Acct ch. 22

change in accounting principle

A change from one generally accepted accounting principle to another. A company reports a change in accounting principle using retrospective application

change in reporting entity

A change from reporting as one type of entity to another type of entity. For example, a company might change the subsidiaries for which it prepares consolidated financial statements.

change in accounting estimate

A change that occurs as the result of new events, more experience, or additional information. Companies should not adjust previously reported results for changes in estimates but should report them prospectively—in the period of change if the change affects that period only, or in the period of change and future periods if the change affects both.

indirect effects of a change in accounting principle

Any change to current or future cash flows of a company that results from making a change in accounting principle that is applied retrospectively. An example is the change in payments in a profit-sharing plan arising from a change in accounting principle. Indirect effects do not change prior period amounts. A company includes in the financial statements a description of the indirect effects and discloses the amounts recognized in the current period and related per share information.

economic consequences

Arguments that focus on the supposed impact of the accounting method on the behavior of investors, creditors, competitors, governments, or managers of the reporting companies themselves.

correction of an error

Change to the financial statements due to an error of any sort (e.g., mathematical mistakes, bad faith changes in estimates, incorrect application of a generally accepted accounting principle, or incorrect classification). Companies must correct errors as soon as they discover them; they record corrections of errors from prior periods as adjustments to the beginning balance of retained earnings in the current period (called prior period adjustments).

direct effects of a change in accounting principle

Changes in assets and liabilities that result directly from making a change in accounting principle. An example is the change in the inventory balance when a company changes from one inventory method to another. Companies report direct effects retrospectively.

prior period adjustments

Corrections of errors from prior periods, made in the accounting records as adjustments to the beginning balance of retained earnings in the current period.

errors in financial statements

Errors resulting from mathematical mistakes, mistakes in applying accounting principles, or oversight or misuse of facts that existed when preparing the financial statements.

noncounterbalancing errors

Errors that affect both the balance sheet and the income statement and will not be offset in the next accounting period.

counterbalancing errors

Errors that affect both the balance sheet and the income statement but that will be offset or corrected over two periods.

impracticable

Retrospective application that is not possible because a company cannot determine the prior period effects using every reasonable effort to do so. If it is deemed impracticable to apply the retrospective approach, the company prospectively applies the new accounting principle

change in estimate effected by a change in accounting principle

Rule applied when it is impossible to determine whether a change in principle or a change in estimate has occurred. In such cases, a company considers the change as a change in estimate.

prospectively

The application of a different accounting principle only in future financial statements. As a result, companies do not adjust opening balances to reflect the change in principle.

retrospective application

The application of a different accounting principle to recast previously issued financial statements as if the new principle had always been in use. Companies treat any part of the effect attributable to years prior to those presented as an adjustment of the earliest retained earnings balance presented.

cumulative effect

The difference in prior years' income between the newly adopted and prior accounting method.

restatement

The process of revising previously issued financial statements to reflect the correction of an error. This term restatement distinguishes an error correction from a change in accounting principle (recasting statements within retrospective application).