In: Accounting
Hot Weelz Ltd., which began operations in January 2015, follows IFRS and is subject to a 30% income tax rate. In 2018, the following events took place:
a) The company switched from the zero-profit method to the percentage-of-completion method of accounting for its long-term construction projects. This change was a result of experience with the project and improved ability to estimate the costs to completion and therefore the percentage complete.
b) Due to a change in maintenance policy, the estimated useful life of Hot Weelz’s fleet of trucks was lengthened.
c) It was discovered that a machine with an original cost of $220,000, residual value of $30,000, and useful life of four years was expensed in error on January 23, 2017, when it was acquired. This situation was discovered after preparing the 2018 adjusting entries but before calculating income tax expense and closing the accounts. Hot Weelz uses straight-line depreciation and takes a full year of depreciation in the year of acquisition. The asset’s cost had been appropriately added to the capital cost allowance (CCA) class in 2017 before the CCA was calculated and claimed.
d) As a result of an inventory study early in 2018 after the accounts for 2017 had been closed, management decided that the weighted average cost formula would provide a more relevant presentation in the financial statements than the FIFO cost formula. In making the change to weighted average cost, Hot Weelz determined the following:
Date |
Inventory—FIFO Cost |
Inventory—Weighted Average Cost |
Dec. 31, 2017 |
$ 80,000 |
$ 65,000 |
Dec. 31, 2016 |
115,000 |
85,000 |
Dec. 31, 2015 |
180,000 |
135,000 |
Required:
1. Analyze each of the four 2018 events described above. For each event, identify the type of accounting change that has occurred, and indicate whether it should be accounted for with full retrospective application, partial retrospective application, or prospective application.
2. Prepare any necessary journal entries that would be recorded in 2018 to account for events C (ignore income tax considerations) and D.
Scenario A: Change in revenue recognition method from zero profit to percentage completion
The aforesaid change is primarily a change in the accounting conventions of the company, wherein the methodology adopted for revenue recognition is undergoing a complete change. Therefore, this change will be a change in accounting policy. Changes in accounting policy require a retrospective impact, i.e. for change in accounting policy for year ended 2018, the company will have to restate the earliest comparative periods (i.e. Dec 2017) opening balances, i.e. balance as on 31 December 2016/1 January 2017 will have to be adjusted to align the assets and liabilities as per the new accounting policy, followed by restatement of profit and loss account for the comparative period, i.e. December 2017. The impact of restatement of 1 January 2017 balances is taken to reserves
Scenario B: Change in useful life of assets
Depreciation method refers to allocation of costs of assets in the pattern of expected usage of the asset. Change in estimate of useful life represents that the company estimates a change in pattern of utilisation of asset. This, therefore, is a change in accounting estimate. There is no retrospective adjustment required. The balance book value of the asset will be divided by the remaining useful life and the future depreciation will be adjusted accordingly.
Scenario C: Rectification of error
Rectification of errors, if material, require restatement of accounts which are impacted by the error. In case the impact of error goes back beyind the comparative period, then the opening reserves balance of the comparative period, i. this case 1 January 2017 will be adjusted to reflect the impact of errors, December 2017 financial statements will be prepared based on the revised opening balances and so on.
In this case, the error impacts only December 2017 accounts. Therefore, there will be no need to restate the opening balances of December 2017. Following entry will be passed to restate the December 2017 accounts:
Particulars |
Debit |
Credit |
Fixed Assets |
220,000 |
|
Operating expenses |
220,000 |
|
Being asset wrongly expensed off no recorded in books and 2017 balances adjusted |
||
Depreciation expense ((220,000-30,000)/4) |
47,500 |
|
Accumulated depreciation |
47,500 |
|
Being depreciation recorded for the year 2017 and due adjustment made to restate 2017 balance |
Following depreciation entry will again be passed in 2018 to provide for 2018 depreciation
Particulars |
Debit |
Credit |
Depreciation expense ((220,000-30,000)/4) |
47,500 |
|
Accumulated depreciation |
47,500 |
|
Being depreciation recorded for 2018 |
Scenario D: Change in method of inventory valuation
Like in Case A, change in method of valuation of inventory is a change in accounting convention and therefore, tantamounts to a change in accounting policy requiring retrospective application. Therefore, the inventory balance of 31 dec 2016 will be restated, with corresponding in pact on December 2017 and December 2018 inventory.
Journals/adjustment required to incorporate this change
Particulars |
Debit |
Credit |
Reserves (as on 31 Dec 2016) |
30,000 |
|
Inventory |
30,000 |
|
Being inventory value as on 31 December 2016 adjusted to incorporate change in accounting policy on inventory valuation |
As a consequence of passing the above entry, the inventory as on 31 Dec 2017 will also reduce from USD 80,000 under FIFO to USD 50,000 (reduction of USD 30,000) recorded above. Therefore, the inventory now needs to be restated to USD 65,000 as on 31 December 2017, which will be done by passing the following entry:
Particulars |
Debit |
Credit |
Inventory |
15,000 |
|
Cost of goods sold |
15,000 |
|
Being inventory value as on 31 December 2017 adjusted to incorporate change in accounting policy on inventory valuation |
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