Goodwin
Corp., which began operations in January 2008, follows IFRS and is subject to a
40% income tax rate. In 2011, the following events took place:
1.
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 hiring an experienced estimator, which
made it possible to estimate completion costs.
2.
Due to a change in maintenance policy, the estimated useful life of Goodwin’s
fleet of trucks was lengthened.
3.
It was discovered that a machine with an original cost of $100,000, residual
value of $10,000, and useful life of four years was expensed in error on
January 23, 2010, when it was acquired. This situation was discovered after
preparing the 2011 adjusting entries but prior to calculating income tax
expense and closing the accounts. Goodwin uses straight-line depreciation and
takes a full year in the year of acquisition. The asset’s cost had been
appropriately added to the CCA class in 2010 before the CCA was calculated and
claimed.
4.
As a result of an inventory study early in 2011 after the accounts for 2010 had
been closed, management decided that the average costing method would provide a
more relevant presentation in the financial statements than does FIFO costing.
In making the change to average cost, Goodwin determined the following:
Date
Inventory-FIFO Cost Inventory-Avg Cost
Dec
31, 2010 90,000 80,000
Dec
31 2009 130,000 100,000
Dec
31 2008 200,000 150,000
Instructions
(a)
Analyze each of the four 2011 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 prospectively.
(b)
Prepare any necessary journal entries that would be recorded in 2011 to account
for events 3 and 4.
(a) 1. Change in accounting policy – full
retrospective application*.
2. Change in estimate – prospectively.
3. Accounting
error correction – full retrospective application.
4. Change in accounting policy – full
retrospective application.
* GAAP specifies that changes in policy should be
accounted for retrospectively with full application to prior periods. In
certain cases, it may be impracticable to determine estimates for prior
periods, in particular if it is impossible to assess circumstances and
conditions in prior years that need to be known in order to develop those
estimates. Partial retrospective or prospective application would then have to
be used.
(b) Event #3:
Equipment............................. 100,000
Depreciation
Expense.................. 22,500 *
Accumulated
Depreciation ($22,500 X 2) 45,000
Retained
Earnings–Correction of Error 46,500 **
Future
Income Tax Asset/Liability. 31,000 ***
* ($100,000 – $10,000)/4 = $22,500
** ($100,000 – $22,500) X (1 – 40%) = $46,500
*** ($100,000 – $22,500) X 40% = $31,000
Event #4:
Retained
Earnings..................... 6,000
Income Tax
Payable.................... 4,000
Inventory......................... 10,000
Changes for 2008 and 2009 have not been
included since inventory changes are counterbalancing and their impact on
opening 2011 retained earnings is nil.
Also note that CRA generally requires a
company to use the same inventory costing method for tax as it uses for
financial reporting purposes. Therefore, the effect of the change in inventory
costing method will result in a current tax amount, not a future tax asset or
liability.
