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Counterbalancing errors, correcting errors

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What are some examples of counterbalancing errors? What are some examples of non-counterbalancing errors? What are the differences between counterbalancing and non-counterbalancing errors? How are each handled? Does it matter if the books are closed? Why or why not?

Why do accountants make errors? What types of errors can occur? Why is it necessary to correct them? What are the ramifications of not correcting errors?

What is a change in accounting principle? How do you determine if a change in principle should be reported retroactively, currently, or prospectively? How do these changes affect the financial statements?

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What are some examples of counterbalancing errors?
1. Paying the January rent on December 31 and expensing it in December. Now there are 13 months of rent in last year but there will only be 11 in this year. Yes, they counterbalance, but both years are incorrect with respect to total rent expense.
2. Paying December wages in January without accruing them in December. Last year's wage expense will be short the December payroll but this year will be overstated by one payroll. They counterbalance but both years are wrong.
3. In coding a bank loan payment, the interest portion was forgotten. It will be expensed in the next accounting period but both periods will be wrong.

What are some examples of non-counterbalancing errors?
1. Miscoding expenses such as charging the January advertising to salary expense.
2. Miscoding expenses to a direct cost instead of an indirect cost which will affect the cost of goods sold and gross margin.
3. Making an error in a depreciation calculation.

What are the differences between counterbalancing and non-counterbalancing errors?
Counterbalancing errors will correct themselves by the end of the second year and then will have no effect going forward, but non-counterbalancing errors will continue to be wrong, but only for the year of the error.

How are each handled?
There are a variety of ways that errors are handled for both types:
1. The accounting staff may ...

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Sam Houston Inc., Change in estimate, Change in inventory method, Change in depreciation method

Sam Houston Inc. was organized in late 2008 to manufacture and Sanitizing Hand Wipes. This was a response to the increase in the number of cases in America in the Fall of 2008. Most of the company's customers are Colleges and Universities. At the end of its fourth year of operation, the company has been fairly successful, as indicated by the following reported net incomes.
2008 $140,000a 2010 $205,000
2009 160,000b 2011 $276,000

a. Includes a $12,000 increase because of change in bad debt experience rates
b. Includes extraordinary gain of $40,000.

The company has decided to expand operations and has applied for a sizable bank loan. The company wants to get into the White Board Cleaning Fluid Business. The bank officer has indicated that the records of Sam Houston Inc. should be audited and presented in comparative statements to facilitate analysis by the bank. Sam Houston Inc. therefore hired the auditing firm of Littlejohn and Littlejohn, CPAs and has provided the following additional information to the CPA firm.

In early 2009, Sam Houston Inc. changed its estimate from 2% to 1% on the amount of bad debt expense to be charged to operations. Bad debt expense for 2008, if a 1% rate had been used, would have been $12,000. The company therefore restated its net income for 2008. The reduction was due to the number of credit checks performed by the company prior to extending credit.

2. In 2011, the auditor discovered that the company had changed its method of inventory pricing from LIFO to FIFO. The effect on the income statements for the previous years is as follows.

2008 2009 2010 2011
Net income $140,000 $160,000 $205,000 $ 276,000
Net income 155,000 165,000 215,000 260,000
$ 15,000 $ 5,000 $ 10,000 ($ 16,000)

3. In 2009, the company changed its method of depreciation from the accelerated method to the straight-line approach. The company used the straight-line method in 2009. They found that the machines were not wearing out as fast as first predicted. The effect on the income statement for the previous year is as follows in 2009.


Net income unadjustedâ?"accelerated $140,000
Net income unadjustedâ?"straight-line 147,000
$ 7,000

4. In 2011, the auditor discovered that:

a. The company incorrectly overstated the ending inventory by $11,000 in 2010.
b. A dispute developed in 2009 with the Internal Revenue Service over the deductibility of entertainment expenses. In 2008, the company was not permitted these deductions, but a tax settlement was reached in 2011 that allowed these expenses. As a result of the court's finding, tax expenses in 2011 were reduced by $60,000.

a. Assume we are in the year 2012.
b. Indicate how each of these changes or corrections should be handled in the accounting records. Ignore income tax considerations. Hint You should have 4 comments.
c. Present comparative income statements for the years 2008 to 2011, starting with income before extraordinary items. Do not prepare pro-forma amounts. Ignore income tax considerations.

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