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Accounting
Changes and
Error
Corrections
Learning Objectives
 Understand the three different types of
accounting changes that have been
identified by accounting standard setters.
 Recognize the difference between a
change in accounting estimate and a
change in accounting principle, and know
how a change in accounting estimate is
reflected in the financial statements.
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Learning Objectives
 Determine if a change in accounting
principle requires a cumulative
adjustment relating to its effect or a
restatement of prior-periods’ financial
statements, and be able to compute the
necessary adjustment.
 Determine when a change in reporting
entity has occurred, and understand the
disclosure requirements associated with
this change.
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Learning Objectives
 Recognize the various type of errors that
can occur in the accounting process,
understand when errors counterbalance,
and be able to correct errors when
necessary.
 Describe the differences between the
U.S. approach to accounting changes
and error corrections and the
international standard found in IAS 8.
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Why Are Accounting
Changes Made?
 A company, as a result of experience or
new information may change its estimates
of revenues or expenses.
 Due to changes in economic conditions,
companies may need to change methods of
accounting to more clearly reflect the
current economic situation.
 Accounting standard-setting bodies may
require the use of a new accounting method
or principle.
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Why Are Accounting
Changes Made?
 The acquisition or divestiture of companies
may cause a change in the reporting entity.
 Management may be pressured to report
profitable performance. Making
accounting changes can often result in
higher net income, thereby reflecting
favorably on management.
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Effect of SFAS No. 106
Company
IBM
Gen. Electric
Bell Atlantic
PepsiCo
The Coca-Cola Company
Tiffany & Co.
One-Time Charge
(in millions)
$2,263
1,799
1,550
357
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Categories of Accounting
Changes
 Change
in accounting estimate
 Change in accounting principle
 Change in reporting entity
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Change in Accounting Estimate
• Employ current and prospective
approach.
• Report current and future financial
statements on new basis.
• Present prior periods as previously
reported.
• Make no adjustments to current period
opening balances.
• Present no pro-forma data.
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Change in Accounting Estimate
Examples of areas where changes in accounting
estimates often are needed:
• Uncollectible receivables.
• Useful lives of depreciable or intangible assets.
• Residual values for depreciable assets.
• Warranty obligations.
• Quantities of mineral reserves to be depleted.
• Actuarial assumptions for pensions or other
postemployment benefits.
• Number of periods benefited by deferred costs.
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Change in Accounting Principle
• Report cumulative effect on income
statement after extraordinary items.
• Criteria for change: change only if the
new principle is preferable:
– provides more useful information.
– is less costly per benefit.
Changes in Accounting Principle-- 12
Disclosure Requirements
• Report current year’s income components on the new
basis.
• Report the cumulative effect of the adjustment, net
of tax, on the income statement.
• Present prior period financial statements as
previously reported.
• Include pro-forma information as if the change were
retroactive--direct and indirect effects.
• Present earnings per share data for all prior periods
presented.
Change in Accounting Principle-- 13
Example: Basic Data
• AlphaTronics, Inc. has decided to
change depreciation methods from
double-declining balance to straight-line.
The income results are summarized as:
– Net difference
$173
– Tax effect
(52)
– Net effect on income
$121
Change in Accounting Principle-Example: Income Statement
AlphaTronics, Inc.
Partial Income Statement
Income from continuing operations
Cumulative effect of change in
accounting principle (net of $52
income tax effect)
Net income
$500
121
$621
Note: pro-forma information should also be disclosed
if available.
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Sample Partial Income Statement
Income from continuing operations
$560,000
Extraordinary gain, net of income taxes
of $30,000
70,000
Cumulative effect on prior years of change
in accounting principle--change to the
straight-line method of depreciation from
double-declining-balance method, net of
taxes of $39,300
91,750
Net income
$721,700
Exceptions to General
Rule--Situations
 A change from LIFO method of inventory
pricing to another method.
 A change in the method of accounting for
long-term construction contracts.
 A change to or from the “full cost” method of
accounting used in extractive industries.
 Changes made at the time of an initial
distribution of company stock.
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Retroactive Restatement
 Several FASB statements require
retroactive restatement.
 Adjust Retained Earnings and the prior
year’s income for the effects of the
change.
 Pro-forma information is not required.
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Exceptions to General
Rule--Change to LIFO
• Change to LIFO--past
records often
inadequate to prepare
pro-formas.
• Beginning inventory
becomes first LIFO
layer.
• No cumulative effect
adjustment is required.
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Change of Principle and
Change of Estimate
If there is both a change
in principle and a change
in estimate for an item, the
event is treated as a
change in estimate.
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Change in Reporting Entity
• Employ retroactive approach.
• Restate financial statements for all
prior periods presented.
• Disclose, in year of change, effect on
income from continuing operations, net
income, and earning per share data for
all periods presented.
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Error Correction-Types of Errors
Errors discovered currently in the course
of normal accounting procedures.
 Math errors.
 Posting to the wrong
account.
 Misstating an account.
 Omitting an account
from the trial balance.
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Error Correction-Types of Errors
Errors limited to balance sheet accounts.
 Debiting Accounts Receivable
instead of Notes Receivable.
 Crediting Interest Payable
instead of Notes Payable.
 Debiting an investment
account instead of Land when
property was purchased for
plant expansion.
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Error Correction-Types of Errors
Errors limited to income statement accounts.
 Debiting Office Salaries
instead of Sales Salaries.
 Crediting Rent Revenue
instead of Commissions
Revenue.
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Error Correction-Types of Errors
Errors affecting both income statement
accounts and balance sheet accounts.
 Debiting Office Equipment
instead of Repairs Expense.
 Crediting Depreciation
Expense instead of
Accumulated Depreciation.
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Errors--Automatically
Counterbalanced
Errors in the income
statement that are not
detected are automatically
counterbalanced in the
following fiscal period.
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Errors--Not Automatically
Counterbalanced
Except for merchandise,
errors in the balance sheet
are inaccurately stated
until such time as
correcting entries are
made.
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Error Correction
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• If detected in current period, before books are
closed:
– Correct the account through normal
accounting adjustment.
• If detected in subsequent period, after books are
closed:
– adjust financial records for effect of material
errors.
– make adjustment directly to Retained
Earnings.
Example: Error Correction
• In 2001, the accountant for Jackman
Enterprises, Inc. forgot to record
$5,000 of depletion at an iron mine
Jackman owns.
• Record the 2003 correcting entry.
Retained Earnings
5,000
Mineral Rights--Iron Mine
5,000
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Error Correction--Disclosure
• If comparative statements are
provided, apply correction
retroactively to prior years.
• Restate beginning balance
of Retained Earnings for
first period presented if
error extends beyond.
• Disclose and explain
error correction in notes.
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The End