Question

DRS Corporation changed the way it depreciates its computers from the sum-of-the-year’s-digits method to the straight-line method beginning January 1, 2021. DRS also changed its estimated residual value used in computing depreciation for its office building. At the end of 2021, DRS changed the specific subsidiaries constituting the group of companies for which its consolidated financial statements are prepared. 

 

Required: 

1. For each accounting change DRS undertook, indicate the type of change and how DRS should report the change. Be specific. 

2. Why should companies disclose changes in accounting principles?

Answer 1

Straight Line Depreciation method is one of the most commonly used depreciation methods. It is considered to be easier and more direct when compared to other methods. The value of equipment/machinery is depreciated uniformly/annually over the years of its estimated useful life.

 

Formula:

Annual Depreciation Expense = (Cost of asset – Residual value)/Useful life of asset

 

Sum-Of-The-Years’ Digits Method is conceptually different and its calculation is based on the assumption that the machinery/equipment purchased, depreciates the most in its initial years of operations and the depreciation expense decreases overtime.

 

The respective assets’ digits of every year until the end of the useful life is added and then individually divided by the sum so obtained. The values derived are converted into percentages and that percentage of depreciation is levied every year.

 

Change in Principle/estimate: Change in accounting methods, methods of depreciation, inventory cost methods are considered to be prospective or retrospective change based on the information available. The revised estimate in values due to the respective change are adjusted in the reporting period along with appropriate disclosure notes specifying the change and its effects on financial statement. No adjustment is required in previous years financial statements if the information is inadequate and impracticable.

 

1.

Change in Depreciation method from SYD to Straight Line	Type	Prospective/Retrospective
	Change in estimate	Prospective

 

Explanation: Change in depreciation method is considered a change in estimate which is always prospective. The entity is not required to revise previous years financial statements. DRS Corporation will just apply straight line method from 1st January,2009 and provide appropriate disclosure notes explaining the same and future benefits accruing out of it.

 

Change in estimated residual value of office building	Type	Prospective/Retrospective
	Change in estimate	Prospective

 

Explanation: Just like change in depreciation method, change in residual value is also change in estimate. Hence, prospective. The depreciation calculated using the straight-line method will have to be adjusted keeping the new residual value in mind. Revision of previous year financial statements is not required. Appropriate disclosure notes stating the same is necessary.

 

Change in specific subsidiaries constituting corporation	Type	Prospective/Retrospective
	Change in reporting entity	Retrospective

 

Explanation: Reporting entity DRS Corporation, reports single set of consolidated statements. A change in reporting entity is a retrospective change and it requires all the previous year consolidated statements to be revised as if the change was prevailing in those financial years. Along with disclosure note, the change in net income, earnings per share and operating earning should be properly stated.

2.

Financial statements prepared and presented at the end of reporting period influences decisions of not just the management of the respective entity, but also the investors/shareholders, creditors/lenders and employees. Every country adopts those accounting principles for the corporations to follow, that guide the businesses to present a true and fair financial position. Often, these entities engage in activities, that have proven to be misleading and have impacted the economy as a whole. That is why, it is important to follow the same accounting principles and adopt such policies, that can facilitate comparison and assist in evaluating the company’s future growth and financial viability. Adopting a change in method, to delude investors, creditors or Government authorities is against the law and it is important for them to appropriately disclose such changes whenever they are required for untroubled operations.