Apb 20

Front 1

Which of the following accounting pronouncements is the most authoritative?

Back 1

The foundation of financial accounting is generally accepted accounting principles (GAAP). In practice, GAAP has come to include SFAS, FASB Interpretations, APB Opinions, ARB and SEC releases. These are the pronouncements to which practitioners look when determining if financial statements fairly present financial position, results of operations, and changes in cash flows.

SAS 69 (AU 411) expanded on the above list and established the hierarchy of GAAP for business enterprises shown below. If the accountant/auditor cannot find a specified accounting treatment in category (A), s/he would proceed to the next lowest category.

• Category (A), officially established accounting principles, consists of Financial Accounting Standards Board (FASB) Statements of Financial Accounting Standards and Interpretations, Accounting Principles Board (APB) Opinions, and AICPA Accounting Research Bulletins.

• Category (B) consists of FASB Technical Bulletins and, if cleared by the FASB, AICPA Industry Audit and Accounting Guides and AICPA Statements of Position.

• Category (C) consists of AICPA Accounting Standards Executive Committee (AcSEC) Practice Bulletins that have been cleared by the FASB and consensus positions of the FASB Emerging Issues Task Force.

• Category (D) includes AICPA accounting interpretations and implementation guides (“Qs and As”) published by the FASB staff, and practices that are widely recognized and prevalent either generally or in the industry.

Front 2

Change in Reporting Entity

Back 2

Change in Reporting Entity

The final type of accounting change which may occur is a change in reporting entity. A change in reporting entity occurs when a change in the structure of the organization is made which results in financial statements that represent a different or changed entity. Some examples of a change in reporting entity include presenting consolidated statements in place of individual statements, a pooling of interests, a change in subsidiaries, or a change in the use of the equity method for an investment.

A change in reporting entity should be disclosed by retroactively restating all of the prior period financial statements presented. A disclosure of the type of change and the reasons for
the change should be added to the financial statements in the year of the change. The disclosure should also include the effect of the change on the net income before extraordinary items, net income, and earnings per share.

Front 3

A retroactive change in accounting principle

Back 3

A retroactive change in accounting principle is determined by computing the effect on beginning retained earnings of applying the new principle to affected prior years and reporting the amount net of tax in the retained earnings statement as an adjustment to the beginning balance. Additionally, financial statements from earlier periods that are presented with the current period’s FS must be retroactively restated. Retroactive restatement means redoing all statements presented as if they had originally been prepared using the new accounting principle. Any part of the cumulative effect which is attributed to financial statements of prior years that are not being presented in the current period should be an adjustment of retained earnings of the earliest period being presented.

There are five special changes that require retroactive restatement of all periods presented as if the new method had been used in all prior periods. These five special changes are

(1) Change from LIFO to another inventory method

(2) Change in method of accounting for long-term contracts

(3) Change to or from the full cost method of accounting for exploration costs in the extractive industries

(4) Any change made by a company first issuing financial statements to the public for the purpose of obtaining additional equity capital or effecting a business combination or registering securities (APB 20)

(5) Change for which the retroactive approach is mandated by an authoritative pronouncement

Front 4

Cumulative-effect-type changes in accounting principle

Back 4

Cumulative-effect-type changes in accounting principle

All other changes in principle are accounted for as current changes in accordance with the cumulative effect method. When a change in accounting principle is accounted for as a current change, then the entire cumulative effect of the change is reported in the current period’s financial statements. The entire cumulative effect would be recorded as an adjustment to an income statement account, and reported as a special item displayed after extraordinary items on the income statement. The cumulative effect should be reported net of tax. The following steps summarize the procedures to account for an accounting change under the cumulative effect method:

1. Compute the prior years’ effect of the change on retained earnings at the beginning of the year in which the change is made.

2. Use the new principle in determining the current year’s net income.

3. Report the effect of the new method on beginning retained earnings less tax effects as “cumulative effect on prior years of new accounting method (described), net of tax” to be displayed after extraordinary items and before net income on the income statement.

4. Present comparative years’ data as previously reported (no restatement).

Hint 4

APB 20

Front 5

The 2003 financial statements of Bice Company reported net income for the year ended December 31, 2003, of $2,000,000. On July 1, 2004, subsequent to the issuance of the 2003 financial statements, Bice changed from an accounting principle that is not generally accepted to one that is generally accepted. If the generally accepted accounting principle had been used in 2003, net income for the year ended December 31, 2003, would have been decreased $1,000,000. On August 1, 2004, Bice discovered a mathematical error relating to its 2003 financial statements. If this error had been discovered in 2003, net income for the year ended December 31, 2003, would have been increased $500,000. What amount, if any, should be included in net income for the year ended December 31, 2004, because of the items noted above?

Back 5

The change from an unacceptable accounting principle to an acceptable accounting principle is considered a correction of an error per APB 20. Thus both of these items are corrections of errors and as such are reported as prior period adjustments. Prior period adjustments are reported in the retained earnings statement and not in the income statement (SFAS 16). Thus 2004 earnings are not affected by the aforementioned items.

Hint 5

APB 20 & SFAS 16

Front 6

Pro forma effects of retroactive application would usually be reported on the face of the income statement for a change

Back 6

C. Answer C is correct because APB 20 states that cumulative effect type changes should be shown on the income statement between the captions “extraordinary items” and “net income.” Additionally, income should be computed on a pro forma basis for all periods presented as if the new principle had been applied in those periods.

Hint 6

APB 20

Front 7

On January 1, 2004, Belmont Company changed its inventory cost flow method to the FIFO cost method from the LIFO cost method. Belmont can justify the change, which was made for both financial statement and income tax reporting purposes. Belmont’s inventories aggregated $4,000,000 on the LIFO basis at December 31, 2003. Supplementary records maintained by Belmont showed that the inventories would have totaled $4,800,000 at December 31, 2003, on the FIFO basis. Ignoring income taxes, the adjustment for the effect of changing to the FIFO method from the LIFO method should be reported by Belmont in the 2004

Back 7

D. Answer D is correct. The solutions approach is to prepare the journal entry to restate the inventory from $4,000,000 to $4,800,000. Since the inventory account must be debited, the cumulative effect is a credit.



Inventory
800,000

?
800,000




Generally, the cumulative effect of any accounting change should be shown in the income statement between extraordinary items and net income. However, one of the exceptions to this general rule per APB 20 is a change from LIFO to any other inventory valuation method. This exception requires an adjustment to beginning retained earnings and retroactive restatement of prior years' financial statements.

Hint 7

FIFO

Front 8

On December 31, 2004, Rapp Co. changed inventory cost methods to FIFO from LIFO for financial statement and income tax purposes. The change will result in a $175,000 increase in the beginning inventory at January 1, 2004. Assuming a 30% income tax rate, the cumulative effect of this accounting change reported in the income statement for the year ended December 31, 2004, is

Back 8

D. Answer D is correct. APB 20 states that a change in inventory methods from LIFO to another method is one of the exceptions requiring the use of the retroactive approach rather than the current approach. The cumulative effect at the beginning of the period of change is recorded as a direct adjustment to retained earnings, and the prior year statements are retroactively restated. The cumulative effect, therefore, is not reported in the income statement when the retroactive approach is used. The journal entry is



Inventory
175,000


Retained earnings

122,500

Deferred tax liability

52,500

Hint 8

APB 20

Front 9

Presenting consolidated financial statements this year when statements of individual companies were presented last year is

Back 9

C. Answer C is correct because per APB 20, accounting changes that result from a change in the business entity should be reflected in financial statements that are restated.

Hint 9

Change business entity

Front 10

When a cumulative effect type change in accounting principle is made during the year, the cumulative effect on retained earnings is determined

Back 10

C. Answer C is correct because the effect on retained earnings resulting from a cumulative effect type change in accounting principle is determined as of the beginning of the year in which the change is made (APB 20).

Hint 10

change in accounting principal