Judgment can at times be required to determine whether an event should be accounted for as a change in accounting estimate or as the correction of an error. The accounting for these topics is addressed in ASC 250 (Accounting Changes and Error Corrections). After reading the following fact pattern, you will be challenged to evaluate whether an event is an error correction or change in estimate, and you will be asked to discuss the differences in the accounting treatment for these two alternatives.
Facts: You are the owner of a lawn service company (LawnCo) which provides grounds and maintenance services to a range of corporate customers. Customers 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 months of services (from Oct.-Dec. 20X1); nevertheless, to maintain a positive relationship, your company continued to provide mowing and weed control services to the eldercare facility during that time. Your company ceased providing services in January 20X2 and found out in that same month that the eldercare facility filed for bankruptcy in September. Your company now believes that collection of the missed payments is extremely unlikely. Your company has already issued financial statements (for the period ending 12/31/X1) 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 $500,000.
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. First, locate the definitions of these terms; next, provide a list of factors which would support each alternative.
2. Next, describe the accounting treatment (as required by the Codification) for each alternative, and then support your explanations with draft journal entries. You are not required to provide detail on how financial statements would be presented / prepared, rather focus on describing the Codification's requirements and how they relate to this issue, and include journal entries that you believe are consistent with those requirements.
3. Finally, briefly state which treatment appears to be more appropriate given the circumstances? If you must make any assumptions in reaching this conclusion, state these.