Advanced Financial Accounting FIN-611 Mian Ahmad Farhan Lecture-30 Accounting Policies, Changes in Accounting Estimates & Errors

Solution

Profit & Loss Account 2004 2004 Rs. Sales (72,750-1,000) 71,750 Cost of sales (47,833) Gross profit (1/3 of sales) 23,917 Operating Expenses (7,750) 16,167 Income tax @ 30% (4,850) Profit after tax 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 2005 Rs. Sales (75,000+1,000-1,500) 74,500 Cost of sales (49,667) Gross profit (1/3 of sales) 24,833 Operating Expenses (7,500) 17,333 Income tax @ 30% (5,200) Profit after tax 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 . Rs. Opening Balance 4,800 Add Profit for the year 11,317 16,117 Less Closing Balance 8,050 8,067

Statement of Retained Earnings 2005 . Rs. Opening Balance 8,067 Add Profit for the year 12,133 20,200 Less Closing Balance 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 = 1 / Useful life x 100 Depreciation Rate = 1 / 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 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 / 6 = 300,000 OR Depreciation rate = 1 / 6 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 53,500 Less Cost of goods sold Profit before income taxes 20,000 6,000 Less Income taxes Profit 14,000

Question 2007 opening retained earning was Rs. 20,000 and closing 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 2007 Sales Less Cost of goods sold 104,000 73,500 Less Cost of goods sold 80,000 60,000 Profit before income taxes 24,000 13,500 Less Income taxes 7,200 4,050 Profit 16,800 9,450 The table will appear as row wise.

Working (2007) Reported cost of goods sold 53,500 Add Overstated closing stock 6,500 60,000

Working (2008) Reported cost of goods sold 86,500 Less Overstated closing stock 6,500 80,000

Statement of Change in Equity 2008 Rs. 2007 Opening retained profit 34,000 20,000 Adjustment in opening retained profit 6,500 Less Income tax effect (30%) 1,950 (4,550) ----- Adjusted opening retained profit Add Profit after tax 29,450 16,800 ---- 9,450 46,250 First Opening retained profit Then 34000 Then 20,000 Then all items 2007 and then all items of 2008 one by one