TOPIC 5 ACCOUNTING CHANGES

Accounting Policies

Question: What are accounting policies? Answer: The specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements.

Hierarchy of Reporting Standards

Question: What is the hierarchy of reporting standards when making accounting judgments? Answer: 1. PFRSs; 2. Judgment (considering requirements in PFRSs for similar transactions and the Conceptual Framework, followed by pronouncements from other standard-setting bodies and industry practices).

Change in Accounting Policy: Accounting Treatment

Question: What is the accounting treatment for a change in accounting policy? Answer: a. Transitional provision; b. Retrospective application; c. If retrospective is impracticable, prospective application.

Change in Accounting Policy: Effect of Adjustment

Question: Where is the adjustment for a change in accounting policy recorded? Answer: On the beginning balance of retained earnings, if accounted for retrospectively.

Change in Accounting Estimate: Accounting Treatment

Question: What is the accounting treatment for a change in accounting estimate? Answer: Prospective application.

Change in Accounting Estimate: Effect of Adjustment

Question: Where is the adjustment for a change in accounting estimate recorded? Answer: In profit or loss of the current period, or current and future periods if the change affects both.

Change in Accounting Policy vs. Estimate

Question: How do you treat a change if it is difficult to distinguish whether it is a change in accounting policy or a change in accounting estimate? Answer: The change is treated as a change in an accounting estimate.

Error (PSA 240)

Question: How is an error defined under Philippine Standards on Auditing No. 240? Answer: An unintentional misstatement in financial statements, including omissions, incorrect estimates from oversight, or mistakes in applying principles.

Fraud

Question: What is the definition of fraud? Answer: The intentional act involving the use of deception to obtain an unjust or illegal advantage.

Prior Period Errors

Question: What are prior period errors? Answer: Omissions from, and misstatements in, financial statements for prior periods arising from a failure to use (or misuse of) reliable information that was available and could reasonably have been obtained.

Correction of Prior Period Errors: Accounting Treatment

Question: How are material prior period errors corrected? Answer: Retrospectively in the first set of financial statements authorized for issue after their discovery by restating comparative amounts or opening balances of assets, liabilities, and equity.

Limitations on Retrospective Restatement

Question: When is retrospective restatement of a prior period error not required? Answer: When it is impracticable to determine either the period-specific effects or the cumulative effect of the error; in such cases, the entity restates opening balances or applies the correction prospectively from the earliest date practicable.

Error Impact: Sales Overstated

Question: If Sales are overstated, what is the effect on Net Income? Answer: Net Income is Overstated (Direct relationship).

Error Impact: Cost of Sales Overstated

Question: If Cost of Sales is overstated, what is the effect on Net Income? Answer: Net Income is Understated (Inverse relationship).

Error Impact: Expenses Overstated

Question: If Expenses are overstated, what is the effect on Net Income? Answer: Net Income is Understated (Inverse relationship).

Error Impact: Beginning Inventory Overstated

Question: If Beginning Inventory is overstated, what is the effect on Cost of Sales? Answer: Cost of Sales is Overstated (Direct relationship).

Error Impact: Ending Inventory Overstated

Question: If Ending Inventory is overstated, what is the effect on Cost of Sales? Answer: Cost of Sales is Understated (Inverse relationship).

Error Impact: Current Assets Overstated

Question: If Current Assets are overstated, what is the effect on Working Capital? Answer: Working Capital is Overstated (Direct relationship).

Error Impact: Current Liabilities Overstated

Question: If Current Liabilities are overstated, what is the effect on Working Capital? Answer: Working Capital is Understated (Inverse relationship).

Balance Sheet Errors

Question: What are balance sheet errors? Answer: Errors affecting only the presentation of an asset, liability, or stockholders’ equity account. They require reclassification in the error year or restatement for comparative purposes in subsequent years.

Income Statement Errors

Question: What are income statement errors and how do they affect Net Income? Answer: Errors affecting only income statement accounts (e.g., improper classification). Because they involve two nominal accounts, net income and retained earnings are unaffected.

Counterbalancing Errors

Question: What are counterbalancing errors? Answer: Errors affecting both the balance sheet and income statement that will offset or be corrected over two accounting periods.

Examples of Counterbalancing Errors

Question: What are examples of counterbalancing errors? Answer: Omissions of prepayments (expense method), precollections (revenue method), accrued expenses, accrued revenues; and over/understatements of sales, purchases, or ending inventory over two years.

Non-counterbalancing Errors

Question: What are non-counterbalancing errors? Answer: Errors affecting both the balance sheet and income statement that do not offset in the next accounting period, requiring correcting entries even if books are closed.

Examples of Non-counterbalancing Errors

Question: What are examples of non-counterbalancing errors? Answer: Prepayments (asset method), precollections (liability method), errors in depreciation, improper capitalization of expense, improper expensing of capital expenditures, and recording proceeds of asset sales as other income.