ite to a sil 4 vealized development costs sna a single Proje The capitalize din 2016. It has now ered 4 at that commence: a for capitalization has never been mot, one of the criteri / nt is required to restate retained Carning 1. What adjustme on January 1, 2019? a. 6,360,000, b. 1,720,000 c. 4,640,000 a. 0 . What amount of the dev expensed in 2019? a. 5,840,000 b. 6,360,000 c. 1,720,000 d. 0 elopment costs should be Problem 11-11 (IAA) During 2019, Build Company changed from the cost recovery method to the percentage of completion method. The tax rate is 30%. Gross profit figures are: : 2017 2018 2019 Cost recovery method 950,000 1,250,000 —_ 1,400,000 Percentage ofcompletion 1,600,000 ~—«*1,900,000 _-2,100,000 How should this accounting change be reported in 2019? a. 1,300,000 increase in profit or loss b. 1,300,000 increase in retained earni c. 910,000 increase in profit or loss ie d. 910,000 increase in retained earnings 220 Scanned with CamScannerproblem 11-12 (IFRS) uring the year ended Decemb ied the following ove et 81: 2019, Samar Company yeve ting er i A come Froese ating to inventory on December 3 Se of - This required a reductio in i al of inventory on that date of 280,000 ‘ . The provision for uncollectibl December 31, 2018 was 300,000. Decne sare on of P50,000 was written off the December 31 aa amount receivable. , 2018 accounts What adjustment is required to i i on January 1, 2019? ; restate retained earnings a, 280,000 b. 300,000 ¢. 580,000 ‘e 0 Problem 11-13 (PHILCPA Adapted) of the 2018 financial statements, Narra ed a computational error of P150,000 in the calculation of the December 31, 2018 inventory. The error resulted in a P150,000 overstatement in the cost of goods sold for the year ended December 31, 2018. After the issuance Company discover’ id the amount of P500,000 in In October 2019, the entity pa ted against it during 2018. settlement of litigation institu In the 2019 financial statements, what is the pretax adjustment to retained éarnings 0” January 1, 2019? & 150,000 credit b. 350,000 debit a 500,000 debit - 650,000 credit 221 Scanned with CamScannerProblem 11-14 (IFRS) Natasha Company reported net income of P700,000 for a9), The entity declared and paid dividends of P 150,000 in, 2014 and P300,000 in 2018. 4 for the year ended December 3 tained earnings of P1,100,09 1, ome for 2018 was P600,009 In the financial statements 2018, the entity reported re January 1, 2018. Thé net ine 0 on r the 2018 financial statements were Approved In 2019, afte \ covered an error In the December 31 for issue, the entity disc 2019 financial statements. as a P650,000 overstatement of no The effect of the error w ember 31, 2018 due ty income for the year ended Dec underdepreciation. 1. What amount was reported as retained earnings on December 31, 2018? a. 1,400,000 b. 1,700,000 c. 2,000,000 d. 2,100,000 2. What amount should be re; i i ported as ret: on December 31, 2019? stain parting a. 1,300,000 b. 2,900,000 c. 1,650,000 d. 1,950,000 222 Scanned with CamScannerproblem 11-15 Multiple choice (Pag 8): 1. we ~ which is the first step withi lecti Within the hi when selecting accounting policies techy of guidance a. Apply a standard fy a to une jroueschon om TERS if it Specifically relates p. Apply the requirements in IFRS dealing with «: and related issue ealing with similar ce. Consider the applicabilit, recognition criteria and Conceptual Framework d. Consider the most rece standard setting bodies Y of the definitio ns, measurement concepts in the nt pronouncements of other Jn the absence of an accountin; i i ‘ g standard that applies specifically to a transaction, what is the most authoritative source in developing and applying an accounting policy? a. The requirement and guidance in the standard or interpretation dealing with similar and related issue b. The definition, recognition criteria and measurement of asset, liability, income and expense in the Conceptual Framework Most recent pronouncement of other standard-setting body d. Accounting literature and accepted industry practice G Achange in accounting policy shall be made when I. Required by law. IL Required by an accountin of the standard. ill i lev: IIL The change will result in more relevat aeeaon about the financial position, performance and cash flows of the entity. ig standard or an interpretation ant or reliable financial Land III only . I and III only Iand II only . I Wand I perp 223 Scanned with CamScanner4, All of the accounting a. b. c. d. 5, Achange in accounting poli except a. b. ice d. 2 following should be treated as a change i policy, exceP' cofng pve ofA for capa nt ane aie has become eligible Zation fop as a proje the first time. w IFRS. A new policy 7 om 8 sulting fr fe . seen levant information, invest, To oe more Fg measured at fair value, han oot sured at cost. . of uy erally a change in accounting policy, ol icy includes all of the following The initial adoption ofa policy to carry assets at revalueg amount. e from cost model to fair value mode] of The chang ing investment property. . measuring mvt entory valuation from FIFO to weight average. : The change in depreciation method from sum of yeary digits to straight line. Which statement is correct concerning application of a change in accounting policy? L IL. ‘An entity shall account for a change in accounting policy resulting from the initial application of a standard or an interpretation in accordance with any transitional provision. When an éntity changes an accounting policy upon initial application of a standard or an interpretation that does not include specific transitional provision applying to that change, the change shall be applied retrospectively. MLWhen an entity changes an accounting polit’ peop voluntarily, the chan i retrospectively. ee I and II land III I, and III |. IWand III 224 Scanned with CamScannerynange in account: Ae ‘ing poli effect of the change should b, Tequires that t} a es he . Beginning retained ear: hown as an adjustment presented. Atnings f Tent to Ps ‘or p. Net income for the cur: Comprehensive income Period. a. the earliest period 2 ‘ome fi presented. Or the earli : 4, Shareholders' equity for th arliest period occurred. © Period in which the change Which is the best explanatio are classified into change in a jn accounting estimate? ay accounting changes unting policy and change a. The materiality of the changes j : ges involved p, The accounting changes involve different recognition in the financial statement: a c. The fact that some methods are conside d G: d. Management decision sae 9, Which of the following is not a change in reporting entity? a. Changing the entities included in combined financial statements b. Disposition of a subsidiary or other business unit c. Presenting consolidated statements in place of the statements of individual entities d. Changing specific subsidiaries that constitute the group of entities for which consolidated financial statements are presented. 10. Prior period errors a. Do not include the effect of accounting policy - : b. Do not affect the presentation of P comparative financial statements. — & Do not require further disclosure in the body of the financial statements. ing balance of a re adjustments of the opening balan aban atthe earliest period presented. retained earnings 0 225 fa mistake in the application rior period Scanned with CamScanner