CHAPTER 8 ACCOUNTING CHANGES Change in accounting estimate TECHNICAL KNOWLEDGE To identify the categories of accounting change. To understand the concept of a change in accounting estimate. To know the recognition and reporting of change in accounting estimate. 216CATEGORIES OF ACCOUNTING CHANGE a. Change in accounting estimate b. Change in accounting policy Accounting changes can have i ity' pe aihed oaeiiaea: a great impact on an entity's Thus, it is critically important th inanci at users of financial statements understand the nature and effect of accounting changes and must not rely solely on the bottom line which is the net income or loss, Change in accounting estimate PAS 8, paragraph 5, defines a change in accounting estimate as an adjustment of the carrying amount of an asset or a liability, or the amount of the periodic consumption of an asse that results from the assessment of the present status ae expected future benefit and obligation associated with the asset and liability. Simply’ stated, a change in accounting estimate is a normal recurring correction or adjustment of an asset or liability which is the natural result of the use of an estimate. The use of reasonable estimate is an essential part of the preparation of financial statements and does not undermine their reliability. ‘An estimate may need revision if changes occur regarding the circumstances on which the estimate was based or as a result of new information, more experience or subsequent development. By very nature, the revision of the estimate does not relate to prior periods and is not a correction of an error. A change in measurement basis is a change in accounting policy and not a change in accounting estimate. Sometimes it is difficult to distinguish a change in accounting estimate and a change in accounting policy. In such a case, the change is treated as a change in accounting: estimate, with appropriate disclosure. 217counting estimate n business activities, ma, t be measured with precisio, Examples of ac inties i As a result of the uncertain : items in financial statements © but can only be estimated. . ed on the latest available ang ne poe may be required for the Estimation involves judgment Dee reliable information. Estima following: a. Doubtful accounts . lescence 7 een te residual value, and expected pattern of consumption. of benefit of depreciable asse d. Warranty cost e. Fair value of financial How to report change in acco The effect of a change in accounti recognized currently and prospective income or loss of: a. The period of change if the change affects that period only. b. The period of change and future periods if the change affects both. 1 assets and financial liabilities unting estimate ng estimate shall be ly by including it in To the extent that a change in accounting estimate gives rise to changes in assets and liabilities, or relates to item of equity, it shall be recognized by adjusting the carrying amount of the related asset, liability or equity in the period of change. A change in an accounting estimate shall not be accounted for by restating amounts reported in financial statements of prior periods. f Changes in accounting estimates are ha ee : te prentl and prospectively, if necessary. ote henge ee Prospective recognition of the effect 3 i , of a chi i ting estimate means that the change is applied. to ‘Transactions other events and conditi estimate, jons from the date of change ” 218Jllustration For example, a depreciable asset costing P: i : g P500,000 is estimated to have a life of 5 years. At the beginning of the third year, the original life is changed to 8 years. Thus, the asset has a remaining life of 6 years. The procedure is not to correct past depreciation. Instead, the eran carrying amount of P300,000 (P500,000 minus p200,000 depreciation for 2 years) is now allocated over 6 years or a subsequent angual depreciation of P50,000. Thus, the entry to record the annual depreciation, starting the third year is: Depreciation 50,000 Accumulated depreciation 50,000 Change in depreciation method Achange in depreciation method is accounted for as a change in accounting estimate. Illustration An entity decided to change from the sum of years’ digit method to the straight line method of depreciation on January 1, 2020. The asset originally has a cost of P1,000,000, acquired on January 1, 2018 and is estimated to have a four-year life. Cost - January 1, 2018 1,000,000 Accumulated depreciation: 2018 (4/10 x 1,000,000) 400,000 2019 (3/10 x 1,000,000) 300,000 700,000 Carrying amount - January 1, 2020 300,000 The procedure is simply to allocate the carrying amount of P300,000 over the remaining life of 2 years using the new depreciation method which is the straight line. Accordingly, the depreciation for 2020 is recorded as follows: Depreciation (300,000 / 2) 150,000 Accumulated depreciation ' 150,000 219QUESTIONS 1. ‘What are the two main categories of accounting changes, 2. Define a change in accounting estimate. 3, Give examples of items in the financial statements th,, may require estimate. 4, How is a change in accounting estimate reported? 6. Explain a change in depreciation method. 220pROBLEMS Problem 81 (IAA) Blue Company purchased a machine on Januai ry 1, 2017 for 6,000,000. At the date of acquisition, the machine had a life of six years with no residual value. The machine was depreciated on a straight line basis, On January 1, 2020, the entity determined that the machine had a useful life of eight years from the date of acquisition with no residual value, What is the depreciation of the machine for 2020? a. 750,000 b. 600,000 c. 375,000 d. 500,000 Problem 8-2 (IFRS) Acute Company was incorporated on January 1, 2017. In preparing the financial statements for the year ended December 31, 2019, the entity used the following original cost and useful life for the property, plant and equipment: Original cost Useful life Building 15,000,000 15 years Machinery 10,500,000 10years Furniture 3,500,000 ‘Tyears On January 1, 2020, the entity determined that the remaining useful life is 10 years for the building, 7 years for the machinery and 5 years for the furniture. The entity used the straight line method of depreciation with no residual value. What is the total depreciation for 2020? a. 2,650,000 b. 3,700,000 ¢. 2,550,000 d. 3,500,000 221Problem 8-3 (AICPA Adapted) oo On Jatuary 1, 2017, Flair Company Pe aight had se for oe a aaey ag depreciated it by the SHAT le Neng a estimated life of 8 years with no res! ale i ined that the mach, 1, 2020, the entity determ) the machin ta uti life of 6 years from the date of acquisition with residual value of P240,000. umulated depreciation on December 31, 20297 What is the acc a. 1,460,000 b. 1,540,000 c. 1,600,000 d. - 1,760,000 Problem 8-4 (IFRS) On January 1, 2016, Roma Company purchased equipment for P4,000,000. The equipment has a useful life of 10 years and a residual value, of P400,000. “On January 1, 2020, the entity determined that the useful life of the equipment was 12 years from the date of acquisition and the residual value was P480,000. 1. What is the carrying amount of the equipment on January 1, 2020? 2,560,000 2,920,000 2,400,000 , 2,800,000 Bese 2. What is the depreciation of the equipment for 2020? 175,000 260,000 360,000 300,000 poop 222Problem 8-5 (AICPA Adapted) Dawn Company purcha: ‘sed a machine on January 1, 2017 for 3,000,000. At'the dat isiti Shine } ‘ Freix years with ne pas ge uisition, the machine had a life depreciated on a straight line Talue. The machine is being, On January 1, 2020, the entity determined that the machine had a useful poo years from the date of acquisition with residual What is the depreciation for 20207 a. 700,000 b. 500,000 c. 750,000 d. 600,000 Problem 8-6 (AICPA. Adapted) On January 1, 2018, Zee Company purchased for P2,400,000 amachine with a useful life of ten years and no residual value. The machine was depreciated by the double declining balance method and the carrying amount of the machine was P1,536,000 on December 31, 2019. The entity changed to the straight line method on January 1, 2020. What is the depreciation for 2020? a. 153,600 b. 307,200 c. 240,000 d. 192,000 Problem 8-7 (AICPA Adapted) On January 1, 2019, Kevin Company purchased a machine for P2,750,000. The machine was depreciated using the sum of years' digits method based on a useful life of 10 years with no residual value. On January 1, 2020, the entity changed to the straight line method of depreciation. ‘ What is the depreciation for 2020? - 180,000 . 220,000 250,000 |. 275,000 peopProblem 8-8 (AICPA Adapted) Turtle Company purchased equipment O71 January 1, 2013 i estimated 5-year ser: for P5,000,000. The equipment had An. the 200% dow i i 5-year a declining belonce method for the first two years and they switch to the straight line depreci®! What amount should be reported as accumulated depreciation on December 31, 2020? a. 3,000,000 b. .8,800,000 ce. 3,920,000 d. 4,200,000 Problem 8-9 (IAA) Xavier Company purchased a machinery on January 1, 2017 for 7,200,000, ‘The machinery has a useful life of 10 years with no residual value and was depreciated using the straight line method. In 2020, a decision was made to change the depreciation method from straight line to sum of years’ digits. The estimate of useful life and residual value remained unchanged. What is the depreciation for 2020? a. 1,260,000 b. 1,440,000 c. 916,360 d. 720,000 Problem 8-10 (AICPA Adapted) On January 1, 2018, Brazilia Com: for P 4,800,000 2 ea Cat a useful Iie at eenterend residual value o} ,000. The machi i the double declining balance.” “Me Was depreciated by The entity changed to the str: 1, 2020, The residual value did got cee, method on Januar! id not change. What is the accumulated depreciation on December 31, 2020? 1,728,000 2,087,000 1,380,090 2,112,000 Bo oe 224Problem 8-11 (IAA) On January 1, 2019, London Com; ‘ , pany purchased a large quantity of Bersonal computers. The cost of these computers On the date of purchase, the mana i H gement estimated that the computers would last approximately four years and would have a residual value at that ti tit used-the double declining balance nesthogeo ne ony During January 2020, the entity realized that technological advancements had made the computers virtually obsolete and that they would have to be replaced. — The management changed the remaining useful life of the computers to two years. What is the depreciation expense for 2020? a.. 3,000,000 b. 2,400,000 ce. 1,500,000 d. 1,200,000 Problem 8-12 (IAA) On January 1, 2020,.Canyon Company decided to decrease the estimated useful life of the patent from 10 years to 8 years. The patent was purchased on January 1, 2015 for P3,000,000 with estimated residual value of zero. The entity decided on January 1, 2020 to change the depreciation method from accelerated method to straight line. On January 1, 2020, the cost of the equipment is P8,000,000 and the accumulated depreciation is P3,400,000. The remaining useful life of the equipment on January 1, 2020 is 10 years and the residual value is P200,000. What is the total charge against 2020 income as a résult of the accounting changes? ‘| a. 940,000 b. 960,000 c. 627,500 4d. 647,500 225e choice (AICPA Adapted) fited by @ deferred oo, has been obtained is . Problem 8-13 Multip! riods bene, in the pe 7 1. A change in the p formation because additional in : jnould be reported in th, ii ts} . a. An accounting change thai periods f the i period of change and future an ge that should be reported } b. An accounting chan oe restating the financial statements of all prior period, presented c. A correction of an error d. Not an accounting change 2. A change in the residual value of an asset arising because additional information has been obtained is a. An accounting change that should be reported in the period of change and future periods if the change affects both 7 b. An accounting change that should be reported by restating the financial statements of all prior periods presented c. A correction of an error d. Not an accounting change 3. Which statement in relation to a change in accounting estimate is true? a. Change in accounting estimate is accounted for retrospectively. Change in accounting esti z é mate re; new information or new development, eeipeite c.. By very nature, the revision of an estimate relates t prior periods and is accounted . d an error, for as a correction d. All of these statements are true in accounting estimate, b. in relation to a chang? 226Qe 4. The effect of a change in accounting policy that is inseparable from the effect of a change in accounting estimate should be reported a. By restating the financial statements of all prior periods presented, b. As a correction of an error. c. As a component of income from continuing operations in the period of change and future periods if the change affects both. d. As a separate disclosure after income from continuing Operations in the period of change and future periods if the change affects both. 5. When an entity changed the expected service life of an asset because. additional information has been obtained, which of the following should be reported? a. Cumulative effect of change in accounting policy b. Proforma effect. of retroactive application c. ‘Prior period error d. An accounting change that should be reported in the period of change and future periods if the change ‘ affects both 227Problem 8-14 Multiple choice (AA) fied as an accounting change? 1. Which is not classi a. Change in accounting policy b. Change in accounting Co a . in the financial s , a Al of these are classified as a0 accounting change 2. Which of the following is the proper ert period to record the effect of a change in accounting es! i ? tively i d prospec! Current period and prosp tively Current period and retrospe' Retrospectively Current period poop 3. Why is retrospective treatment of change 1n accounting estimate prohibited? a. Achange in accounting estimate is a normal recurring correction or adjustment. b. The retrospective treatment is not allowed. c. Retrospective treatment of a change in accounting estimate is required by IFRS. d. IFRS does not prohibit retrospective treatment of change in accounting estimate. 4, Which of the following is required for a change from sum of years’ digits to straight line method of depreciation? The cumulative effect on prior years is reported in the statement of retained earnings Retrospective restatement Recomputation of depreciation for current and future years ‘All of these are required BP Os fF 5. Which of the following is not a justi: i depreciation methed? "© Justification for a chané® a. A change in the estimated useful lif b. A change in the pattern of estimated future benefit To conform with the depreciati ‘in a particular industry Pre enou-methed preyed d. A change in the future benefit from the asset 228e Problem 8:15 Multiple choice (AICPA Adapted) j. How should the effect of change i ‘ timate be accounted for? : inge in accounting estima a. By restating amounts of prior periods b. By reporting proforma amounts for prior periods c. As a prior period adjustment to beginning retained earnings reported in financial statements d. In the period of change and future periods if the change affects both 2. Which of the following is characteristic of a change in accounting estimate? a, It usually need not be disclosed b. It does not effect the financial statements of prior period c. It should be reported through the restatement of the financial statements d, It makes necessary the reporting of proforma amounts for prior periods . Which-of the following should be reported when an entity changed from the straight line depreciation to the double declining balance depreciation? Cumulative effect of change in accounting policy . Proforma effect of retroactive application Prior period error An accounting change that should be reported currently and prospectively peop . Which is the best explanation why accounting changes are classified into change in accounting policy and change in accounting estimate? a. The materiality of the change b. Each change involves different method of recognition in the financial statements ; ' c. The fact that some treatments are considered GAAP d.. The [Link] provide a favorable profit picture 229