Chapter 22

Describe the accounting for changes in accounting principles.

A change in accounting principle involves a change from one generally accepted accounting principle to another. A change in accounting principle is not considered to result from the adoption of a new principle in recognition of events that have occurred for the first time or that were previously immaterial. If the accounting principle previously followed was not acceptable or if the principle was applied incorrectly, a change to a generally accepted accounting principle is considered a correction of an error

Identify changes in a reporting entity.

An accounting change that results in financial statements that are actually the statements of a different entity should be reported by restating the financial statements of all prior periods presented, to show the financial information for the new reporting entity for all periods.

Describe the accounting for changes in estimates.

Companies report changes in estimates prospectively. That is, companies should make no changes in previously reported results. They do not adjust opening balances nor change financial statements of prior periods.

Identify economic motives for changing accounting methods

Managers might have varying motives for income reporting, depending on economic times and whom they seek to impress. Some of the reasons for changing accounting methods are: (1) political costs, (2) capital structure, (3) bonus payments, and (4) smoothing of earnings.

Understand how to account for impracticable changes

Retrospective application is impracticable if the prior period effect cannot be determined using every reasonable effort to do so. For example, in changing to LIFO, the base-year inventory for all subsequent LIFO calculations is generally the opening inventory in the year the company adopts the method. There is no restatement of prior years' income because it is often too impractical to do so.

Describe the accounting for correction of errors

Companies must correct errors as soon as they discover them, by proper entries in the accounts, and report them in the financial statements. The profession requires that a company treat corrections of errors as prior period adjustments, record them in the year in which it discovered the errors, and report them in the financial statements in the proper periods. If presenting comparative statements, a company should restate the prior statements affected to correct for the errors. The company need not repeat the disclosures in the financial statements of subsequent periods.

Understand how to account for retrospective accounting changes

The general requirement for changes in accounting principle is retrospective application. Under retrospective application, companies change prior years' financial statements on a basis consistent with the newly adopted principle. They treat any part of the effect attributable to years prior to those presented as an adjustment of the earliest retained earnings presented.

Identify the types of accounting changes

The three different types of accounting changes are: (1) Change in accounting principle: a change from one generally accepted accounting principle to another generally accepted accounting principle. (2) Change in accounting estimate: a change that occurs as the result of new information or as additional experience is acquired. (3) Change in reporting entity: a change from reporting as one type of entity to another type of entity.

Analyze the effect of errors

Three types of errors can occur: (1) Balance sheet errors, which affect only the presentation of an asset, liability, or stockholders' equity account. (2) Income statement errors, which affect only the presentation of revenue, expense, gain, or loss accounts in the income statement. (3) Balance sheet and income statement errors, which involve both the balance sheet and income statement. Errors are classified into two types: (1) Counterbalancing errors are offset or corrected over two periods. (2) Noncounterbalancing errors are not offset in the next accounting period and take longer than two periods to correct themselves.

Make the computations and prepare the entries necessary to record a change from or to the equity method of accounting

When changing from the equity method to the fair value method, the cost basis for accounting purposes is the carrying amount used for the investment at the date of change. The investor company applies the new method in its entirety once the equity method is no longer appropriate. When changing to the equity method, the company adjusts the accounts to be on the same basis as if the equity method had always been used for that investment.