ACC 311 Chapter 22

Accounting Changes

3 types of ___________ __________: 1) Changes in accounting principle 2) Changes in accounting estimate 3) Changes in a reporting entity

Doesn't

A change in an accounting principle _________ include: 1- Initial adoption of GAAP because of events or transactions occurring for the first time or that were previously immaterial *EX: Starbucks used average cost to value their inventory, but is going to adopt FIFO for all newly acquired inventory, and use average cost for previously acquired inventory. 2- Adoption or modification of an accounting principle for transactions or events that are clearly different in substance from those previously occurring. 3- Change to GAAP from a principle that is not generally accepted. *Would be treated as an error instead.

Step 3 of Retrospective Adjustment Method

Adjust the financial statements of the current period and each prior period to reflect the specific effects of applying the new accounting principle (Therefore the comparative financial statements would appear as if the newly adopted accounting principle was used in every period presented).

Errors

Another category that requires adjustment is ________, which are the result of mathematical mistakes, mistakes in the application of GAAP, or the oversight or misuse of facts that existed when the financial statements were prepared. *Not necessarily an accounting change but still require a correction. **EX: Company incorrectly counting its inventory. ******** ACCOUNTED FOR AS A PRIOR PERIOD ADJUSTMENT.

Preferable

Any change in accounting principle must be justified on the grounds that the new principle is _________ to the old method, which means that the new method represents an improved method of measuring business operations in the particular circumstance. *EX: Nike justifying changing from LIFO to FIFO by stating that "This change was predicated on the fact that the LIFO method no longer matches the realities of how we do business."

Reporting Entity

Changes in a __________ ________ represent a change in the type of entity being reported. *When a parent company owns a subsidiary, it operates and reports financial results in a consolidated manner and if the parent company sells off the subsidiary the reporting entity has changed. **********ACCOUNTED FOR AS A RETROSPECTIVE ADJUSTMENT SO THAT ALL THE FINANCIAL STATEMENTS PRESENTED ARE FOR THE SAME ENTITY.

Accounting Estimate

Changes in an _________ __________ are a revision of an estimate used in the accounting process. *This type of change is inherent in the periodic presentation of financial statements and occurs as the result of new or additional information. **EX: Advances in coffee brewing technology making Starbucks change the estimated life of its coffee brewing equipment from 7 to 4 years. *******ACCOUNTED FOR PROSPECTIVELY.

Accounting Principle

Changes in an __________ ___________ represents a change from one generally accepted accounting principle to another generally accepted accounting principle (can be voluntary or mandatory). **EX: Starbucks changing cost flow assumption from average cost to FIFO. *******ACCOUNTED FOR BY RETROSPECTIVE APPLICATION OF THE NEW ACCOUNTING PRINCIPLE.

Step 1 of Retrospective Adjustment Method

Compute the cumulative effect of the change to the new accounting principle as of the beginning of the first period presented.

Step 4 of Retrospective Adjustment Method

Disclose the following information: 1- Nature & reason for the change in accounting principle (including an explanation of why the new principle is preferable) 2- Description of the prior period information that has been retrospectively adjusted 3- Effect of the change on income, earnings per share, and any other financial statement line item for the current period and the prior periods retrospectively adjusted. 4- Cumulative effect of the change on Retained Earnings at the beginning of the earliest period presented.

Income Statement

Errors affecting only the _________ ________, require reclassification but do not affect the total amount reported as income. If the error occurred in a prior period, the company does not make a correcting journal entry. *EX: Classifying sales revenue as interest revenue.

Balance Sheet

Errors affecting only the _________ _________, the company reclassifies the item to the proper account when discovered and restates any comparative financial statements presented. *EX: Classifying an account receivable as note receivable

Counterbalancing Errors

Errors that are automatically corrected in the next accounting period, even if they are not discovered. *Errors affecting both the income statement and balance sheet.

Noncounterbalancing Errors

Errors that are not offset in the next accounting period. *Take more than two accounting periods to correct themselves.

Direct Effect

In situations in which a change in accounting principle has both a direct and and indirect effect on prior years' income, a company recognizes only the ___________ _________ in determining the amount of the retrospective adjustment.

Step 2 of Retrospective Adjustment Method

Prepare a journal entry to adjust the books values of the assets and liabilities that are affected by the change so that their balances reflect the amounts that would have existed under the newly adopted accounting principle. *An offsetting adjustment is made to the beginning balance of Retained Earnings for the cumulative effect of the change.

Impracticable

Retrospective adjustment is considered ___________ if any of the following conditions exist: 1- The company can't, after reasonable effort, determine the effect on prior periods. 2- Retrospective adjustments depend on management's intent that cannot be independently verified. 3- Significant estimates are required that cannot be objectively verified. **If retrospective adjustment is ____________, the new accounting principle should be applied prospectively as of the earliest date practicable.

Two Methods of Reporting Accounting Changes and Errors

T___ M________ o___ R__________ A________ C________ a____ E_______: 1- Retrospective Adjustment Method 2- Prospective Method

Direct Effect

The _________ ________ of a change in accounting principle is the amount by which a company's prior years' income is increased or decreased specifically as a result of the change in accounting principle.

Indirect Effect

The _________ _________ of a change in accounting principle is the amount by which the company's prior years' income is affected by how the change in principle affects other elements of income. *Company changes from LIFO to FIFO, and has management bonuses, the amount of income is changed because of a changing COGS is the direct and the amount income is changed because of the bonuses is the _________.

Indirect Effect

The __________ ________ that would have been recognized if the newly adopted principle had been used in prior periods are NOT included in the retrospective adjustment but would be accounted for in the current period.

Prospective Method

This method of reporting accounting changes- Does not require an adjustment to previously issued financial statements, but the accounting change is accounted for in the current and future periods. *Used for accounting estimate changes. **Advantage is once financial statements are prepared according to GAAP, the reported information does NOT change. ***Relatively easy to implement and imposes less cost on the company relative to the other method.

Retrospective Adjustment Method

This method of reporting accounting changes- Requires that any previously issued financial statements are reported for comparative purposes be revised to reflect the impact of the accounting change. *Used for accounting principle changes, & reporting entity changes. **Major advantage of this method is that it achieves comparability and consistency between the accounting periods. **A more faithful representation of financial information by presenting the effect of prior economic events and transactions in the period in which they occurred instead of the period in which an accounting change is made.

Step 3

_____ _ of error correction: Evaluate whether the error has caused additional errors in other accounts.

Step 4

_____ _ of error correction: Prepare the correcting entry.

Step 2

______ _ of error correction: Determine the journal entry that should have been recorded.

Step 1

______ _ of error correction: Analyze the original erroneous journal entry and determine what accounts and/or amounts were recorded in error.