CHAPTER 7 – ACCOUNTING CHANGES AND ERROR CORRECTION (PAS 8)
Learning outcomes:
1. To identify the accounting changes.
2. To know the recognition and reporting of change in accounting estimate.
3. To know the recognition and reporting of a change in accounting policy.
4. To know the guideline when selecting accounting policy in the absence of an accounting standard.
5. To know the recognition and reporting of prior period errors.
6. To understand the accounting treatment of prior period errors.
7. To be able to distinguish counterbalancing errors and non-counterbalancing errors.
8. To be able to prepare the necessary correcting entries for prior period errors.
Methodology:
▪ Courseware/Face-to-face
Lecture/Discussion:
Accounting changes
Accounting change is classified into:
a. Change in accounting policy
b. Change in accounting estimate
Accounting policies
➢ are “specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting
financial statements.
➢ When selecting and applying accounting policies for a particular transaction, an entity shall refer to the hierarchy
guidance summarized below:
1. PFRSs (PAS, PFRS and Interpretations)
2. Judgment
- When making judgment:
✓ Requirements in other PFRSs dealing with similar transactions
✓ Conceptual framework
- Management may consider the following:
✓ Pronouncements issued by other standard-setting bodies (e.g., US GAAP)
✓ Other accounting literature and industry practices
A. Changes in Accounting Estimates
➢ Estimates involve judgments based on latest available information.
➢ A change in accounting estimate is an adjustment of the carrying amount of an asset or a liability, or the amount
of periodic consumption of an asset, that results from the assessment of the present status of, and expected
future benefits and obligations associated with, assets and liabilities.
Examples:
a. Change in depreciation or amortization method (i.e., from straight-line to sum-of-the-years’ digit)
b. Change in estimated useful life or residual value of a depreciable asset
c. Change in the required balance of allowance for uncollectible accounts or impairment losses
d. Change in estimated warranty obligations and other provisions
Accounting treatment for changes in accounting estimates:
➢ Changes in accounting estimates are accounted for by prospective application.
➢ Prospective application means recognizing the effects of the change in profit or loss, either in:
a. The period of change; or
b. The period of change and future periods, if both are affected.
B. Changes in Accounting Policies
- PAS 8 requires the consistent selection and application of accounting policies
- PAS 8 permits a change in accounting policy only if the change: (usually results from a change in
measurement basis)
a. is required by a PFRS; or
b. results in reliable and more relevant information
Examples:
a. Change from FIFO to the Weighted Average cost formula for inventories
b. Change from the cost model to the fair value model of measuring investment property
c. Change from the cost model to the revaluation model of measuring PPE and intangible assets
d. Change in business model for classifying financial assets, i.e., FVPL to amortized cost
e. Change in the method of recognizing revenue from long-term construction contracts
f. Change to a new policy resulting from the requirement of a new PFRS
Changes in Accounting Policies are accounted for using the following order of priority:
Accounting treatment
1. Transitional provision in a PFRS, if any
2. Retrospective application, in the absence of a transitional provision
3. Prospective application, if retrospective application is impracticable
Retrospective application
➢ Means adjusting the opening balance “of each affected component of equity (e.g., retained earnings) for the
earliest prior period presented and the other comparative amounts disclosed for each prior period presented as
if the new accounting policy had always been applied”.
C. Errors
➢ Include misapplication of accounting policies, mathematical mistakes, oversights or misinterpretations of
facts, and fraud.
➢ Errors can be errors of commission or errors of omission.
Types of errors according to the period of occurrence are as follows:
a. Current period errors – are errors in the current period that were discovered either during the current period or
after the current period but before the financial statements were authorized for issue (subsequent events).
These are corrected simply by correcting entries (reclassifying entries).
b. Prior period errors – are errors in one or more prior periods that were only discovered either during the current
period or after the current period but before the financial statements were authorized for issue. These are
corrected by retrospective restatement.
Retrospective Restatement (Accounting treatment)
➢ Means (a) restating the comparative amounts for the prior period (s) presented in which the error occurred; or
(b) if the error occurred before the earliest prior period presented, restating the opening balances of assets,
liabilities and equity for the earliest prior period presented.
Retrospective restatement (prior period errors) Retrospective application (change in accounting policy)
Correcting a prior period error as if the error had never Applying a new accounting policy as if the policy had
occurred. always been applied.
Types of errors
1. Errors in principle
2. Clerical and similar errors
a. Transplacement error – e.g., 1,000 is recorded as 100 or 10,000
b. Transposition error – e.g., 14,250 is recorded as 12,450 or 14,520
c. Error of omission – unrecorded transaction
d. Error of commission – error in recording
e. Compensating errors – e.g., 500 overstatements in sales account is compensated by a 500 overstatement
in salaries expense account
f. Accounting system error – e.g., computer program error
g. Counterbalancing and non-counterbalancing errors
Errors affecting both the SOFP and the income statement are either:
1. Counterbalancing errors – are errors which, if remained uncorrected, are automatically corrected or offset in the
next accounting period.
Effect of counterbalancing error at year-end Year 1 Year 2 Year 3
Profit or loss Overstated understated none
SOFP Erroneous None none
Examples of Counterbalancing errors:
1. Inventory/Purchases
2. Sales
3. Prepaid expenses
4. Accrued expenses
5. Deferred or unearned income
6. Accrued income
Relationship between accounts if under periodic inventory system:
➢ Ending inventory: Cost of goods sold – Inverse relationship
➢ Beginning inventory & Purchases: Cost of goods sold – Direct relationship
➢ Beginning inventory & Purchases: Profit – Inverse relationship
2. Non-counterbalancing errors
- Errors which, if remained uncorrected, are not automatically corrected or offset in the next accounting
period.
Effect of non-counterbalancing error at year-end Year 1 Year 2 Year 3
Profit or loss Overstated none none
SOFP Erroneous erroneous erroneous
Examples:
1. Misstatement in depreciation
2. Erroneous capitalization of cost that should be expensed outright
3. Non-capitalization of capitalizable cost
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PRACTICE EXERCISES:
Change in accounting estimate
1. ABC Co. bought a patent for P600,000 on January 2, 2018, at which time the patent had an estimated useful life
of ten years. On February 2, 2022, it was determined that the patent’s useful life would expire at the end of 2024.
Required:
a. How much would XYZ record as amortization expense for this patent for the year ending December 31,
2022?
b. How much is the carrying amount of the patent on December 31, 2022?
Change in accounting policy
2. On December 31, 2022, DEF Co. appropriately changed its inventory valuation method to FIFO cost from
Average cost for both financial statement and income tax purposes. The change will result in a P140,000
increase in the beginning inventory at January 1, 2022. Assume a 30% income tax rate.
Required:
a. What is the cumulative effect of this accounting change?
b. What is the entry to record the effect of this accounting change?
3. On January 1, 2022, XYZ Co. changed its inventory cost flow formula from the Average method to the FIFO
method. XYZ Co.’s year-end inventories determined under both methods are summarized below.
Year FIFO Average
2020 620,000 566,000
2021 800,000 720,000
XYZ Co.’s income tax rate is 30%.
Required:
a. What is the cumulative effect of this accounting change?
b. What is the entry to record the effect of this accounting change?
Correction of errors
4. JKL Co. reports on a calendar year basis. Its 2021 and 2022 financial statements contained the following errors:
2021 2022
Under (Over) statement of ending inventory 10,000 (4,000)
Depreciation understatement 4,000 6,000
Failure to accrue salaries at year-end 8,000 12,000
Requirements:
a. What are net effects of the errors on JKL’s 2021 and 2022 profit or loss, respectively?
b. What is the effect of the errors on JKL’s December 31, 2022 retained earnings?
Correction of errors
5. MNO Co.’s December 31 year-end financial statements contained the following errors:
2021 2022
Ending inventory 4,000 understated 3,600 overstated
Depreciation understatement 800 understated -
An insurance premium of P3,600 was prepaid in 2021 covering the years 2021, 2022, and 2023. The entire
amount was charged to expense in 2021. In addition, on December 31, 2022, fully depreciated machinery was
sold for P6,400 cash, but the sale was not recorded until 2023. There were no other errors during 2021 or 2022,
and no corrections have been made for any of the errors. Ignore income tax considerations.
Requirements:
a. What are the net effects of the errors on MNO’s 2021 and 2022 profit or loss, respectively?
b. What is the effect of the errors on MNO’s December 31, 2022 retained earnings?
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