Accounting Changes

and Errors

Changes in Accounting Principle

 Retrospective adjustment.
 Cumulative effect adjustment to beginning retained earnings.
 Approach preserves comparability across years.
 Examples include:
► Change from FIFO to average-cost.
► Change from the percentage-of-completion to the
completed-contract method.

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 Changes in Accounting Principle

Change in Accounting Principle: Gaubert Inc. decided in March

2019 to change from FIFO to weighted-average inventory pricing.
Gaubert’s income before taxes, using the new weighted-average
method in 2019, is P30,000.
ILLUSTRATION 4.17
Pretax Income Data Calculation of a Change in
Accounting Principle

ILLUSTRATION 4.18
Income Statement
Presentation of a Change
in Accounting Principle
(Based on 30% tax rate)

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 Accounting Changes

Change in Accounting Estimates

 Accounted for in the period of change or the period of
and the future periods if the change affects both.
 Not handled retrospectively.
 Not considered errors.
 Examples include:
► Useful lives and residual values of depreciable assets.
► Uncollectible receivables.
► Inventory obsolescence.

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 Change in Accounting Estimates

Change in Estimate: Arcadia HS, purchased equipment for

P510,000 which was estimated to have a useful life of 10 years
with a residual value of P10,000 at the end of that time.
Depreciation has been recorded for 7 years on a straight-line
basis. In 2019 (year 8), it is determined that the total estimated
life should be 15 years with a residual value of P5,000 at the
end of that time.

Questions:
 Does prior years’ depreciation need to be restated?
 Calculate the depreciation expense for 2019.

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 After
Change in Accounting Estimates 7 years

Equipment cost P510,000 First, establish NBV

Residual value - 10,000 at date of change in
Depreciable base 500,000 estimate.
Useful life (original) 10 years
Annual depreciation P 50,000 x 7 years = P350,000

Balance Sheet (Dec. 31, 2018)

Fixed Assets:
Equipment P510,000
Accumulated depreciation 350,000
Net book value (NBV) P160,000

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 After
Change in Accounting Estimates 7 years

Net book value P160,000 Depreciation

Residual value (new) 5,000 Expense calculation
Depreciable base 155,000 for 2019.
Useful life remaining 8 years
Annual depreciation P 19,375

Journal entry for 2019

Depreciation Expense 19,375

Accumulated Depreciation 19,375

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 Accounting Errors

Corrections of Errors
 Result from:
► mathematical mistakes.
► mistakes in application of accounting principles.
► oversight or misuse of facts.

 Corrections treated as prior period adjustments.

 Adjustment to the beginning balance of retained
earnings.

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 Corrections of Errors

Illustration: In 2019, Tsang Ltd. determined that it incorrectly

overstated its accounts receivable and sales revenue by
P100,000 in 2018. In 2019, Tsang makes the following entry to
correct for this error (ignore income taxes).

Retained Earnings 100,000

Accounts Receivable 100,000

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 Accounting Errors
ILLUSTRATION 4.19
Summary Summary of Accounting
Changes and Errors

Type of
Situation
Changes in Accounting Principle
Criteria Change from one generally accepted accounting
principle to another.

Examples Change in the basis of inventory pricing from FIFO to

average-cost.

Placement on Recast prior years’ income statements on the same

Income basis as the newly adopted principle.
Statement

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 Accounting Errors
ILLUSTRATION 4.19
Summary Summary of Accounting
Changes and Errors

Type of
Situation
Changes in Accounting Estimate
Criteria Normal, recurring corrections and adjustments.

Examples Changes in the realizability of receivables and

inventories; changes in estimated lives of equipment,
intangible assets; changes in estimated liability for
warranty costs, income taxes, and salary payments.

Placement on Show change only in the affected accounts (not shown

Income net of tax) and disclose the nature of the change.
Statement

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 Accounting Errors
ILLUSTRATION 4.19
Summary Summary of Accounting
Changes and Errors

Type of
Situation
Corrections of Errors
Criteria Mistake, misuse of facts.

Examples Error in reporting income and expense.

Placement on Restate prior years’ income statements to correct for

Income error.
Statement

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 Change in Accounting Estimate

Accounting Treatment
The effect of a change in accounting estimate shall be recognized
currently and prospectively by including it in profit or loss of:

a. The period of change if the change affects that period only.

b. The period of change and future period if the change affects
both.

Prospective recognition of the effect of a change in accounting

estimate means that the change is applied to transactions, other events
and conditions from the date of change in estimate.

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Accounting Policies
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 statements

The following are not changes in accounting policy:

a. The application of an accounting policy for events or transactions
that differ in substance from previously occurring events or
transactions
b. The application of a new accounting policy for events or
transactions which did not occur previously or
that was immaterial

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 Change in Accounting Policies

Accounting Treatment
With transitional provision: A change in accounting policy
required by a standard or an interpretation shall be applied
in accordance with transitional provisions therein.
Without transitional provision: If the standard or interpretation
contains no transitional provisions or if an accounting policy is
changed voluntarily, the change shall be applied retrospectively or
retroactively.
PAS 8, paragraph 22, provides that “an entity shall adjust the
opening balance of each affected component of equity for the earliest
period presented and the comparative amounts disclosed for each prior
period presented as if the new policy had always been applied.”

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 Change in Accounting Policies
Limitation of Retrospective Application
Retrospective application of a change in accounting policy is not required if it is
impractical to determine the cumulative effect of change.

For a particular prior period, it is impractical to apply a change in accounting

policy when:
a. The effects of the retrospective application are not determinable.
b. The retrospective application requires assumptions about what management’s
intentions would have been at that time.
c. The retrospective application requires significant estimate, and it is impossible
to distinguish objectively information about the estimate that:
1. Provides evidence of circumstances that existed at that time, and
2. Would have been available at that time

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 Change in Accounting Policies
Prospective Application
When it is impractical to apply a new accounting policy retrospectively because
it cannot determine the cumulative effect of applying the policy to all prior periods,
the entity shall apply the new policy prospectively from the earliest period
practicable.
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.

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 existing in the prior
year. Thus, the financial statements of all prior periods presented shall be restated to
show financial information for the new reporting entity.

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 Change in Accounting Policies
Absence of Accounting Standard
PAS 8, paragraph 10, provides that in the absence of an accounting standard
that specifically applies to a transaction or event, management shall use its judgment
in selecting and applying an accounting policy that results in information that is
relevant to the economic decision making needs of users and faithfully represented.

Paragraphs 11 and 12 specify the following hierarchy of guidance which

management may use when selecting accounting policies in such circumstances:
a. Requirements of current standards dealing with similar matters.
b. Definition, recognition criteria and measurement concepts for assets,
liabilities, income and expenses in the Conceptual Framework for Financial
Reporting
c. Most recent pronouncements of other standard-setting bodies that use similar
Conceptual Framework, other accounting literature and accepted industry practices.

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 Prior Period Errors

Prior period errors are omissions from and misstatements in the

financial statements for one or more periods arising from a failure to
use or misuse of reliable information that:

a. Was available when financial statements for those periods were

authorized for issue.

b. Could reasonably be expected to have been obtained and taken

into account in the preparation and presentation of those financial
statements.

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 Prior Period Errors
Accounting Treatment
Prior period errors shall be corrected retrospectively by adjusting the opening
balances of retained earnings and affected assets and liabilities.

This is known as retrospective restatement which is “correcting the recognition,

measurement and disclosure of amounts of elements of financial statements as if the
prior period error had never occurred.

In other words, the net income, its components, retained earnings and other affected
balances for the prior period presented shall be adjusted accordingly. If the error
occurred before the earliest period presented, the opening balances of assets,
liabilities and equity for the earliest period presented shall be restated.

When it is impractical to determine the cumulative effect at the beginning of the

current period of an error on all prior periods, the entity shall restate the comparative
information to correct the error prospectively from the earliest date practicable.
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 Prior Period Errors
Disclosures of Prior Period Errors
An entity shall disclose the following:
1. The nature of prior period error
2. The amount of correction for each prior period presented to the
extent practicable:
a. For each financial statement line item affected
b. For basic and diluted earnings per share
3. The amount of correction at the beginning of the earliest prior
period presented
4. If retrospective restatement is impracticable for a particular prior
period, the circumstances that led to the existence of that condition
and a description of how and from when the error has been corrected

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The following is a partial list of accounts, after adjustments, of the Kopiko Company on December 31, 2019:

Depreciation – building and office equipment P145,000 The following information is also available:
Sales commissions and salaries 182,000
a. During the year, the company declared and paid P0.75 per
Inventory, January 1, 2019 341,000
share cash dividend on its 80,000 ordinary shares.
Store supplies expense 56,000
b. A physical count determined that the December 31, 2019
Retained earnings, January 1, 2019 1,785,000
ending inventory is P446,000.
Purchase returns and allowances 62,000
c. A typhoon destroyed a warehouse resulting in a pretax loss of
Bad debts expense 27,000
P120,000.
Freight in 135,000
d. The debit balance in the Discontinued Operations relates to
Sales discounts 49,000
the pre-tax summarized operations and disposal of an
Purchases 1,730,000
unprofitable line of business, which the enterprise decided to
Delivery expense 77,000
discontinue on May 1, 2019. This line was considered as a cash
Office supplies expense 19,000 generating unit (CGU). During the year 2019, before the unit’s
Ordinary share capital, P10 par 800,000 actual disposal, the CGU had revenues of P900,000 and
Share premium 610,000 expenses of P1,050,000. On September 1, 2019, the assets of the
Loss on sale of equipment 50,000 CGU were sold at a loss of P200,000.
Insurance and taxes 85,000 e. The company found and corrected a pretax P180,000
Sales 3,529,000 understatement of the 2018 depreciation expense due to a
Rent revenue 105,000 mathematical error.
Office salaries 320,000 f. During the year, 10,000 new ordinary shares were issued at an
Advertising expense 170,000 average price of P14 per share. These amounts are already
Sales returns and allowances 121,000 reflected in the given balances.
Purchase discounts 41,000 g. The company adopts the policy recognizing actuarial gains
Depreciation – store equipment 96,000 and losses in other comprehensive income. No actuarial gains
Discontinued operations (Debit) 350,000 and losses were recognized in the prior periods.
Interest expense 37,000 h. There were no investments disposed of during the year.
Unrealized gains and losses on investments carried at 50,000 i. The company’s income tax rate is 30%. The company has not
FVOCI, January 1, 2019 (Credit)
recorded yet the company’s income tax relating to profit or loss
Unrealized gains recorded during the year on 80,000 and to other comprehensive income.
investments at FVOCI
Actuarial gains taken to other comprehensive income 40,000
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 At the beginning of 2017, the Jjamppong Company 1. Share capital as of December 31, 2019
made P100,000 in expenditure that should have been Answer: 2,000,000
recorded as expense immediately. However, the
company erroneously recorded this expenditure as a
2. Retained earnings, January 1, 2018 as restated
debit to the equipment account and depreciated the
same over 5 years, with no scrap value being Answer: 1,444,000
considered. The error was discovered in 2019 when
the financial statements for 2018 had been issued. 3. Retained earnings, December 31, 2018
  Answer: 1,758,000
The company reported retained earnings at the end of
2017 of P1,500,000. During the year 2018, the 4. Retained earnings, December 31, 2019
company reported profit of P500,000 and declared Answer: 2,008,000
dividends of P200,000. Profit for 2019 (correctly stated)
was P750,000 and dividends declared during the year
were P500,000. 5. Total equity, January 1, 2018, as restated
  Answer: 3,444,000
The company’s share capital remained unchanged at
P2,000,000 since December 31, 2018. There is no 6. Total equity, December 31, 2018
other shareholder’s equity account except ordinary Answer: 3,758,000
share capital and retained earnings. The company’s
income tax rate is 30% 7. Total equity, December 31, 2019
Answer: 4,008,000

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