Ray Solutions decided to make the following changes in its accounting policies on January 1, 2016:
a. Changed from the cash to the accrual basis of accounting for recognizing revenue on its service contracts.
b. Adopted straight-line depreciation for all future equipment purchases, but continued to use accelerated depreciation for all equipment acquired before 2016.
c. Changed from the LIFO inventory method to the FIFO inventory method.
Required:
For each accounting change Ray undertook, indicate the type of change and how Ray should report the change. Be specific.

 

Sample Answer

Sample Answer

 

Accounting Policy Changes at Ray Solutions: Analysis and Reporting

Ray Solutions made significant accounting policy changes on January 1, 2016, impacting revenue recognition, depreciation methods, and inventory valuation practices. Each change represents a distinct type of accounting change that requires specific reporting to ensure transparency and compliance with accounting standards.

a. Change from Cash to Accrual Basis for Revenue Recognition

Type of Change: Change in Accounting Principle

Ray Solutions transitioning from cash basis to accrual basis for recognizing revenue on service contracts represents a change in accounting principle. This change aims to better match revenues with the periods in which services are provided, providing a more accurate representation of the company’s financial performance.

Reporting the Change:

Ray Solutions should report the change in accounting principle in its financial statements as a retrospective adjustment. This involves restating prior financial statements to reflect the impact of the new accounting principle consistently. The cumulative effect of the change should be disclosed in the footnotes to the financial statements.

b. Adoption of Straight-Line Depreciation for Future Equipment Purchases

Type of Change: Change in Accounting Estimate

Ray Solutions’ decision to adopt straight-line depreciation for all future equipment purchases while maintaining accelerated depreciation for existing equipment represents a change in accounting estimate. This change reflects a shift in management’s judgment regarding the useful lives and depreciation methods for assets.

Reporting the Change:

The adoption of straight-line depreciation for future equipment purchases should be reported prospectively in Ray Solutions’ financial statements. The impact of this change should be reflected in future depreciation expense calculations for newly acquired equipment, while existing equipment continues to be depreciated using the accelerated method.

c. Switch from LIFO to FIFO Inventory Method

Type of Change: Change in Accounting Principle

Ray Solutions’ switch from the Last-In, First-Out (LIFO) inventory method to the First-In, First-Out (FIFO) method constitutes a change in accounting principle. This change alters how inventory costs are assigned and can impact reported inventory values and cost of goods sold.

Reporting the Change:

The switch from LIFO to FIFO inventory method should be reported as a retrospective adjustment in Ray Solutions’ financial statements. Prior financial statements should be restated to reflect the impact of the change consistently. The reasons for the change and its effects on financial performance should be disclosed in the footnotes to the financial statements.

Conclusion

In conclusion, Ray Solutions’ accounting policy changes, including transitioning to accrual basis for revenue recognition, adopting straight-line depreciation for future equipment purchases, and switching from LIFO to FIFO inventory method, represent significant shifts in accounting practices. By identifying the type of change for each policy adjustment and understanding how to report these changes accurately, Ray Solutions can ensure transparency and compliance with accounting standards in its financial reporting.

 

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