Advanced financial accounting - Lecture 30: Accounting policies, changes in accounting estimates and errors. The main topics covered in this chapter include: profit and loss account; statement of retained earnings; prospective application; retrospective restatements;... Please refer to the lecture for details!
Advanced Financial Accounting FIN-611 Mian Ahmad Farhan Lecture-30 Accounting Policies, Changes in Accounting Estimates & Errors Solution Profit & Loss Account 2004 Sales (72,750-1,000) Cost of sales Gross profit (1/3 of sales) Operating Expenses Income tax @ 30% Profit after tax 2004 Rs 71,750 (47,833) 23,917 (7,750) 16,167 (4,850) 11,317 Working (2004) Gross profit = 717,50 x 1/3 = 23,917 Cost of goods sold = 71,750 – 23,917 = 47,833 Income tax = 16,167 x 30% = 4,850 Profit & Loss Account 2005 Sales (75,000+1,000-1,500) Cost of sales Gross profit (1/3 of sales) Operating Expenses Income tax @ 30% Profit after tax 2005 Rs 74,500 (49,667) 24,833 (7,500) 17,333 (5,200) 12,133 Working (2005) Gross profit = 74,500 x 1/3 = 24,833 Cost of goods sold = 74,500 – 24,833 = 49,667 Income tax = 17,333 x 30% = 5,200 Statement of Retained Earnings 2004 2004 Opening Balance Add Profit for the year Less Closing Balance Rs 4,800 11,317 16,117 8,050 8,067 Statement of Retained Earnings 2005 2005 Opening Balance Add Profit for the year Less Closing Balance Rs 8,067 12,133 20,200 10,250 9,950 Working (2005) Gross profit = 717,50 x 1/3 = 23,917 Cost of goods sold = 72,750 – 23,917 = 47,833 Income tax = 16,167 x 305 = 4,850 Prospective Application Prospective application of a change in accounting policy and of recognizing the effect of change in an accounting estimate respectively are: a) Applying the new accounting policy to transactions, other events and conditions occurring after the date as at which the policy is changed b) Recognizing the effect of the change in the accounting estimates in the current and future affected by the change Question Idrees Sports Private Limited purchased an assets with followings details: Cost price = Rs 2,500,000 Estimated useful life = 10 years Estimated residual value = Rs 100,000 In third year, the company estimates the useful life of its assets at six years with residual value Rs 220,000 The company depreciates its asset on straight line method Required: Account for the above Accounting Estimates in the Financial Statement of Idrees Sports Private Limited in the third year Solution Straight line method Depreciation Rate = / Useful life x 100 Depreciation Rate = / 10 x 100 = 10% First year depreciation = 2,500,000 – 100,000 = 2,400,000 x 10% = 240,000 Second year depreciation = 2,500,000 – 100,000 = 2,400,000 x 10% = 240,000 Third year depreciation = 2,500,000 – 480,000 = 2,020,000 Amount of depreciation = 2,020,000 – 220,000 = 1,800,000 = 1,800,000 / = 300,000 OR Depreciation rate = / x 100 = 16.666% Depreciation expense = 1,800,000 x 16.666 / 100 = 300,000 Prior Period Error Retrospective Restatements Retrospective Restatements is correcting the recognitions, measurement and disclosure of amounts of elements of financial statements as if a prior period error had never occurred i.e correction of error is to be made by restating the previous income statement and opening balance of previous periods’ retained earnings Question During 2008, Saleem Co discovered that some products that hade been sold during 2007 were incorrectly included in inventory at 31 December 2007 at Rs 6,500 Saleem Co accounting record for 2008 show sales of Rs 104,000, cost of goods sold of Rs 86,500 (including Rs 6,500) for the error in opening inventory and income taxes of Rs 5,250 Question 2007 Rs Sales 73,500 Less Cost of goods sold 53,500 Profit before income taxes 20,000 Less Income taxes Profit 6,000 14,000 Question 2007 opening retained earning was Rs 20,000 and closing retained earning was Rs 34,000 Saleem Co income tax rate was 30% for 2008 and 2007 It had no other income or expenses Saleem Co had Rs 50,000 of share capital through out and no other components of equity except for retained Earning Solution 2008 Sales 2007 104,000 73,500 Less Cost of goods sold 80,000 60,000 Profit before income taxes 24,000 13,500 7,200 4,050 16,800 9,450 Less Income taxes Profit Working (2007) Reported cost of goods sold Add Overstated closing stock 53,500 6,500 60,000 Working (2008) Reported cost of goods sold Less Overstated closing stock 86,500 6,500 80,000 Statement of Change in Equity 2008 Rs Opening retained profit 2007 Rs 34,000 Adjustment in opening retained profit 6,500 Less Income tax effect (30%) 1,950 20,000 (4,550) Adjusted opening retained profit Add Profit after tax 29,450 16,800 -9,450 46,250 29,450 ... 23,917 = 47,833 Income tax = 16,167 x 305 = 4,850 Prospective Application Prospective application of a change in accounting policy and of recognizing the effect of change in an accounting estimate... Applying the new accounting policy to transactions, other events and conditions occurring after the date as at which the policy is changed b) Recognizing the effect of the change in the accounting. .. previous income statement and opening balance of previous periods’ retained earnings Question During 2008, Saleem Co discovered that some products that hade been sold during 2007 were incorrectly included