Question

Question 16

Question 16) for each of the following separate cases, identify if the case is error or change in accounting estimate and identify the correct accounting treatment.

A) In 2019, after the entity’s 2018 financial statements were approved for issue, the entity discovered that, as a result of a computational error, depreciation expense for 2018 was understated by AED 1,000.

B) the CFO in Company WXY had decided to change the recognition method of investment properties from cost model to be measured by fair value model starting from 2019.

C) An entity acquired a machine for AED140,000 on 1 January 2010. It estimated that the machine would have a 10-year useful life, no residual value. Early in January 2014 the entity estimates that the machine has a remaining useful life of 10 years (ie measured from 1 January 2014).

D) While preparing the financial statements in 2019, the external auditor found that the previous accountant had used to record AED10,000 rent expense in the company’s records which is not exist in reality and the company has no rented flats during those years. The accountant recorded that expense over the previous four years (2015, 2016, 2017, and 2018).

E) In 2014, after the entity’s 2013 financial statements were approved for issue, the entity discovered that, as a result of a computational error, depreciation expense for 2013 was understated by AED 36

Answer 1

A) In 2019, after the entity’s 2018 financial statements were approved for issue, the entity discovered that, as a result of a computational error, depreciation expense for 2018 was understated by AED 1,000.

Solution : This is a case of error and not change in accounting estimate.

1) Errors in financial statements reduce the reliability of information presented. Errors must therefore be discovered and corrected on a timely basis to ensure that users can rely on the information contained in the financial statements.

2) Prior Period Errors must be corrected Retrospectively in the financial statements. Retrospective application means that the correction affects only prior period comparative figures. Current period amounts are unaffected.

Therefore, comparative amounts of each prior period presented which contain errors are restated. If however, an error relates to a reporting period that is before the earliest prior period presented, then the opening balances of assets, liabilities and equity of the earliest prior period presented must be restated.

3) Errors discovered after reporting date

Accounting Errors discovered after the reporting date but before the authorization of financial statements are adjusting events after the reporting date as per IAS 10 and must therefore be corrected in the current period prior to the issuance of financial statements.

Current Scenario : Therefore in the current case, assuming that the errors are discovered before the reporting date, the comapny is required to restate the comparative figures of previous financial year by increasing the depreciation expense by AED 1000 for previous financial yaer. This will lead to change in opening balance of Asset (in question of error of depreciation) which will be reduced by the same amount with a corresponding change in retained earnings (decrease by AED 1000)

B) the CFO in Company WXY had decided to change the recognition method of investment properties from cost model to be measured by fair value model starting from 2019.

Solution : This is a case of change in accounting estimate and not change in error.

Accounting Estimates involve management's judgment of expected future benefits and obligations relating to assets and liabilities (and associated expense and income) based on information that best reflects the conditions and circumstances that exist at the reporting date. By its nature, estimates are subjective and may require frequent revisions in future. Revision of estimates must be distinguished correction of errors which occur because of not using information that was available at the time of preparation of financial statements.

Changes in Accounting Estimates - Treatment

Estimates must be revised when new information becomes available which indicates a change in circumstances upon which the estimates were formed.

Changes in Accounting Estimates must be accounted for prospectively in the financial statements, i.e. the effects of the change must be incorporated in the accounting period in which the estimates are revised.

Current Scenario : Therefore, carrying amounts of assets and liabilities and any associated expense and gains are adjusted in the period of change in estimate.

C) An entity acquired a machine for AED 140,000 on 1 January 2010. It estimated that the machine would have a 10-year useful life, no residual value. Early in January 2014 the entity estimates that the machine has a remaining useful life of 10 years (ie measured from 1 January 2014).

Solution : This is a case of change in accounting estimate and not change in error.

Accounting Estimates involve management's judgment of expected future benefits and obligations relating to assets and liabilities (and associated expense and income) based on information that best reflects the conditions and circumstances that exist at the reporting date. By its nature, estimates are subjective and may require frequent revisions in future. Revision of estimates must be distinguished correction of errors which occur because of not using information that was available at the time of preparation of financial statements.

Changes in Accounting Estimates - Treatment

Estimates must be revised when new information becomes available which indicates a change in circumstances upon which the estimates were formed.

Changes in Accounting Estimates must be accounted for prospectively in the financial statements, i.e. the effects of the change must be incorporated in the accounting period in which the estimates are revised.

Current Scenario : Since this is a change in accounting estimate, this would not have any affect on comparative or prior period financial statements. Since the machine, as per the new estimates, is going to last over 4 years more than the previous estimated life, depreciation will be calculated from 2014 to 2023 (next 10 yaears) on residual value of machine from the year of change in estimate.

Residual Value of Machine on 01.01.2014 - 140000 - (140000/10*4) = 84000

Depreciation for next 10 years beginning 2014 to 2023 = 84000/10 = 8400

Residual value as on 31.12.2023 = Nil

D) While preparing the financial statements in 2019, the external auditor found that the previous accountant had used to record AED 10,000 rent expense in the company’s records which is not exist in reality and the company has no rented flats during those years. The accountant recorded that expense over the previous four years (2015, 2016, 2017, and 2018).

Solution : This is a case of error and not change in accounting estimate.

1) Errors in financial statements reduce the reliability of information presented. Errors must therefore be discovered and corrected on a timely basis to ensure that users can rely on the information contained in the financial statements.

2) Prior Period Errors must be corrected Retrospectively in the financial statements. Retrospective application means that the correction affects only prior period comparative figures. Current period amounts are unaffected.

Therefore, comparative amounts of each prior period presented which contain errors are restated. If however, an error relates to a reporting period that is before the earliest prior period presented, then the opening balances of assets, liabilities and equity of the earliest prior period presented must be restated.

3) Errors discovered after reporting date

Accounting Errors discovered after the reporting date but before the authorization of financial statements are adjusting events after the reporting date as per IAS 10 and must therefore be corrected in the current period prior to the issuance of financial statements.

Current Scenario : Therefore, since this is a case of accounting error, changes will be made restrospectively in the comparative financials by adjusting the prior period financials. Rent of AED 10000 *4 = AED 40000 will be reversed in the comparativre financials and retained earnings will be increased be increased by the same amount with corresponding reduction in the notes/accounts payable. The openings of retained earnings & notes/accounts payable will be revised in the current financials.

E) In 2014, after the entity’s 2013 financial statements were approved for issue, the entity discovered that, as a result of a computational error, depreciation expense for 2013 was understated by AED 36.

Solution : This is a case of error and not change in accounting estimate.

1) Errors in financial statements reduce the reliability of information presented. Errors must therefore be discovered and corrected on a timely basis to ensure that users can rely on the information contained in the financial statements.

2) Prior Period Errors must be corrected Retrospectively in the financial statements. Retrospective application means that the correction affects only prior period comparative figures. Current period amounts are unaffected.

Therefore, comparative amounts of each prior period presented which contain errors are restated. If however, an error relates to a reporting period that is before the earliest prior period presented, then the opening balances of assets, liabilities and equity of the earliest prior period presented must be restated.

3) Errors discovered after reporting date

Accounting Errors discovered after the reporting date but before the authorization of financial statements are adjusting events after the reporting date as per IAS 10 and must therefore be corrected in the current period prior to the issuance of financial statements.

Current Scenario : Since the error has been detected after approval of issue of financial statement, under reporting of depreciation by AED 36 will be adjusted in next year financial while reporting comparatives of 2018 as a prior period error.

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