316 - chapter 20
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A disclosure note should describe the nature of and the reason for the change.
The prospective approach is used instead of the retrospective approach when it is:
Impracticable to determine some period-specific effects.
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Impracticable to determine the cumulative effect of prior years. Mandated by Financial Accounting Standards Board or other authoritative pronouncements.
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Report the correction as a prior period adjustment if retained earnings is one of the incorrect accounts affected.
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A "prior period adjustment" to retained earnings would be reported, net of tax, and a disclosure note should describe the nature of the error
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A change in depreciation method is considered to be a change in accounting estimate that is achieved by a change in accounting principle.
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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 presented.
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A disclosure note should describe the effect of a change in estimate on income before extraordinary items, net income, and related per-share amounts for the current period.
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A reporting entity can be a single company or a group of companies that reports a single set of consolidated financial statements. A change in reporting entity occurs as a result of:
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Adjust the beginning balance of retained earnings for the earliest period reported.
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Advantage: it achieves comparability可比性among financial statements because all the financial statements are presented on the same basis.
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Earnings quality refers to the ability of reported earnings (income) to predict a company's future earnings.
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Effect on union negotiations. Issuance of new accounting standards. Effect on income taxes.
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However, a change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle. In other words, a change in the depreciation method reflects a change in the
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Identify the type of accounting error for the following item: Depreciation expense was understated.
Correction of Accounting Errors
Identify the type of accounting error for the following item: Ending inventory was incorrectly counted.
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If so, financial statements for all years presented for comparative purposes are retrospectively restated to reflect the effects of the error correction.
changes in accounting principles
In general, we report voluntary changes in accounting principles retrospectively.
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Include a disclosure note describing the nature of the error and the impact of its correction on net income.
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Prior years' statements are not revised. Account balances are not revised.
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Report any per share amounts affected for the current and all prior periods presented.
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Since both expenses and losses reduce income, the error does not effect income.
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Since the inventory balance effects cost of goods sold, income will also be incorrect in the two periods, by the same amount.
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TWO approaches to reporting accounting changes and error corrections are used, depending on the situation:
Revise prior years' statements (that are presented for comparative purposes) to reflect the impact of the change.
The balance in each account affected is revised to appear as if the newly adopted accounted method had been applied all along or that the error had never occurred.
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The balance in the investment account when the equity method is discontinued would serve as the new "cost" basis for writing the investment up or down to market value in the next set of financial statements.
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The effect of the change on net income, income before extraordinary items, and related per share amounts should be shown for all periods presented.
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Two of the qualitative characteristics of accounting information are consistency and comparability
Accounting errors can occur for any of the following reasons:
Use of an inappropriate accounting principle Mistakes in applying generally accepted accounting principles
change in estimate
a disclosure note should describe the effect of a change in estimate on income before extraordinary items, net income, and related per-share amounts for the current period
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and retained earnings when those statements are reported again for comparative purposes in the current annual report.
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and the impact of its correction on each year's net income, income before extraordinary items, and earnings per share
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change from equity method to other method is a change in accounting principle
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or by making a correcting entry to adjust the incorrect account balances to the correct amounts.
2. Prospective預期approach
requires neither a modification of prior years' financial statements nor a journal entry to adjust account balances.
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An error correction may involve the restatement of prior year's account balances.
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The financial statements that were incorrect as a result of the errors would be retrospectively restated to report the correct interest amounts, income,
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When a company revises a previous estimate, prior financial statements are not revised. No adjustment is made to existing accounts.
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When the furniture sale transaction was recorded, depreciation expense was debited for the amount that should have been a debit to loss on sale.
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Retrospectively restate all prior years' financial statements that were incorrect and presented for comparative purposes
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presenting consolidated financial statements in place of statements of individual companies, or changing specific companies that constitute the group for which consolidated statements are prepared.
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(a) estimated future benefits from the asset, (b) the pattern of receiving those benefits, or (c) the company's knowledge about those benefits, and therefore the two events should be reported the same way.
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, if retained earnings is one of the accounts that requires adjustment, that adjustment is made to the beginning balance of retained earnings for the earliest period reported in the comparative statements of shareholders' equity.
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. Instead, the change is simply implemented now, and its effects are reflected in the financial statements of the current and future years only
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. It is a noncounterbalancing error since only one period's income is affected.
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. It is accounted for prospectively, the same way that we account for a change in accounting estimate.
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. The accounting profession's response to these changes often involves the development of new or modified reporting standards that are more appropriate for the changed environment.
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. While accountants make every effort to achieve these financial reporting attributes, they cannot ignore the normal changes that continually occur in a dynamic business environment.
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Identify the type of accounting error for the following item: Loss on sale of furniture was incorrectly recorded as depreciation expense.
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If an error is discovered in the same year that it was made, we can correct it by reversing the incorrect entry and then recording the correct entry,
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If an error is discovered that does not affect the income of prior years, a prior period adjustment to retained earnings is not necessary since income for prior years and retained earnings are correct.
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If ending inventory is incorrectly counted, the ending inventory in one period will be incorrect and the beginning inventory in the next period will also be incorrect.
The correction of accounting errors involves four steps:
Prepare a journal entry to correct any balances that are incorrect as a result of the error.
In the first set of financial statements after the change is made, a disclosure note is needed to:
Provide justification for the change. Point out that comparative information has been revised.
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Remember that we use the retrospective approach for error corrections.
Changes in Estimates and Some Changes in Principle
The change is implemented in the current period, and its effects are reflected in the financial statements of the current and future years only.
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The highly summarized information presented here should provide you with a quick reference and a very useful study guide for the material in this chapter.
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The table on this screen summarizes the accounting and reporting for accounting changes and error corrections.
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There also would be no revision of prior years, but the change should be described in a disclosure note.
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These two disclosures are not necessary in subsequent financial statements.
The retrospective approach: most changes in accounting principle
This means reporting all previous period's financial statements as if the new method had been used in all prior periods.
loss contingency
change in estimate of loss contingency: either debit or credit loss- litigation and either debit loss - litigation or gain - litigation
Management must justify the change.
. Hopefully, changes are made in the best interest of fair and consistent financial reporting, but that may not always be the case.
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1. Retrospective追溯approach - revised the previous years for comparative purpose.
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All financial statements presented for comparative purposes are restated. A disclosure note is included to describe the nature of the error.
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All previous periods' financial statements that are presented are recasted as if the new reporting entity existed in those periods. In the first financial statements after the change
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Consistency and comparability are two fundamental qualitative characteristics of accounting information.
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We still use the retrospective approach to correct the incorrect account balances and restate all financial statements that are presented for comparative purposes. A disclosure note is included to describe the nature of the error.
from the equity method to other method
When a company changes from the equity method, no adjustment is made to the carrying amount of the investment. Instead, the equity method is simply discontinued, and the new method is applied from then on.
The correction of errors affecting the income of prior years requires the retrospective approach:
All incorrect account balances are corrected. A prior period adjustment to retained earnings is necessary since the income of prior periods is incorrect.
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An expense is understated, so income is understated. The error affects only the year in which the error was made.
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Arithmetic mistakes Fraud or gross negligence in reporting
Accounting changes are made by management for a variety of reasons including:
Changing business environment. Effect on compensation, such as bonuses and stock options. Effect on debt agreements
A prior period adjustment is required for:
Counterbalancing errors discovered in the second year. Noncounterbalancing errors discovered in any year after the year of the error.
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• Revise comparative financial statements • Adjust accounts for the change • Disclosure note