Chapter 22 Notes
Accounting Changes and Errors
Types of Accounting Changes:
- Change in Accounting Policy (Principle)
Examples include:
- Average cost to LIFO.
- Completed-contract to percentage-of-completion method
- Changes in Accounting Estimate.
- Change in Reporting Entity.
Note: Adoption of a new principle in recognition of events that have occurred for
the first time or that were previously immaterial is not an accounting change.
Errors are not considered an accounting change
Three approaches for reporting changes:
- Currently.
- Retrospectively.
- Prospectively (in the future).
FASB requires use of the retrospective approach.
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Retrospective Accounting Change Approach
Company reporting the change
Adjust financial statements for each prior period presented.
Adjust the carrying amounts of assets and liabilities as of the beginning of the first
year presented.
Make an offsetting adjustment to the opening balance of retained earnings as of the
beginning of the first year presented
Major disclosure requirements:
a. The nature and reason for the change in accounting principle.
b. The method of applying the change, and:
(1) A description of the prior period information that has been
retrospectively adjusted
(2) The effect of the change on income from continuing operations, net
income, any other affected line item, and any affected per share
amounts for the current period and for any prior periods
retrospectively adjusted.
(3) The cumulative effect of the change on retained earnings or other
components of equity or net assets in the balance sheet as of the
beginning of the earliest period presented.
Direct and indirect effects of changes in accounting principle
a. Direct effects should be presented retrospectively; for example, the
adjustment to an inventory balance as a result of a change in the
inventory valuation method.
b. Indirect effects are not shown retrospectively, but rather are reported in
the current period only; for example, a change in profit-sharing that is
based on the reported amount of revenue.
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Impracticable Changes.
1. The retrospective approach should not be used if any one of the following
conditions exists:
a. The company cannot determine the effects of the retrospective
application.
b. Retrospective application requires assumptions about management’s intent
in a prior period.
c. The company cannot objectively verify the necessary information to
develop any estimates for a prior period under the retrospective approach.
2. Apply the prospective approach as of the earliest date practicable, if the
retrospective approach is deemed impracticable.
3. Disclosures.
a. Restate any necessary balances.
b. The effect of the change on the results of operations for the period of
change.
c. Explain the reasons for omitting the computations of the cumulative effect
for prior years.
d. Justify the change in method.
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Changes in Accounting Estimate
Changes in accounting estimates are reported prospectively
Examples of Estimates
- Uncollectible receivables.
- Inventory obsolescence.
- Useful lives and salvage values of assets.
- Periods benefited by deferred costs.
- Liabilities for warranty costs and income taxes.
- Recoverable mineral reserves.
- Change in depreciation methods.
Prospective Reporting
- Changes in accounting estimates are reported prospectively.
- Account for changes in estimates in:
- the period of change if the change affects that period only, or
- the period of change and future periods if the change affects both.
Disclosures
- Changes in estimates made as part of normal operations are not usually
disclosed unless material.
- Changes that affect several periods:
(1) Disclose the effect on income from continuing operations, and
(2) Related per share amounts for the current period.
- Changes in estimate effected by a change in accounting principle:
(1) Indicate why the new method is preferable.
(2) Include all other disclosures required for changes in accounting
principle.
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Change in Reporting Entity
Reported by changing the financial statements of all prior periods presented
Examples of a change in reporting entity are:
- Presenting consolidated statements in place of statements of individual
companies.
- Changing specific subsidiaries that constitute the group of companies for
which the entity presents consolidated financial statements.
- Changing the companies included in combined financial statements.
- Changing the cost, equity, or consolidation method of accounting for
subsidiaries and investments.
Accounting Errors
- Record and report as prior period adjustments.
- All material errors must be corrected.
- Record corrections of errors from prior periods as an adjustment to the
beginning balance of retained earnings in the current period.
- Such corrections are called prior period adjustments.
For comparative statements, a company should restate the prior statements
affected, to correct for the error.
Single period statements. The amount of the error less the tax implications, if
any, is shown as a prior period adjustment to beginning retained earnings.
Comparative statements.
a. Correct the amounts for all affected accounts reported in the statement for
all periods reported.
b. Show any catch-up adjustment as a prior period adjustment to retained
earnings for the earliest period reported.
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Summary of Accounting Changes and Correction of
Errors
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