STUDY STEPS

Understanding the Nature of Accounting Changes

Changes in accounting policies

According to Parts I and II of the CICA Handbook, changes in accounting policies are changes in the choice of “specific principles, bases, conventions, rules, and practices applied by an entity in preparing and presenting financial statements.” Changes in accounting policies may be required under IFRS or ASPE (for example, on initial adoption of a new accounting standard), or they may be voluntary.

Under IFRS, a voluntary change in accounting policy is only permitted if it would result in presentation of reliable and more relevant information in the financial statements. For example, a voluntary change in accounting policy would not be permitted if the change would result in presentation of reliable but equally or less relevant information in the financial statements.

Under ASPE, for a voluntary change in accounting policy, the same criteria requiring reliable and more relevant information in the financial statements applies, except within certain specifically identified accounting standards (including, for example, accounting for income taxes). Within these specifically identified accounting standards, a change between or among alternative ASPE methods of accounting and reporting is permitted, even if the new method would not result in presentation of more relevant information in the financial statements. For example, ASPE allows a voluntary change from the future income taxes method to the taxes payable method of accounting for income taxes, even if the change does not result in presentation of more relevant information in the financial statements.

Changes in accounting policies are reflected in the financial statements using (1) full retrospective application if practicable, (2) partial retrospective application if full retrospective application is impracticable, or (3) prospective application if partial retrospective application is impracticable. Accounting standards specifically state that retrospective application is impracticable only if one or more of these three circumstances apply:

1. The effects of the retrospective application cannot be determined.
2. Assumptions are needed about what management's intentions were in that prior period.
3. Significant estimates must be made that need to take into account circumstances that existed in that prior period, and it is no longer possible to do this.

Full retrospective application requires:

1. A journal entry to recognize the effects of the new accounting policy that is being applied retrospectively, including any related income tax effects. This journal entry records the cumulative effect of the change in accounting policy, as of the beginning of the current accounting period, effectively bringing the opening balances of asset, liability, and equity accounts (including retained earnings and accumulated other comprehensive income) to the correct revised amounts. Note that the current year effect of a change in accounting policy would be recorded in the specific income statement and statement of financial position accounts directly, in the current period.
2. Restatement of prior period financial statements included alongside the current year's financial statements for comparative purposes. In the financial statements of the earliest prior period included for comparative purposes, the opening balances of asset, liability, and equity accounts (including retained earnings and accumulated other comprehensive income) are adjusted to reflect the cumulative effect of the change in accounting policy. This is necessary in order to show continuity and reconciliation of statement of financial position accounts between the comparative financial statements presented.
3. Specific disclosures, as required under IFRS or ASPE. Under IFRS, retrospective application also requires presentation of the opening statement of financial position for the earliest comparative period included.

Partial retrospective application is similar to full retrospective application, except that the opening balances of asset, liability, and equity accounts are adjusted in the earliest period for which restatement is possible. Thus, the effect of the accounting change is applied to the carrying amounts of assets, liabilities, and affected components of equity at the beginning of the earliest period for which restatement is possible.

Changes in accounting estimates

A change in accounting estimate is an adjustment to the carrying amount of an asset or a liability or the amount of an asset's periodic consumption, and results from either an assessment of the present status of or the expected future benefits and obligations associated with the asset or liability. A change in accounting estimate is usually the result of new information or a change in circumstances. For example, a change in the estimated remaining service life of an asset might result from actual experience confirming that the asset's physical life is longer than originally expected. Prior period financial statements were prepared using estimates that were made in good faith, based on available information and known circumstances in those prior periods. Therefore, prior period financial statements are not adjusted to reflect changes in accounting estimates that arise in the current period. A change in accounting estimate is accounted for prospectively: (1) in the current period if the change affects the current year only, or (2) in the current period and in future periods if the change affects both. Prospective application simply means that in the current period and going forward, the new estimate is applied to (or used in the calculations related to) the balance(s) of the related asset, liability, and/or equity account(s) as of the date of change.

If it is unclear whether an accounting change is a change in accounting policy or a change in accounting estimate, the accounting change should be treated as a change in accounting estimate.

Correction of a prior period error

A prior period error is a mistake or omission (either intentional or unintentional) that is not discovered until after the financial statements for the period have been issued. Correction of a prior period error is accounted for retrospectively because the relevant prior periods’ financial statements are incorrect and/or misleading, and should be adjusted. Retrospective treatment of a correction of a prior period error is called retrospective restatement, because amounts that were reported in the relevant prior periods’ financial statements are corrected as if the error had never occurred. Retrospective restatement is similar to retrospective application, as described above.

Under IFRS, correction of a prior period error is accounted for using full retrospective restatement if practicable, partial retrospective restatement if full retrospective restatement is impracticable, or prospective application if partial retrospective restatement is impracticable. However, under ASPE, correction of a prior period error must be accounted for using full retrospective restatement.

Be careful to differentiate between changes in accounting estimates and the correction of a prior period error. Changes in accounting estimates are a normal part of the accounting process, and a result of routine assessment of present status and future benefits and obligations of assets and liabilities. A prior period error is a mistake or omission, or a result of lack of expertise or good faith.

TIPS ON CHAPTER TOPICS

ILLUSTRATION 21-1

Summary of Accounting Methods for Accounting Changes

CASE 21-1

PURPOSE: This case will provide examples of changes in accounting policies, changes in accounting estimates, and corrections of a prior period error, and identify the proper accounting treatment for each.

Instructions

For each item in the list:

(a) Use the appropriate number to indicate if the item is:

1. a change in accounting policy.
2. a change in accounting estimate.
3. a correction of a prior period error.
4. none of the above.

(b) Use the appropriate letter to indicate if the item is to receive:

R: retrospective treatment.

PA: partial retrospective treatment.

PR: prospective treatment.

N: none of the above.

For items requiring retrospective treatment, unless otherwise implied or indicated, assume that full retrospective treatment is practicable.

Solution to Case 21-1

EXPLANATION: First determine the nature of the change, then determine how to treat the change. Notice that in most instances, the answer to part (a) determines the answer to part (b). A change in accounting policy is treated retrospectively (unless full retrospective application or restatement is impracticable). A change in accounting estimate is accounted for prospectively. Therefore, an answer of 1 for part (a) requires an answer of R or PA for part (b), an answer of 2 for part (a) requires an answer of PR for part (b), and an answer of 3 for part (a) requires an answer of R or PA for part (b).

ILLUSTRATION 21-2

Calculating and Recording the Effects of a Change in Accounting Policy

1. Calculate and record the effect of a change in accounting policy on income of periods prior to the change, as follows:
   1. Determine the cumulative effect of the change on retained earnings (and other affected components of equity) as of the beginning of the current period (the period of change), as follows:

      (a) Identify the revenue and/or expense account(s) and amount(s) that were affected in the prior periods when the previous accounting policy was applied.

      (b) Calculate what the amount(s) of those revenue and/or expense account(s) would have been in the prior periods if the new accounting policy was applied in those periods. Also consider the effect on the amount of income taxes reported.

      (c) Compare the amount(s) in part (a) above with those in part (b) above. The net difference is the (net of tax) effect of the change on income of prior periods.

   2. Record the effect of the change on income of prior periods as follows:

      (a) Determine whether the adjustment to retained earnings (and/or other affected components of equity) for the effect on prior periods is a debit or a credit.

      (1) If application of the new accounting policy would have resulted in higher net incomes in prior years, the adjustment to retained earnings (and/or other affected components of equity) is a credit.

      (2) If application of the new accounting policy would have resulted in lower net incomes in prior years, the adjustment to retained earnings (and/or other affected components of equity) is a debit.

      (b) Record the rest of the journal entry so that asset and liability account balances are restated to balances that would have existed at the beginning of the current period had the new accounting policy been applied in all prior periods.

2. Calculate and record the effect of the change in accounting policy on income of the current period, as follows:
   1. Identify the revenue and/or expense account(s) and amount(s) on the current period income statement calculated as a result of application of the new accounting policy.
   2. Calculate the amount(s) of those revenue and/or expense account(s) in the current period if the previous accounting policy was applied in the current period.
   3. Compare the amount(s) in (1) above with the amount(s) in (2) above. The net difference is the effect of the change on income of the current period.

      

      The effect of the change on income of the current period does not include the cumulative effect of the change on income of prior periods.

   4. Disclose the (net of tax) effect of the change on income of the current period in the notes to the financial statements of the current period.

EXERCISE 21-1

PURPOSE: This exercise will illustrate the following for a change in accounting policy: (1) calculation of effect on prior periods, (2) calculation of effect on the period of change, and (3) calculation of amounts for retrospective application.

In Years 1, 2, and 3, Spencer Corporation used weighted average cost to calculate ending inventory and cost of goods sold for book purposes and for tax purposes. In Year 4, Spencer changed to FIFO for book purposes, because FIFO would result in presentation of reliable and more relevant information in the financial statements. Assume the weighted average cost formula was used throughout Year 4, and the change in policy was decided on after all adjusting entries were made for Year 4, but before the closing entries were recorded. Spencer uses a periodic inventory system, and has a tax rate of 30% for all years. Spencer prepares financial statements in accordance with IFRS. Cost of goods sold for Years 1 through 4, under each cost formula, is as follows:

Instructions

Solution to Exercise 21-1

EXPLANATION: The current year (year of change) is Year 4. Therefore, the prior years affected are Years 1, 2, and 3. The total amount that was reported as cost of goods sold in Years 1, 2, and 3 (calculated using weighted average cost) is compared with the total amount that would have been reported as cost of goods sold in those same years if FIFO (the new cost formula) was used. The difference is the total effect on the prior periods' income before taxes, which is commonly called the cumulative effect on prior periods. The cumulative effect, net-of-tax, is calculated by multiplying the cumulative effect on prior periods by the 70% net-of-tax rate (100% minus the 30% tax rate).

EXPLANATION: The new cost formula (FIFO) would have yielded lower cost of goods sold and therefore more net income if it was used in prior periods; therefore, the adjustment to record the cumulative effect of the change as of the beginning of Year 4 is a credit to retained earnings.

The rest of the journal entry restates the balances of affected asset and liability accounts, to balances that would have existed at the beginning of Year 4, had FIFO (the new cost formula) been applied in all prior years. At the end of Year 3, inventory would have been higher by $4,100 if FIFO was used in all prior years. Use of FIFO for tax purposes would have resulted in additional income taxes payable of $1,230 ($4,100 × 30% = $1,230) at the end of Year 3. This is because the same inventory cost formula must be used for tax purposes as is used for financial reporting purposes.

ILLUSTRATION 21-3

Accounting for a Change in Accounting Estimate for a Plant Asset

Whenever there is a change in estimated useful life or estimated residual value for a depreciable asset, the following format will aid in the calculation of depreciation.

EXERCISE 21-2

PURPOSE: This exercise will illustrate the proper accounting procedures for a change in accounting estimate.

Mitten Corporation acquired a plant asset costing $300,000 at the beginning of Year 1. After depreciating it for four years using the straight-line method, a 10-year useful life, and an expected residual value of $30,000, Mitten estimated the asset would be useful for a total of 12 years with a residual value of $20,000. The tax rate is 30% for all years. Mitten prepares financial statements in accordance with IFRS.

Instructions

Solution to Exercise 21-2

ILLUSTRATION 21-4

Common Relationships and Assumptions Inherent in Correcting Error Situations

1. It is assumed that an accrued expense not recorded at the end of a period is paid (and recorded as expense) in the following period.
2. It is assumed that an accrued revenue not recorded at the end of a period is received (and recorded as revenue) in the following period.
3. It is assumed that a prepaid expense omitted in Year 1 is recorded as expense in Year 1 when the cash was disbursed. Unless otherwise indicated, it is assumed that the related expense is consumed in Year 2 (although not recorded as such, since the prepaid expense was omitted in Year 1).
4. It is assumed that an unearned revenue omitted in Year 1 is recorded as revenue in Year 1 when the cash was received. Unless otherwise indicated, it is assumed that the related revenue is earned in Year 2 (although not recorded as such, since the unearned revenue was omitted in Year 1).
5. Ending inventory of one period is beginning inventory of the following period.
6. If purchases of inventory that are made near the end of Year 1 are not recorded until Year 2, and the merchandise is also omitted from ending inventory for Year 1, there is no net effect on net income of Year 1 or Year 2.
7. Unless otherwise indicated, if depreciation expense for Year 1 is omitted in Year 1, depreciation expense for Year 2 is assumed to be recorded correctly in Year 2 (for the amount related to Year 2 only).

ILLUSTRATION 21-5

Guide to Preparing Correcting Journal Entries

SHORT METHOD

Step 1:	Adjust current revenue and/or expense (or gain and/or loss) accounts affected by the error.
Step 2:	Adjust asset and/or liability accounts to their proper balances (if applicable).
Step 3:	Adjust revenue and/or expense items of prior periods with an entry to retained earnings (and/or other affected components of equity).

OR

LONG METHOD

Step 1:	Reconstruct the incorrect journal entry that was actually recorded, if any (sometimes no journal entry was recorded, when in fact, a journal entry should have been recorded).
Step 2:	Reconstruct the journal entry that should have been recorded. Analyze it to determine the impact on each account affected (what was understated, overstated, and so on). Remember: A = L + OE.
Step 3:	Record a correcting journal entry to bring affected accounts to their correct current balances. Start with the reconstructed incorrect journal entry that was actually recorded (from Step 1), and the reconstructed journal entry that should have been recorded (from Step 2), and apply three additional steps: Step 3(a): If the reconstructed journal entries involve any revenue or expense items of prior periods, cross out these account names, and replace them with Retained Earnings. Step 3(b): Clean up the reconstructed journal entries by netting amounts recorded to the same account(s), and record the combined (correcting) journal entry. Step 3(c): Record an adjusting entry for the current year if necessary.

EXERCISE 21-3

PURPOSE: This exercise will provide an example of the accounting procedures for correction of prior period errors accounted for with full retrospective application.

The Build-away Construction Company enters into long-term construction contracts. Gross profit amounts calculated using the completed-contract method and the percentage-of-completion method for Years 1 through 3 are as follows:

The company applied the completed-contract method in Years 1 and 2 for both book purposes and tax purposes. In Year 3, the company discovered that the percentage-of-completion method should have been applied for book purposes only. The tax rate is 30% for all years. The company prepares financial statements in accordance with ASPE, and applies the future income taxes method of accounting for income taxes.

Instructions

Solution to Exercise 21-3

EXERCISE 21-4

PURPOSE: This exercise will provide examples of errors and discuss their effect on net income and the statement of financial position.

The Mahdi Corporation discovered errors during an audit in 2015. The company has a calendar-year reporting period. The errors are as follows:

Error 1:	Accrued interest on notes payable of $3,500 was omitted at the end of 2014.
Error 2:	Prepaid insurance of $1,800 was overlooked at the end of 2014. (The premium paid in advance relates to insurance coverage for 2015.)
Error 3:	Accrued interest on investments of $5,100 was understated at the end of 2014.
Error 4:	Unearned rent revenue of $4,500 was understated at the end of 2014.
Error 5:	A truck with a cost of $10,000, a useful life of four years, and a residual value of $4,000 was expensed when it was purchased at the beginning of 2014.
Error 6:	Amortization of patent, $700, was omitted in 2014.

Instructions

Solution to Exercise 21-4

For each error, the (b) and (c) solution and explanation is presented below:

APPROACH TO PART (B): Using journal entries, reconstruct what was done and compare that with what should have been done, in order to determine the effects of each.

APPROACH TO PART (C): To prepare correcting journal entries, follow the three steps in the “short method” outlined in Illustration 21-5. Refer to the Explanation to the Solution to part (b) to determine the required correcting journal entry.

ERROR 1

(b) Effects of Error 1: Failure to accrue interest expense in 2014:

1. Net income for 2014 is overstated (because interest expense is understated).
2. Liabilities are understated, and owners' equity is overstated at 12/31/14.
3. Net income for 2015 is understated (because interest expense is overstated).
4. There is no effect on the statement of financial position at 12/31/15.

EXPLANATION:

An adjusting entry to record accrued interest expense of $3,500 was omitted in 2014. The amount would have been paid and recorded as an expense in 2015. The payment in 2015 should have been recorded as a reduction in Interest Payable (a liability), but an Interest Payable was never reflected on the books.

(c) Correcting journal entry for Error 1 at 12/31/15 before closing:

Error 1: Explanation for journal entry:

Step 1:	Interest Expense in 2015 will be overstated unless a correcting journal entry is made; therefore, Interest Expense for 2015 should be reduced with a credit.
Step 2:	No assets or liabilities are affected at 12/31/15.
Step 3:	Interest Expense for 2014 was understated. However, the Interest Expense account cannot be debited because all income statement amounts for 2014 were closed to Retained Earnings at the end of 2014. Therefore, a debit to Retained Earnings is required to correct for the error.

ERROR 2

(b) Effects of Error 2: Failure to defer insurance expense in 2014:

1. Net income for 2014 is understated (because insurance expense is overstated).
2. Assets are understated, and owners’ equity is understated at 12/31/14.
3. Net income for 2015 is overstated (because insurance expense is understated).
4. There is no effect on the statement of financial position at 12/31/15.

EXPLANATION:

Insurance premiums for 2015 were paid in advance in 2014. Payment in 2014 must have been recorded with a charge to insurance expense. An adjusting entry at the end of 2014 to record deferral of a portion of the expense to 2015 was omitted. As a result, no portion of the insurance premium was recorded as an expense in 2015 (the year in which some of the benefits of the insurance premium were consumed, in the form of insurance coverage).

(c) Correcting journal entry for Error 2 at 12/31/15 before closing:

Error 2: Explanation for journal entry:

Step 1:	Insurance Expense in 2015 will be understated unless a correcting journal entry is made; therefore, Insurance Expense for 2015 should be increased with a debit.
Step 2:	No assets or liabilities are affected at 12/31/15.
Step 3:	Insurance Expense for 2014 was overstated. However, the Insurance Expense account cannot be credited because all income statement amounts for 2014 were closed to Retained Earnings at the end of 2014. Therefore, a credit to Retained Earnings is required to correct for the error.

ERROR 3

(b) Effects of Error 3: Failure to accrue interest income in 2014:

1. Net income for 2014 is understated (because interest income is understated).
2. Assets are understated, and owners' equity is understated at 12/31/14.
3. Net income for 2015 is overstated (because interest income is overstated).
4. There is no effect on the statement of financial position at 12/31/15.

EXPLANATION:

An adjusting entry to record accrued interest income of $5,100 was omitted in 2014. The amount would have been received and recorded as income in 2015. The receipt in 2015 should have been recorded as a reduction in Interest Receivable (an asset), but an Interest Receivable was never reflected on the books.

(c) Correcting journal entry for Error 3 at 12/31/15 before closing:

Error 3: Explanation for journal entry:

Step 1:	Interest Income in 2015 will be overstated unless a correcting journal entry is made; therefore, Interest Income for 2015 should be reduced with a debit.
Step 2:	No assets or liabilities are affected at 12/31/15.
Step 3:	Interest Income for 2014 was understated. However, the Interest Income account cannot be credited because all income statement amounts for 2014 were closed to Retained Earnings at the end of 2014. Therefore, a credit to Retained Earnings is required to correct for the error.

ERROR 4

(b) Effects of Error 4: Failure to defer rent revenue in 2014:

1. Net income for 2014 is overstated (because rent revenue is overstated).
2. Liabilities are understated and owners' equity is overstated at 12/31/14.
3. Net income for 2015 is understated (because rent revenue is understated).
4. There is no effect on the statement of financial position at 12/31/15.

EXPLANATION:

In 2014, some rent revenue was collected in advance. (It is assumed that the revenue was earned in 2015 or there would have been a description of another error.) Receipt in 2014 must have been recorded with a credit to revenue. An adjusting entry at the end of 2014 to record deferral of a portion of the revenue to 2015 was omitted. As a result, no portion of the rent collected was recorded as revenue in 2015 (the year in which the rent revenue was earned).

(c) Correcting journal entry for Error 4 at 12/31/15 before closing:

Error 4: Explanation for journal entry:

Step 1:	Rent Revenue in 2015 will be understated unless a correcting journal entry is made; therefore, Rent Revenue for 2015 is increased with a credit.
Step 2:	No assets or liabilities are affected at 12/31/15.
Step 3:	Rent Revenue for 2014 was overstated. However, the Rent Revenue account cannot be debited because all income statement accounts for 2014 were closed to Retained Earnings at the end of 2014. Therefore, a debit to Retained Earnings is required to correct for the error.

ERROR 5

(b) Effects of Error 5: Failure to capitalize truck in 2014 and depreciate:

1. Net income for 2014 is understated by $8,500.
2. Net assets are understated by $8,500, and owners' equity is understated by $8,500 at 12/31/14.
3. Net income for 2015 is overstated by $1,500.
4. Net assets are understated by $7,000, and owners' equity is understated by $7,000 at 12/31/15.

EXPLANATION:

In 2014, acquisition of a truck for $10,000 was incorrectly recorded as an expense. The truck should have been depreciated with an annual charge of $1,500 to depreciation expense, beginning in 2014. This means that the income statements for 2014, 2015, 2016, and 2017 are affected by the error, as are the statements of financial position at the end of each of those four years. This error would eventually offset in the period of disposal of the truck. (A gain would be overstated in that period, and only then would the error offset on the statement of financial position.)

EFFECTS: Expenses are overstated by $10,000 in 2014 and Depreciation Expense is understated by $1,500 each year the truck is held. Therefore, net income for 2014 is understated by $8,500; owners' equity at 12/31/14 is understated by $8,500; net assets at 12/31/14 are understated by $8,500; net income for 2015 is overstated by $1,500; owners' equity at 12/31/15 is understated by $7,000; and net assets at 12/31/15 are understated by $7,000.

(c) Correcting journal entry for Error 5 at 12/31/15 before closing:

Error 5: Explanation for journal entry:

Step 1:	Depreciation Expense in 2015 will be understated unless a correcting journal entry is made; therefore, Depreciation Expense of $1,500 should be recorded with a debit.
Step 2:	Trucks will be understated at 12/31/15 by a cost of $10,000 unless a correcting journal entry is made. Likewise, Accumulated Depreciation—Trucks will be understated by two years’ worth of depreciation unless a correcting journal entry is made. Therefore, Trucks should be debited for $10,000 and Accumulated Depreciation—Trucks should be credited for $3,000.
Step 3:	Expenses for 2014 were overstated by $10,000 and Depreciation Expense for 2014 was understated by $1,500. However, all income amounts for 2014 were closed to Retained Earnings at the end of 2014. Therefore, a credit to Retained Earnings of $8,500 (that is, the amount by which Retained Earnings is understated at the beginning of 2015) is required to correct for the error.

ERROR 6

(b) Effects of Error 6: Failure to amortize patent in 2014:

1. Net income for 2014 is overstated by $700 (because patent amortization is understated).
2. Net assets are overstated by $700, and owners' equity is overstated by $700 at 12/31/14.
3. Net income for 2015 is not affected.
4. Net assets are overstated by $700, and owners' equity is overstated by $700 at 12/31/15.

EXPLANATION:

Failure to record amortization of a patent is not a counterbalancing error. This error will eventually offset in the period when the patent is fully amortized (it will be amortized one year after it should have been fully amortized) or when the patent is disposed of (through sale or abandonment and written off). There is no mention of a similar omission in 2015 so the assumption is that 2015 amortization expense was recorded properly. Therefore, this error affected the income statement of 2014, and will affect the income statement of the period of disposal (or of the last period of amortization) and every statement of financial position prepared in between these two periods.

(c) Correcting journal entry for Error 6 at 12/31/15 before closing:

Error 6: Explanation for journal entry:

Step 1:	Amortization Expense for 2015 is apparently correctly recorded.
Step 2:	Accumulated Amortization—Patents will be understated at 12/31/15 unless a correcting journal entry is made. Therefore, Accumulated Amortization—Patents should be increased with a credit.
Step 3:	Amortization Expense for 2014 was understated. However, the Amortization Expense account cannot be debited because all income statement amounts for 2014 were closed to Retained Earnings at the end of 2014. Therefore, a debit to Retained Earnings is required to correct for the error.

EXERCISE 21-5

PURPOSE: This exercise will illustrate the effects of various errors involving purchases and ending inventory.

Smith Sports Equipment Company sells sporting goods. By taking a physical count and pricing its inventory using the FIFO cost formula, inventory was determined to be $430,000 and $572,000 at December 31, 2014, and December 31, 2015, respectively. Net income was reported to be $200,000 and $218,000 for 2014 and 2015, respectively. The following errors occurred in accounting for inventory transactions.

Error 1:	Purchases of $30,000 made near the end of 2014 were shipped f.o.b. shipping point by the vendor on December 29, 2014; they were not received by Smith until January 3, 2015. These purchases were omitted from the physical count at December 31, 2013, and were not recorded as purchases until January 3, 2015.
Error 2:	Merchandise costing $21,000 was on the premises but overlooked during the physical inventory count at December 31, 2014.
Error 3:	Merchandise costing $32,000 was double-counted during the physical inventory count at December 31, 2015.
Error 4:	Sales made near the end of 2015 were shipped f.o.b. destination by Smith on December 28, 2015; they were not received by customers until January 4, 2016. These items, costing $17,000, were omitted from the inventory sheets of the physical count taken on December 31, 2015, and were treated as sales of $28,500 in 2015.

Instructions

Calculate the correct net income amounts for 2014 and 2015.

Solution to Exercise 21-5

EXPLANATION: Analyses of effects of errors on cost of goods sold:

EXERCISE 21-6

PURPOSE: This exercise will allow you to practise analyzing the effects of errors on net income.

The Bourbonnière Corporation calculated net income of $22,000 and $30,000 for Years 1 and 2, respectively. The following errors were later discovered:

Error 1:	Depreciation on computers was omitted in Year 1, $900.
Error 2:	Deferred (prepaid) expenses were understated at the end of Year 1, $400.
Error 3:	Accrued revenues were omitted at the end of Year 1, $600.
Error 4:	Deferred (unearned) revenues were understated at the end of Year 1, $980.
Error 5:	Accrued expenses were overlooked at the end of Year 1, $650.

Instructions

Calculate the correct net income amounts for Year 1 and Year 2.

Solution to Exercise 21-6

ANALYSIS OF MULTIPLE-CHOICE QUESTIONS

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