describe a circumstance m c Weighing Alternatives Change in Estimate versus Erro
ID: 2564284 • Letter: D
Question
describe a circumstance m c Weighing Alternatives Change in Estimate versus Error Correction Facts: You are the owner of a la company (LawnCo) which provides grounds and maintenance services to a range of corporate customers. Customers SUril t are expected to pay on the first of each month, in advance of receiving services. One of your corporate customers is an eldercare facility whose grounds you have maintained for many years. The customer has not paid for the last three rvices (from Oct.-Dec. 20X1); nevertheless, to maintain a positive relationship, your company contin- uring that time. Your company ceased d out in that same month that the eldercare facility filed for bankruptcy months of se ued to provide mowing and weed control services to the eldercare facility d providing services in January 2 in September. Your company now believes that collection of the missed payments is extremely unlikely nd foun Your company has already issued financial statements to lenders (for the period ending 12/31/XI) which reflected revenue and a corresponding account receivable related to this customer of $10,000 per month for services provided to this customer. Those financial statements also reflected the company's standard allowance (reserve) amount on receivables, of 4% of sales. In total, your company's average monthly sales amount to S500.000. Required 1. Evaluate whether receipt of this information indicates you have a change in accounting estimate or whether the customer's bankruptcy should result in this event being considered an error in previously issued financial statements 2. Next, describe the accounting treatment (as required by the Codification) for each alternative, then support your 3. Finally, briefly state which treatment appears to be more appropriate given the circumstances. If you must make explanations with draft journal entries. any assumptions in reaching this conclusion, state these. e the Coodwill Aecountine Alternative Availahle to Private CnmnaniExplanation / Answer
Answer 1: Accounting Standards Codification (ASC) Topic 250 includes financial accounting and reporting guidance for changes in accounting. Changes in accounting include changes in accounting principle, changes in estimates and changes in reporting entity. ASC 250 also provides financial accounting and reporting guidance for error corrections
Errors may occur in the recognition, measurement, presentation or disclosure of transactions or events. Examples of corrections of errors in previously issued financial statements include oversight or misuse of facts that existed at the time the financial statements were prepared.
In the extant case, the Company continued to provide the services in good faith and there was an oversight of the fact that the customer has filed of the bankruptcy. Hence, the standard allowance did not take in to account the said fact. This falls in the definition of error.
From the above, it is evident that financial statement have already been issued to the lenders, Any error in the financial statements of a prior period discovered after the financial statements are issued or are available to be issued shall be reported as an error correction, by restating the prior-period financial statements. Restatement requires all of the following:
a. The cumulative effect of the error on periods prior to those presented shall be reflected in the carrying amounts of assets and liabilities as of the beginning of the first period presented.
b. An offsetting adjustment, if any, shall be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period.
c. Financial statements for each individual prior period presented shall be adjusted to reflect correction of the period-specific effects of the error.
Answer 2: The revenue recognised for the said customer for Oct -Dec aggregated to $ 30,000. Since this customer always paid in advance, the same was not considered in the standard allowance of 4%. Hence, the Company needs to make an additional allowance of 100% of $30,000 =$30,000 in the books (as collection is extremely unlikely) . Hence, the value of receivables shall be adjusted in the Financial statements for prior period presented.
Journal Entry:
Retained Earnings Dr. $30000
To Standard Allowance Reserve A/c Cr. $30000
Hence, the receivables will be disclosed net of this additional allowance of $30,000
Answer 3: There are two treatments possible for rectifying the error. First since the collection was uncertain, the entire revenue from this customer is reversed in the comparative period presented. Secondly, additional allowance is made for $30,000 to reflect the uncertainity in the comparative period presented.
When the uncertainty relating to collectability arises subsequent to the time of sale or the rendering of the service, it is more appropriate to make a separate allowance to reflect the uncertainty rather than to adjust the amount of revenue originally recorded, hence The second approach is more appropriate.
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