Chapter 20, Problem 20.14P

1.

To determine

Change in the accounting principles

Change in the accounting principle means change in the accounting methods and accounting estimates. Examples are changes in methods of depreciation and changes in methods of inventory costing.

Accounting error

Accounting error is that mistake which occur in accounting, relating to a routine activity or relating to the principle of accounting.

To prepare: The Journal entries in the result of the change or error correction, and adjusting entries for 2016 related to the situation described.

Explanation of Solution

The journal entries in the result of change or error correction, and adjusting entries for 2016 related to the situation described are as follows.

a) Journal entry for adjustment for inventory understated in 2015

Account Titles and Explanation	Post Ref.	Debit ($ In Millions)	Credit ($ In Millions)
Inventory		10
Retained Earnings			10
(To Record The Adjustment Entry)

Table (1)

Inventory understated in the year 2015 was adjusted with retained earnings in the beginning of the year 2016. There is increase in the inventory after adjustment thus, inventory is debited. Retained earnings are also increased after adjustment thus, retained earnings are credited.

Note: overstatement of inventory in the year 2014 are adjusted automatically in the year 2016, thus no adjustment entry is required.

b)  Journal entry for settlement of lawsuit

Account Titles and Explanation	Post Ref.	Debit ($ In Millions)	Credit ($ In Millions)
Litigation (Liability)		7
Litigation (Gain)			3
Cash			4
(To record the settlement of lawsuit entry)

Table (2)

A liability was accrued in 2014 for a probable payment of $7 million in connection with a lawsuit ultimately settled in December 2016 for $4 million. There is a decrease in the liability, thus litigation (liability) is debited. Decrease in the cash, thus cash is credited. There is a contingency gain (litigation gain) of $3 millions, thus it is credited.

c) A patent costing $18 million at the beginning of 2014, expected to benefit operations for a total of six years, has not been amortized since acquired.

Account titles and Explanation	Post Ref.	Debit ($ In Millions)	Credit ($ In Millions)
Retained Earnings		6
Patents			6
(To record Patents Amortization adjustment entry)

Table (3)

Patents costing $18 million in 2014, has amortized in the year 2016. The amortization value is $3 million per year. As it is not amortized in the years 2014 and 2015 then the amount $6 million ( $\$3+\$3$), thus it is credited. By the amortizing the patents retained earnings are decreased thus retained earnings are debited.

Account titles and Explanation	Post Ref.	Debit ($ In Millions)	Credit ($ In Millions)
Patent Amortization Expense		3
Patent			3
(To record Amortization entry for 2016)

Table (4)

In the 2016, patent is amortized. It decreases patent account thus, patent account is credited. Patent amortization expense is debited.

d) Depreciation expenses recorded

Account titles and Explanation	Post Ref.	Debit ($ In Millions)	Credit ($ In Millions)
Depreciation Expense       (a)		4
Accumulated Depreciation			4
(To Record the Depreciation Expense for 2016)

Table (5)

Change in the method of depreciation is a change in the accounting estimate. So there is no need of retrospective restatements of financial information. Depreciation is an expense thus it is debited. Accumulated depreciation increased, it decreases asset value and thus it is credited.

Working note:

1. (a) Compute depreciation expense after the change in the method of depreciation in 2016.

Particulars	$ In Million
Cost Of The Equipment	30
Less: Depreciation In 2014 (SYD Method)	10
Depreciation In 2015 (SYD Method)	8
Un depreciated Equipment Cost                  (a)	12
Estimated Remaining Life Of The Equipment            (b)	3 years
Annual Depreciation On SLM (c) = $(\text{a})÷\text{ (b)}$	4

Table (6)

Note: SYD is sum-of-the-years’-digits method of depreciation and SLM is straight-line method of depreciation.

Compute depreciation in SYD method for 2014 and 2015

$\begin{array}{c}\text{Depreciation}\text{=}\text{Cost of the asset }\times \left(\begin{array}{l}\text{Number of years of}\\ \text{ estimated liferemaining }\\ \text{at the beginning of the year}\end{array}\right)\begin{array}{l}\text{÷}\text{SYD}\hfill \end{array}\\ \text{SYD}\text{=}\frac{\text{n}\left(\text{n+1}\right)}{\text{2}}\end{array}$

Where n is estimated life of the asset.

$\begin{array}{c}\text{Depreciation in 2014 = \$30 }\times \frac{5}{15}\\ =\$10\\ \text{Depreciation in 2015 = \$30 }\times \frac{4}{15}\\ =\$8\end{array}$

(2)

To determine

The amounts are reported again in the 2014–2016 comparative financial statements.

Explanation of Solution

Revised values in 2014 are as follows for comparative financial statements.

Particulars	Assets	Liabilities	Share holders’ equity	Net income	Expenses
In 2014	$740	$330	$410	$210	$150
2014 inventory	(12)		(12)	(12)	12
contingency loss	No prior period adjustments
patent amortization	(3)		(3)	(3)	3
depreciation	No prior period adjustments
Revised values	$725	$330	$395	$195	$165

Table (7)

 Revised values in 2017 are as follows for comparative financial statements.

Particulars	Assets	Liabilities	Share holders’ equity	Net income	Expenses
In 2015	$820	$400	$420	$230	$175
2014 inventory  (overstated)				12	(12)
2015 inventory  (understated)	10		10	10	(10)
Contingency loss	No prior period adjustments
Patent amortization	(6)		(6)	(3)	3
Depreciation	No prior period adjustments
Revised values	$824	$330	$424	$249	$156

Table (8)

• In the year 2014, inventory is overstated by $12 million. It increases expenses and decreases net income. Decrease in the net income decreases shareholders equity and overvaluation of inventory decreases assets after adjustment.
• In the year 2015, inventory understated by $ 10 million. Adjust the overvaluation of inventory on 2014 first. Undervaluation of inventory in 2015 decreases expenses and increases net income. Increase in the net income increases shareholders equity and undervaluation of inventory increases assets after adjustment.
• Contingency loss occurred in 2014, settled in 2016 thus, there is no adjustment entries are needed.
• A patent costing $18 million at the beginning of 2014, expected to benefit operations for a total of six years, has not been amortized since acquired. In the year 2014, patent amortization amount $3 million is deducted from assets. It is an expense thus it is added to expenses. Increases in expenses decreases net income, decrease in net income decreases shareholders’ equity.
• In 2015, patent amortization expenses are added to expenses, it increases expenses. Increases in expenses decreases net income. Assets and shareholders’ equity are decreased by cumulative patent amortization amount of 2014 and 2015.
• There are no prior period adjustments for depreciation in 2014 and 2015. Change in the depreciation method reported prospectively from the first financial statements after such change