Chapter 21 - Accounting Changes & Error Analysis

For any change in accounting principle, firms must provide the following footnote disclosures in the year of the change:

1. Description of the nature of the change 2. Management's justification for the change, which indicates why the new method is preferable 3. The method of applying the change (retrospective or prospective method) 4. A description of any adjusted prior-period information 5. The effect of the change on income from continuing operations, net income, per share amounts, and any other affected line item 6. The cumulative effect of the change on retained earnings for the first balance sheet presented

A change in the reporting entity primarily involves:

1. Presenting consolidated or combined financial statements instead of individual financial statements 2. Changing the specific subsidiaries that make up the group of entities for which consolidated financial statements are presented 3. Changing the entities included in combined financial statementsA change in the reporting entity primarily involves:

changes from one generally accepted accounting method to another generally accepted accounting method

1. changes in accounting principle

3 main types of accounting changes

1. changes in accounting principle 2. changes in accounting estimate 3. changes in reporting entity

inventory errors are self-correcting within -- acct periods

2

Self-correcting errors are classified as errors that will self-correct within --- ----.

2 years

involve revisions of estimates used in accounting

2. changes in accounting estimate

occur when a company reports financial statements that are, in effect, financial statements for a different reporting entity

3. changes in reporting entity

---- errors, which affect only asset, liability, and equity accounts, are typically the result of a misclassification of accounts in the recording of a transaction.

Balance sheet

---- enhances the usefulness of relevant and faithfully represented information by helping users to identify and understand the similarities and differences in items reported.

Comparability

---- refers to the firm's use of the same accounting methods for the same transactions from period to period.

Consistency

which statements can accounting errors impact

IS and BS

---- financial statements adjust opening balance sheet accounts for the cumulative effect of applying the new principle in all prior years and present all subsequent financial statements as if the policy had always been used.

Restated

Consequently, the standards only permit accounting changes when companies provide ---- ---s to assist financial statement users in restoring comparability with prior years' financial information.

adequate disclosure

Accounting changes due to revisions of underlying estimates involve areas such as

bad debt expense, depreciation expense, inventory obsolescence, and pensions. Estimates are a natural part of the accounting process.

Income statement errors do not affect the --- --- and may not affect net income.

balance sheet

For example, a change in depreciation method is based on a change in the estimate regarding the future economic benefits to be derived from the use of the asset. Firms

change in accounting estimate effected by a change in accounting principle

The adoption of a new principle in recognition of events that have occurred for the first time is not considered a

change in accounting principle.

switching to an aging of accounting receivables to compute bad debt expense and the allowance for bad debts instead of using a % of sales type of change: ? acct method: ?

change in estimate effected by a change in principle -prospective

A ---- occurs when a company reports financial statements that are, in effect, financial statements for a different reporting entity.

change in the reporting entity

The acquisition of a business is not considered a...

change in the reporting entity.

Changing accounting principles and estimates from period to period detracts from ----.

comparability

If accountants discover income statement errors in the year the error occurred, then they must be ---

corrected

An --- is an unintentional mistake often due to an incorrect application of an accounting policy or incorrect mathematical computation.

error fraud: intentional

Changes in estimates are --- , particularly as management becomes more experienced and as new information becomes available.

expected

A firm should voluntarily change accounting principles only if the new principle more accurately portrays its ....

financial position and performance.

A change in accounting estimate effected by a change in accounting principle is a change in estimate that is inseparable

from the effect of a related change in accounting principle.

All accounting changes make the financial statements ---- from period to period.

inconsistent

If accountants discover income statement errors after financial statements are prepared, ... instead..

no correcting entry is made. The company should restate the incorrect amounts from the financial statements that have already been issued in any future comparative financial statements.

if EI in the following year is recorded correctly, the original error will have the -- effect in the 2nd year

opposite

if a firm understates ending inventory because it counted incorrectly (very common), COGS will be ---

overstated and net income will be understated

Firms account for a change in accounting estimate effected by a change in accounting principle the same way as a change in accounting estimate—that is, under which method.

prospective

Firms must report changes in accounting estimates using the --- method.

prospective That is, firms implement the new estimate in the year of the change and in all future years, as appropriate. Prior years' financial statements are not affected.

Companies using the ---- method to report an accounting change make the change in the current year (that is, the year of the change) and all future years.

prospective They do not make adjustments to previously issued financial statements. The prospective method treats information for all prior years as final and does not change previously issued financial information.

accounting is full of changes and estimates - the underlying goal of the conceptual framework is to incorporate any changes to make the financial statements --- and ---- of a company, while upholding the characteristic of . ----

relevant, faithfully representative -comparability

Companies reporting an accounting change with the ---- method restate all prior-year financial statements presented in the annual report as if the newly adopted principle had always been used.

retrospective

Firms account for a change in the reporting entity using the --- method by adjusting all financial statements presented from prior periods to reflect the change.

retrospective

Firms account for a change in the reporting entity using the ---- method by adjusting all financial statements presented from prior periods to reflect the change.

retrospective

A balance sheet error typically is not —...the firm must make a correcting entry to reclassify the item it incorrectly recorded.

self-correcting Most other errors will eventually correct themselves, but the correction often takes many years.

Some errors affect both the income statement and the balance sheet—do these errors correct themselves?

they may or may not correct themselves.

change in the useful life for a plant asset type of change: ? acct method: ?

type of change: change in estimate acct method: prospective

change from the straight line method to the declining-balance method type of change: ? acct method: ?

type of change: change in estimate effected by a change in accounting principle acct method: prospective

adoption of the FIFO method for a new product line type of change: ? acct method: ?

type of change: not a change, new product line acct method:

Changes in accounting principle may be --- or ---.

voluntary or mandatory

When a company changes its accounting method or an accounting estimate for a particular transaction, its financial statements are not --- from year to year—and financial statements that are not comparable from year to year violate the conceptual framework.

consistent

change in the accounting for long-term contracts type of change: ? acct method: ?

type of change: principle acct method: retrospective

change from the average-cost method to the LIFO method type of change: ? acct method: ?

type: principle method: retrospective