Intermediate Accounting 2 Chapter 20 Accounting Changes and Error Corrections
Accounting changes fall into one of the three categories:
-Change in principle -Change in accounting estimate -Change in reporting entity
Change in accounting estimate info
-Changes to accounting assumptions including depreciation which is described as "a change in estimate achieved by a change in accounting principle" -Reported prospectively (do not change prior statements).
Change in reporting entity circumstances/info
-Replacing individual financial statements with a consolidated financial statement OR -Changing the composition of entries in the consolidated financial statements. In general, consolidated statements for the new entity are restated as though the new entity had existed for all periods reported (typically 2-3 years). This topic is addressed more in advanced accounting.
Modified retrospective accounting approach
Apply to adoption period only, and adjust beginning R/E for cumulative prior effects. May be allowed for FASB-mandated changes or when full retrospective treatment is impracticable (Information does not exist to recreate to recast prior years' financial statements, or the information is too expensive to create/recreate)
Change in accounting principle circumstances/info
Circumstances: -Change from GAAP to GAAP method -Change from non-GAAP to GAAP method is a correction of error.
Change in accounting principle definition
Description: Change from one generally accepted accounting principle to another. Examples: Adopt a new accounting standard, change methods of inventory costing, change from cost method to equity method, or vice versa.
Change in reporting entity definition
Description: Change from reporting as one type of entity to another type of entity. Examples: Consolidate a subsidiary not previously included in consolidated financial statements, report consolidated financial statements in place of individual statements.
Error correction definition
Description: Correct an error caused by a transaction being recorded incorrectly or not at all. Examples: Mathematical mistakes, an inaccurate physical count of inventory, change from the cash basis of accounting to the accrual basis, failure to record an adjusting entry, recording an asset as an expense, or vice versa, fraud or gross negligence.
Retrospective accounting approaches
Most common treatment for voluntary changes in accounting principle Comparative statements restated as though the change had been in effect in prior years: 1) Revise comparative financial statements 2) Adjust affected accounts for the change in accounting principle 3)Add disclosure notes
Prospective accounting approach
No prior accounts or statements are changed, only future accounting changes Circumstances: -May be allowed for FASB-mandated changes -May be used when retrospective application is impracticable (almost always true when a change to LIFO method) -Always used for changes in estimate.
Three approaches to reporting accounting changes and error corrections are used, depending on the situation:
Retrospective approach, modified retrospective approach, prospective approach.
An exception to the retrospective application of a change in accounting is a
change in the method of depreciation (or amortization or depletion).
Note disclosure explains why the change was needed as well as
its effects on items not reported on the face of the primary statements.
Revisions are viewed as a
natural consequence of making estimates
The correction of an error is another adjustment sometimes made to financial statements that are
not actually an accounting change but is accounted for similarly.
Sometimes a lack of information makes it impracticable to
report a change retrospectively so the new method is simply applied prospectively.
If a new accounting standards update specifically requires prospective accounting, that
requirement is followed.
Prospective approach definition
requires neither a modification of prior years' financial statements nor a journal entry to adjust account balances. Instead, the change is simply implemented in the period of the change, and its effects are reflected in the financial statements of the period of the change and future periods only.
Change in accounting estimate definition
Description: Revise an estimate because of new information or new experience. Examples: Change depreciation methods, change the estimate of useful life of depreciable asset, change estimate of periods benefited by intangible assets, change estimate of residual value of the depreciable asset, Change actuarial estimates pertaining to a pension plan.
Retrospective approach definition
Financial statements issued prior to the change are adjusted to reflect the impact of the change whenever those statements are presented again for comparative purposes (comparative financial statements). For each year reported in the comparative statements, the balance of each account affected is adjusted to incorporate the change.
Modified Retrospective approach definition
requires the application of the new standard only to the adoption period (that is, the current period) as well as adjustment of the balance of retained earnings at the beginning of the adoption period to capture the cumulative effects of prior periods without actually adjusting the numbers of the prior periods reported.
If it is impracticable to adjust each year reported, the change is applied
retrospectively as of the earliest year practicable.
Previous years' financial statements are
retrospectively restated to reflect the correction of an error.
A change in reporting entity requires that financial statements of prior periods be
retrospectively revised to report the financial information for the new reporting entity in all periods.
We report most voluntary changes in accounting principles
retrospectively. This means reporting all previous periods' financial statements as if the new method had been used in all prior periods.
When it is not possible to distinguish between a change in principle and a change in estimate, the change should be
treated as a change in estimate.
