Accting2501 | Concept Of Materiality Assessment Answers

1. Materiality

Define the concept of materiality. Give 2 examples and clearly explain why you think that they are material.

2. Accounting Changes & Correction of Errors

a. List and describe 3 accounting changes. Give an example of each change. Describe how each change should be accounted for in the financial statements.

b. What is an error? Give an example. Describe the ways errors can be corrected and accounted for in the financial statements.

3. Comprehensive Income.

a. Define comprehensive income.

b. Explain why comprehensive income is important.

c. List and describe the 4 components of other comprehensive income under US GAAP. ?

d. What are the 2 choices for financial statement presentation of comprehensive income under US GAAP? 

1: Materiality

The concept of materiality is defined as the financial accounting and reporting principle that the organizations might not consider trivial matters; however, they are needed to be disclosed, as they are deemed to be significant for the report audience (Eilifsen & Messier Jr, 2014).

Example 1: ABC Limited has generated sales of $100,000 and it has total assets of $50,000 in 2018. The external auditors of the organization have identified that sales amounting to $3,000 need not be realized in the year, since there is no transfer of risks and rewards evident in sales. This amount of $3,000 could be considered as material in the context of total assets of $50,000, as financial statements need to be adjusted.

Example 2: Lira Corporation operates in a nation that would enact a new law having the potential to impair its business operations. Even though there is absence of any figure, the development disclosure is needed in the financial statements on materiality account, since the new law could end the sales and profits made potentially from the nation.

2: Accounting changes and correction of errors

Requirement a:

Change in the useful life of an asset:

If the useful life of an asset is changed, it would not change the total depreciation amount of that asset. If an asset valued $6,000 is depreciated for five years using straight-line method, the annual depreciation would be $1,200 or $100 per month. When the useful life of the asset after two years is changed to a year already depreciated, the leftover $3,600 would be spread over a year or $300 per month. The effect of this change would be on the balance sheet statement and the income statement as follows:

Balance sheet: Depreciation expense => Accumulated depreciation => Book value of the asset

Income statement: Depreciation expense => Net income

The revision is to be disclosed as footnotes to the financial statements.

Change in salvage value of an asset:

It is assumed that XYZ Company purchased an asset for $20,000 three years ago having an economic life of 10 years. When it is acquired, the asset is deemed to have a salvage value of $2,000. However, later on, it has been identified that the salvage value after four yours is nil. Since the salvage value is nil, depreciation would be the entire amount of carrying value of the asset after three years. This would result in fall in fixed assets and increase in operating expenses in the income statement.

Accounting for obsolete inventory:

It is assumed that an organization sold $100,000 of additional excess home coffee roasters it could not sell, which was sold for $20,000. This would result in debiting cost of sales account by $80,000 and crediting reserve for obsolete inventory account by $80,000. However, later on, the selling price is recognized as $19,000 and due to this, reserve for obsolete inventory and cost of sales would be debited by $80,000 and $1,000 respectively and inventory would be credited by $81,000.

Requirement b:

Accounting error could be defined as a non-fraudulent discrepancy in financial documentation, which is used in financial reporting. One such error is the error of duplication, in which bad debt expense account might have been debited twice. In order to correct this error, accounts receivable account needs to be debited and bad debt expense account would be credited.

3.Comprehensive income

Requirement a:

Comprehensive income is the change in the net assets of an organization from non-owner sources during a particular timeframe; thus, depicting a holistic overview of its net income not mentioned in the income statement (Black, 2016).

Requirement b:

Comprehensive income provides is a significant metric of financial analysis for detailed inclusive analysis of earnings and profitability of an organization. The analysts could gather overview of the business investments. The unrecognized gains or losses might estimate the actual and recognized gains or losses on investments. Moreover, it assists in analyzing the foreign operations as well as the effect of foreign exchange variations on the organization.

Requirement c:

The four components of other comprehensive income listed in US GAAP include the following:

• “Unrecognized holding gains or losses on investments categorized as available for sale” is used for adjusting the carrying amounts related to marketable securities (Detzen, 2016).
• “Foreign currency translation gain or loss” is utilized so that the outcomes of the foreign subsidiaries of the parent organization could be converted into its reporting currency.
• “Pension plan gain or loss” includes the difference between the pension paid by the employer and the expected amount.
• “Pension prior service costs or credits” denote the systematic realization of pension expense in upcoming years due to retroactive change to the benefit formula of the plan.

Requirement d:

As per US GAAP, organizations are needed to report comprehensive income components in either of the following two ways:

• Single continual statement related to comprehensive income
• Separate but consecutive statements

References:

Abernathy, J., Hackenbrack, K. E., Joe, J. R., Pevzner, M., & Wu, Y. J. (2015). Comments of the Auditing Standards Committee of the Auditing Section of the American Accounting Association on PCAOB Staff Consultation Paper, Auditing Accounting Estimates and Fair Value Measurements: Participating Committee Members. Current Issues in Auditing, 9(1), 1-11.

Black, D. E. (2016). Other comprehensive income: a review and directions for future research. Accounting & Finance, 56(1), 9-45.

Detzen, D. (2016). From compromise to concept?–a review of ‘other comprehensive income’. Accounting and Business Research, 46(7), 760-783.

Eilifsen, A., & Messier Jr, W. F. (2014). Materiality guidance of the major public accounting firms. Auditing: A Journal of Practice & Theory, 34(2), 3-26.