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INTERMEDIATE

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					                   INTERMEDIATE
                    ACCOUNTING
                         Sixth Canadian Edition
            KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK




                       Part II
              Change in Reporting Entity
• Current-period financial statements are reporting on an
  operation that is a different operation than in the previous
  period
• Disclosure requirements to provide sufficient information
  for user assessment
• Business combinations
• Discontinuing, disposal of a segment
                  Business Combination
• Disclosure includes:
  • Description of enterprise acquired, including percentage of
    voting shares
  • Date from which income from the acquired entity is included in
    the statements
  • Cost of the purchase; how cost is allocated to asset classes and
    liabilities assumed
• Pro-forma information may also be reported
      Segment Disposal/Discontinuance
• When a segment is discontinued, or formal plans to do so are
  made, required disclosure includes:
  • Income statement reporting on the continuing and discontinued operations
    for current and prior periods
  • Description of discontinued operation with date of disposal
  • Description and carrying value of major assets and liabilities of discontinued
    segment
                 Motivations for Change
• Political costs
   • Larger firms, larger profits, may become political targets
   • Accounting policies selected to reduce profits
• Capital structure
   • Debt/equity structure will impact accounting policies based on EPS impact,
     debt restraints
• Bonus payments
   • When bonuses attached to income, managers may select methods that
     maximize income
• Smooth earnings
   • Gradual increase (decrease) in income to shift attention
                               Error Analysis
• Three questions to ask in analyzing error:
   • What type of error is involved?
   • What entries are needed to correct the error?
   • How are the financial statements to be restated once the error is
     discovered?
                                Type of Error
• Balance Sheet errors
   • Affect only the balance sheet
   • Not classifying the correct amount of long term debt as current.
• Income Statement Errors
   • Affect only the income statement
   • Recording a transaction into the wrong account or classifying an account in
     the wrong grouping.
   • Transportation out classified as part of Cost of Goods Sold and not as a
     selling cost.
• In both cases often referred to as a classification issue as error is uniquely
  confined to the impact on one statement.
                                Type of Error
• The more intriguing, and more difficult to handle are errors which
  affect both the Balance Sheet and Income Statement.
• Counterbalancing errors
   • Error that has an affect in one period and in the subsequent period the effect
     counterbalances.
   • E.g: overstatement of inventory or over-accrual of an expense
   • If ending inventory is overstated in period 1 (net income overstated)– opening inventory
     will be overstated in period 2 (Net income understated).
   • If an expense is overstated in period 1 – in the following year it will be understated.
   • The effect on net income will counterbalance.
                            Type of Error
•   Non counterbalancing error
•   Errors that do not counterbalance in one period
•   E.g: expensing an item that should be capitalized.
•   If the item would have been amortized over 5 years the
    error will counterbalance over 5 years.
                  Counterbalancing errors
• The entries to correct for counterbalancing errors depend
  on if the books have been closed or not.
• Books have been closed
    • If the error has already counterbalanced – no entry is required
    • If the error is not counterbalanced – adjust the balance of
      retained earnings and the balance sheet account affected.
                  Counterbalancing Errors
• Books have not been closed
    • If the error is in the second year and already counterbalanced it is
      necessary to adjust the current period income accounts and the balance of
      retained earnings
    • If the error is not yet counterbalanced an entry is required to adjust
      beginning balance of retained earnings and correct the current period
      income statement and balance sheet accounts affected.
• It is also necessary to adjust the prior years income statement
  even if no entry is required.
                          Types of Errors
• Failure to record accrued wages:
    • At the end of 2001 Error Co. failed to accrue $2,000 in accrued wages.
    • In 2002 the error is detected and the books have not been closed for 2002.
    Dr: Retained Earnings $2,000
      Cr: Wages                           $2,000
    • This will reduce the wages in 2002 that belong to 2001, and the increase in
      wages that belong to 2001 subsequently reduces income and therefore
      retained earnings.
    • If the books for 2002 are closed no entry as the error is counterbalanced.
                          Types of Errors
• Failure to record prepaid expenses
    • In 2001 company purchased a two year insurance policy for $1,500.
    • The purchase was recorded as a debit to insurance expense.
  • Assuming the books are not closed in 2002 when the error is discovered,
    the journal entry is:
  Dr: Insurance expense          $750
    Cr: Retained earnings              $750
  • $1,500 / 2 = $750.
  • If the books for 2002 are closed no entry as the error is counterbalanced.
                         Types of Errors
• Understatement of unearned revenue
  • At the end of the year in 2001 $20,000 was received for rent relating to
    2002.
  • The account credited was rental revenue.
  • Assuming the books have not been closed:
  Dr: Retained earnings $20,000
    Cr: Rent Revenue                   $20,000
  • Prior years income was overstated by incorrectly including $20,000 to
    income. This entry corrects this.
  • If the books for 2002 are closed no entry as the error is counterbalanced.


                         Types of Errors
• Overstatement of accrued revenue
  • At the end of the year in 2001 $4,000 was accrued for interest
    relating to 2002.
  • The account credited was interest revenue.
  • Assuming the books have not been closed:
  Dr: Retained earnings      $4,000
    Cr: Rent Revenue               $4,000
  • If the books for 2002 are closed no entry as the error is
    counterbalanced.
                         Types of Errors
• Overstatement of purchases
  • At the end of the year in 2001 $5,000 of merchandise was recorded that
    related to 2002.
  • The company uses the periodic inventory system.
  • Assuming the books have not been closed:
  Dr: Purchases                  $5,000
    Cr: Retained earnings              $5,000
  • If the books for 2002 are closed no entry as the error is counterbalanced.
                         Types of Errors
• Understatement of ending inventory
  • At the end of the year in 2001 ending inventory was understated
    by $10,000.
  • Assuming the books have not been closed:
  Dr: Inventory (beginning) $10,000
    Cr: Retained earnings          $10,000
  • If the books for 2002 are closed no entry as the error is
    counterbalanced.
                           Types of Errors
• Overstatement of purchases and inventory
  • Both physical inventory and purchases are incorrectly stated
  • At the end of the year in 2001 ending inventory and purchases are
    overstated by $15,000.
  • Assuming the books have not been closed:
  Dr: Purchases                  $15,000
    Cr: Inventory (beginning)          $15,000
  • No entry to retained earnings required as their was no effect on net income
  • If the books for 2002 are closed no entry as the error is counterbalanced.
            Non Counterbalancing Errors
• Failure to record amortization
  • A machine was purchased for $10,000 in 2001 and was incorrectly
    expensed.
  • Amortization would normally have been $1,000.
  • The error was discovered in 2002.
  • If the books are not closed the journal entry would be:
     Dr: Machinery           $10,000
     Dr: Amortization        $1,000
       Cr: Accumulated amortization    $2,000
       Cr: Retained earnings           $9,000

            Non Counterbalancing Errors
• Failure to record amortization
  • If the books are closed the journal entry would be:
     Dr: Machinery            $10,000
      Cr: Accumulated amortization              $2,000
      Cr: Retained earnings                     $8,000
            Non Counterbalancing Errors
• Failure to adjust bad debt
  • The company in 2001 recorded bad debt using the direct write off method.
  • The company estimated an additional $1,000 should be recorded to bad
     debt in 2001 and $500 to 2002.
  If the books are not closed the journal entry would be:
     Dr: Bad debt expense           $500
     Dr: Retained earnings          $1,000
       Cr: Allowance for doubtful
              accounts                       $1,500

            Non Counterbalancing Errors
• Failure to record amortization
  • If the books are closed the journal entry would be:
     Dr: Retained earnings     $1,500
      Cr: Allowance for doubtful
           accounts                  $1,500


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