Question

Kingbird Inc. has recently hired a new independent auditor, Karen Ogleby, who says she wants “to get everything straightened out.” Consequently, she has proposed the following accounting changes in connection with Kingbird Inc.’s 2020 financial statements.

For each of the changes described above, decide whether:

(1)		The change involves an accounting principle, accounting estimate, or correction of an error.
(2)		Restatement of opening retained earnings is required.

					(1)		(2)
1.		At December 31, 2019, the client had a receivable of $823,000 from Hendricks Inc. on its balance sheet. Hendricks Inc. has gone bankrupt, and no recovery is expected. The client proposes to write off the receivable as a prior period item.
2.		The client proposes the following changes in depreciation policies.
		(a)	For office furniture and fixtures, it proposes to change from a 10-year useful life to an 8-year life. If this change had been made in prior years, retained earnings at December 31, 2019, would have been $253,000 less. The effect of the change on 2020 income alone is a reduction of $78,000.
		(b)	For its new equipment in the leasing division, the client proposes to adopt the sum-of-the-years’-digits depreciation method. The client had never used SYD before. The first year the client operated a leasing division was 2020. If straight-line depreciation were used, 2020 income would be $108,000 greater.
3.		In preparing its 2019 statements, one of the client’s bookkeepers overstated ending inventory by $232,500 because of a mathematical error. The client proposes to treat this item as a prior period adjustment.
4.		In the past, the client has spread preproduction costs in its furniture division over 5 years. Because its latest furniture is of the “fad” type, it appears that the largest volume of sales will occur during the first 2 years after introduction. Consequently, the client proposes to amortize preproduction costs on a per-unit basis, which will result in expensing most of such costs during the first 2 years after the furniture’s introduction. If the new accounting method had been used prior to 2020, retained earnings at December 31, 2019, would have been $384,000 less.
5.		For the nursery division, the client proposes to switch from FIFO to LIFO inventories because it believes that LIFO will provide a better matching of current costs with revenues. The effect of making this change on 2020 earnings will be an increase of $328,000. The client says that the effect of the change on December 31, 2019, retained earnings cannot be determined.
6.		To achieve an appropriate recognition of revenues and expenses in its building construction division, the client proposes to switch from the completed-contract method of accounting to the percentage-of-completion method. Had the percentage-of-completion method been employed in all prior years, retained earnings at December 31, 2019, would have been $1,054,000 greater.

What would be the proper adjustment to the December 31, 2019, retained earnings?

Answer 1

Requirement a1

It is a change in accounting estimate as the uncollectible receivables are accounting estimates requiring the exercise of judgment and restating prior year items are not appropriate and therefore restatement of opening retained earnings is not required.

Requirement a2

1. Reduction in useful life from 10 years to 8 years is a change in accounting estimate and restatement of opening retained earnings is not required.
2. No change, neither related to accounting principle or accounting estimate occurred nor it is correction of an error and therefore restatement of opening retained earnings is not required.

Requirement a3

Ending inventory is overstated due to mathematical error in the previous year and therefore it needs to be corrected by restating the opening retained earnings.

Requirement a4

It is a change in accounting estimate and the restatement of opening retained earnings is not required.

Requirement a5

The switch from FIFO cost flow assumption to LIFO cost flow assumption is a change in accounting principle and the restatement of opening retained earnings is not required because the effect on net income in the prior reporting period is not determinable.

Requirement a6

The switch from completed-contract method to percentage-of-completion method is a change in accounting principle and the opening retained earnings need to adjusted accordingly.

Requirement b: Compute the adjustment to retained earnings as follows

Particulars	Amount
Mathematical Error	($232,500)
Adjustment for change in method of accounting	$1,054,000
Total adjustment to December 31, 2019 retained earnings	$821,500