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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Sometimes a business entity may change its method of accounting for certain items. It may classify the change as a change in accounting principle, a change in accounting estimate, or a change in reporting entity. The following are three situations faced by Hyde Company relating to accounting changes.

Situation I

Hyde determined that the depreciable lives of its fixed assets are presently too long to fairly match the cost of the fixed assets with the revenue produced. Hyde decided at the beginning of the current year to reduce the depreciable lives of all of its existing fixed assets by 5 years.

Situation II

On December 31, 2018, Hyde owned 51% of Patten Company, at which time Hyde reported its investment using the cost method, owing to political uncertainties in the country in which Patten was located. On January 2, 2019, the management of Hyde was satisfied that the political uncertainties were resolved and the assets of the company were in no danger of nationalization.

Accordingly, Hyde will prepare consolidated financial statements for Hyde and Patten for the year ended December 31, 2019.

Situation III

Hyde decides in January 2019 to adopt the straight-line method of depreciation for equipment. The straight-line method will be used for new acquisitions, as well as for previously acquired equipment for which depreciation had been provided on an accelerated basis.

Directions

For each of the preceding situations, research the related generally accepted accounting principles and prepare a short memo to the president that explains the following: type of accounting change; manner of reporting the change under current generally accepted accounting principles, including a discussion, where applicable, of how amounts are computed; effect of the change on the balance sheet and income statement; and note disclosures that would be necessary. Cite your references and applicable paragraph numbers.

To determine

Prepare a memo explaining the type of accounting change, method of reporting the change under Generally Accepted Accounting Principles (GAAP), effect of the change on balance sheet and income statement, and the required disclosures, along with the references, for the given three situations.

Explanation

Accounting changes: When a company requires to sacrifice the consistent accounting methods and procedures, to enhance the usefulness and relevance of the accounting information, those changes are referred to as accounting changes. Such inevitable accounting changes decrease the comparability and consistency of accounting information. The reasons for accounting changes could be new methods introduced by FASB (Financial Accounting Standards Board), changes in accounting principles, and changes in accounting estimates.

The following are the three types of accounting changes:

  • Change in an accounting principle: This change occurs when a company decides to change from an accounting principle to another, like change from LIFO to FIFO. A change in accounting principle effects the values that impact the figures of previous and current years, thus, impairs the consistency and comparability. Hence, the changes in accounting principle should be adjusted with a retrospective effect to impact the previous financial statements, to increase the comparability and the consistency of the values between the previous and current accounting periods.
  • Change in an accounting estimate: This change occurs when a company decides to change the estimates based on the additional information or future events. A change in accounting estimate results out of new experiences and effects the values of current and future period only, but not the previous periods. Hence, the changes in accounting estimates should be accounted for prospectively.
  • Change in a reporting entity: A change in reporting entity occurs due to changes in ownership and operating control due to acquisition. Hence, the changes in reporting entity should be adjusted with a retrospective effect to represent the parent and subsidiary companies as one entity.

Methods of reporting accounting changes:

  • Retrospective adjustment method: This method requires that the previously reported financial statements should be revised to reflect the current accounting change. The change in a reporting entity and change in accounting principle are accounted for retrospectively.
  • Prospective method: This method requires that the current financial statements should be accounted for the changes, and the previously reported financial statements need not be revised. The change in accounting estimate is accounted for prospectively.

Prepare a memo explaining the type of accounting change, method of reporting the change under Generally Accepted Accounting Principles (GAAP), effect of the change on balance sheet and income statement, and the required disclosures, along with the references, for the given three situations...

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