Question

Each of the following situations occurred during 2011 for one of your audit clients:1. The write-off of inventory due to obsolescence.2. Discovery that depreciation expenses were omitted by accident from 2010's income statement.3. The useful lives of all machinery were changed from eight to five years.4. The depreciation method used for all equipment was changed from the declining-balance to the straight-line method.5. Ten million dollars face value of bonds payable were repurchased (paid off) prior to maturity resulting in a material loss of $500,000. The company considers the event unusual and infrequent.6. Restructuring costs were incurred.7. The Stridewell Company, a manufacturer of shoes, sold all of its retail outlets. It will continue to manufacture and sell its shoes to other retailers. A loss was incurred in the disposition of the retail stores. The retail stores are considered components of the entity.8. The inventory costing method was changed from FIFO to average cost.Required:1. For each situation, identify the appropriate reporting treatment from the list below (consider each event to be material):a. As an extraordinary item.b. As an unusual or infrequent gain or loss.c. As a prior period adjustment.d. As a change in accounting principle.e. As a discontinued operation.f. As a change in accounting estimate.g. As a change in accounting estimate achieved by a change in accounting principle.2. Indicate whether each situation would be included in the income statement in continuing operations (CO) or below continuing operations (BC), or if it would appear as an adjustment to retained earnings (RE). Use the format shown below to answer requirements 1 and 2

Answer 1

Answer:

Situations during 2011 at an Audit Client

A. Appropriate Reporting Treatments:

1. Write-off of inventory due to obsolescence.

a. As an extraordinary item.

2. Discovery that depreciation expenses were omitted by accident from 2010's income statement.

c. As a prior period adjustment.

3. The useful lives of all machinery were changed from eight to five years.

f. As a change in accounting estimate.

4. The depreciation method used for all equipment was changed from the declining-balance to the straight-line method.

g. As a change in accounting estimate achieved by a change in accounting principle.

5. Ten million dollars face value of bonds payable were repurchased (paid off) prior to maturity resulting in a material loss of $500,000. The company considers the event unusual and infrequent.

b. As an unusual or infrequent gain or loss.

6. Restructuring costs were incurred.

b. As an unusual or infrequent gain or loss.

7. The Stridewell Company, a manufacturer of shoes, sold all of its retail outlets. It will continue to manufacture and sell its shoes to other retailers. A loss was incurred in the disposition of the retail stores. The retail stores are considered components of the entity.

e. As a discontinued operation.

8. The inventory costing method was changed from FIFO to average cost.

d. As a change in accounting principle.

B. Inclusion in the Income Statement:

1. CO

2. RE

3. CO

4. RE

5. BC

6. BC

7. BC

8. CO

Explanation:

1. Investopedia.com defined "Unusual or infrequent items" as "gains or losses from a lawsuit; losses or slowdown of operations due to natural disasters; restructuring costs; gains or losses from the sale of assets; costs associated with acquiring another business; losses from the early retirement of debt; and plant shutdown costs."

2. Extraordinary gains or losses are economic events which originate from continuing infrequent and unusual operations.  These gains and losses stem from the normal business activities of the company, but, they do not happen regularly, and are abnormal in nature.

3. A prior period adjustment is the correction of a past accounting error that occurred in the past financial statements.

4. According to investopedia.com, "A change in accounting principle is a change in how financial information is calculated, while a change in accounting estimate is a change in the actual financial information.  Changes in accounting principles are done retroactively, where financial statements have to be re-stated.  But, changes in estimates are not applied retroactively.