Change in Accounting Estimate and Accounting Principle

1. Chapter 20 Illustrated Solution: Problem 20-25 Change in Accounting Estimate and Accounting Principle

2. Problem Introduction Change in depreciation methods on the equipment. Change in the useful life of a building. Change in the estimate of bad debts as a percent of credit sales.

3. Part 1—Accounting Treatment for Changes • The change from straight-line to sum-of-the-years’-digits method to depreciate the equipment is a change in accounting principle and requires a cumulative adjusting entry.

4. Part 1—Accounting Treatment for Changes • The change from straight-line to sum-of-the-years’-digits method to depreciate the equipment is a change in accounting principle and requires a cumulative adjusting entry. • The revision of the estimated life of the building is a change in estimate and should be accounted for prospectively.

5. Part 1—Accounting Treatment for Changes • The change from straight-line to sum-of-the-years’-digits method to depreciate the equipment is a change in accounting principle and requires a cumulative adjusting entry. • The revision of the estimated life of the building is a change in estimate and should be accounted for prospectively. • The change in the percentage of credit sales to expense to bad debts is a change in estimate and is also accounted for prospectively.

6. Part 2—Journal Entry • To prepare the journal entry, we must first determine: • The amount of depreciation that has been recognized, and • The amount that would have been recognized had the new method been used.

7. Part 2—Journal Entry • To prepare the journal entry, we must first determine: • The amount of depreciation that has been recognized, and • The amount that would have been recognized had the new method been used. • In this case, straight-line depreciation resulted in $17,200 being depreciated in years 1999 through 2002, computed as follows: • ($48,000 - $5,000)  10 years = $4,300 per year; $4,300 x 4 years = $17,200

8. Part 2—Journal Entry • Had the sum-of-the-years’ digits method been used, depreciation expense would have been $26,582, computed as follows: • 1999 — $43,000 x 10/55 = $ 7,881 • 2000 — $43,000 x 9/55 = 7,036 • 2001 — $43,000 x 8/55 = 6,255 • 2002 — $43,000 x 7/55 = 5,473 • $26,582

9. Part 2—Journal Entry • The journal entry to record the change in accounting principle will increase the accumulated depreciation account for the difference between the depreciation that would have been taken using the sum-of-the-years’-digits method and the depreciation that was taken using the straight-line method. • This difference is equal to • $9,382 ($26,582 – $17,200 = $9,382)

10. Part 2—Journal Entry • The journal entry to record the change in accounting principle will increase the accumulated depreciation account for the difference between the depreciation that would have been taken using the sum-of-the-years’-digits method and the depreciation that was taken using the straight-line method. • This difference is equal to • $9,382 ($26,582 – $17,200 = $9,382) Cumulative Effect of Change in Accounting Principle … 9,382 Accumulated Depreciation …………………………. 9,382

11. Income Statement Format Revenue: Sales Less: Sales discounts Sales returns and allowances Cost of goods sold: Inventory—beginning Net purchases: Purchases Less: Purchase discounts Purchase returns and allowances Freight-in Cost of goods available for sale Less: Inventory—ending Gross profit Operating expenses: Selling expenses: General and administrative expenses: Operating income Other revenues and gains: Income from continuing operations before income taxes Income tax expense Income from continuing operations Discontinued operations (net of taxes) Extraordinary items (net of taxes) Cumulative effect of changes in accounting principles (net of taxes) Net income

12. Part 3 — Journal Entries • The journal entry to record the depreciation expense on the equipment in year 2003 will continue using the sum-of-the-years’-digits method. In 2003, this will result in depreciation expense of $4,691 • ($43,000 6/55 = $4,691 rounded)

13. Part 3 — Journal Entries • The journal entry to record the depreciation expense on the equipment in year 2003 will continue using the sum-of-the-years’-digits method. In 2003, this will result in depreciation expense of $4,691 • ($43,000 6/55 = $4,691 rounded) Depreciation Expense …………………………………… 4,691 Accumulated Depreciation …………………………. 4,691

14. Part 3 — Journal Entries • Because the change in useful life of the building is a change in estimate, we do not make any adjustments to past entries. The new annual depreciation expense for the building beginning in 2003 is computed as follows:

15. Part 3 — Journal Entries • Because the change in useful life of the building is a change in estimate, we do not make any adjustments to past entries. The new annual depreciation expense for the building beginning in 2003 is computed as follows: Book value on Jan. 1, 2003 $66,332 [$85,000 – (4 x $4,667)]  New remaining useful life  16 years = New depreciation expense = $3,208 per year (rounded)

16. Part 3 — Journal Entries • Because the change in useful life of the building is a change in estimate, we do not make any adjustments to past entries. The new annual depreciation expense for the building beginning in 2003 is computed as follows: • The journal entry to record the depreciation expense on the building is: Book value on Jan. 1, 2003 $66,332 [$85,000 – (4 x $4,667)]  New remaining useful life  16 years = New depreciation expense = $3,208 per year (rounded) Depreciation Expense—Building …………………… 3,208 Accumulated Depreciation—Building ………… 3,208

17. Part 4 — Journal Entries • Because Johnston Doors is using the allowance method, the entry to write off actual bad debts removes the actual amount from both the Accounts Receivable and the Allowance for Bad Debts. In this case, the actual amount for 2003 totaled $5,500.

18. Part 4 — Journal Entries • Because Johnston Doors is using the allowance method, the entry to write off actual bad debts removes the actual amount from both the Accounts Receivable and the Allowance for Bad Debts. In this case, the actual amount for 2003 totaled $5,500. Allowance for Bad Debts ……………………………… 5,500 Accounts Receivable ……………………………… 5,500

19. Part 4 — Journal Entries • Johnston has decided to use 2% of credit sales as their best estimate of bad debt expenses the company incurs beginning in 2003. Credit sales for 2003 totaled $250,000 which results in a bad debt expense for the year of $5,000. • ($250,000 x .02 = $5,000)

20. Part 4 — Journal Entries • Johnston has decided to use 2% of credit sales as their best estimate of bad debt expenses the company incurs beginning in 2003. Credit sales for 2003 totaled $250,000 which results in a bad debt expense for the year of $5,000. • ($250,000 x .02 = $5,000) Bad Debt Expense ……………………………………. 5,000 Allowance for Bad Debts …………………………. 5,000

21. Part 5 • Because the change in percentage used to estimate bad debts is treated as a change in estimate, there is no cumulative adjustment to the allowance account at the beginning of 2003.

22. End of Problem