1.x Accounting Changes and Error Correction

Question 1

Name the three types of accounting changes

Answer 1

1) Change in an accounting principle 2) Change in an accounting estimate 3) Change in a reporting entity

Question 2

What is meant by retrospective treatment?

Answer 2

Applying a different accounting principle to previously issued financial statements, as if that principle had always been used. Shown as of the beginning of the first period presented by adjusting the opening balance of retained earnings for that period.

Question 3

Define prospective treatment.

Answer 3

The accounting change affects the current and ensuing periods.

Question 4

How is a change in an accounting estimate reported?

Answer 4

Prospectively, so the effect is shown in the current period and/or future periods which are affected by the change, and the financial statements are not restated.

Question 5

How is a change in the reporting entity reported?

Answer 5

Retrospective treatment. All current and prior period financial statements presented are restated. Any remaining balance affects beginning Retained Earnings (net of tax) as a prior period adjustment.

Question 6

How are corrections of an error reported?

Answer 6

Reported as prior period adjustments to retained earnings and all comparative financial statements presented are restated.

Question 7

How are changes in accounting principle applied?

Answer 7

Retrospective Application: Prior Periods adjusted Retained Earnings adjusted Ex: Completed Contract to % Completion -OR- LIFO to FIFO

Question 8

Would a change from Completed Contract to Percentage of Completion be a change in accounting principle- or a change of estimate? How would it be applied?

Answer 8

A change of principle. Applied retrospectively.

Question 9

Would a change from LIFO to FIFO be a change in accounting principle or a change of estimate? How would this change be applied?

Answer 9

A change in accounting principle. Applied retrospectively.

Question 10

How is a change in accounting estimate applied?

Answer 10

A change in accounting estimate is applied prospectively (going forward). No backwards adjustment is made.

Question 11

Would a change from straight line depreciation to double declining balance be a change in accounting principle or a change in estimate? How would this change be applied?

Answer 11

Change in depreciation method would be a change in accounting estimate. It is applied prospectively.

Question 12

How is a correction of an accounting error made?

Answer 12

Cumulative effect of error gets adjusted to the beginning balances of assets and liabilities in the earliest period presented in the comparative statements. The correction of the error must be included in the footnotes.

Question 13

What are the requirements for a prior period adjustment?

Answer 13

Effect is Material Is identifiable in Prior Period Couldn’t be estimated in Prior Periods

Question 14

How is a change from a non-GAAP accounting method to a GAAP method recorded?

Answer 14

It is treated as a correction of an accounting error. Cumulative effect of error gets adjusted to the beginning balances of assets and liabilities in the earliest period presented in the comparative statements Correction of the error must be included in the footnotes

Question 15

How does an inventory error effect the financial statements?

Answer 15

Effect on Ending Inventory : Effect on Net Income If one is overstated- both overstated. If one is understated- both understated. Misstating inventory corrects itself after TWO periods.

Question 16

How is a change in entity recorded?

Answer 16

Applied retrospectively. All prior periods presented for comparative purposes must reflect the change Footnote disclosures must be made Changing to Consolidated Statements

Question 17

Changes from one generally accepted principle to another is what type of accounting change? What approach is used?

Answer 17

Change in accounting principle. Retrospective treatment.

Question 18

Distinguish between retrospective and retroactive treatment.

Answer 18

Both apply changes to previously issued financial statements. Retroactive changes correct an error whereas retrospective changes improve the comparability of prior period figures to the period when the change in accounting principle was made.

Question 19

What change in treatment removes the accounting change from the income statement and moves it to the statement of retained earnings?

Answer 19

Retrospective treatment

Question 20

What are some of the footnote disclosures required for a change in accounting principle?

Answer 20

1) Nature and reason for a change, and explanation as to why the new method is preferable 2) Method of applying the change 3) Description of the prior period information that is retrospectively adjusted 4) Effect of the change on income from continuing operations, net income, and any other affected F/S item 5) Cumulative effect of the change on retained earnings

Question 21

What are some of the required disclosures for a correction of an error?

Answer 21

1) Effect of correction on each financial statement line item and any per-share amounts for all periods presented 2) Cumulative effect of restatement on retained earnings or other components of equity as of the beginning of the earliest period presented 3) A statement that previously issued financial statements have been restated

Question 22

What is a self-correcting error?

Answer 22

A self-correcting error is one that will correct itself in time, even if it is not discovered. The miscounting of inventory is a self-correcting error. While the error in ending inventory will have an effect on two balance sheets and two income statements, if inventory is correctly counted at the end of the next year, then there will be no further errors as a result of the miscounting.

Question 23

Do inventory errors correct themselves? After how long?

Answer 23

Yes, ALWAYS after two years.

Question 24

What is usually the first footnote to financial statements?

Answer 24

Summary of significant accounting policies (revenue recognition, inventory valuation, depreciation method, etc.)

Question 25

What type of error and accounting treatment is required when changing from the cash method of accounting to the accrual method of accounting?

Answer 25

Correction of an error: retroactive treatment

Question 26

If it is impractical to determine the cumulative effect to any of the prior periods resulting from a change in accounting principle, is prospective treatment permitted?

Answer 26

Yes, any change in which a cumulative effect adjustment is considered impractical to calculate is permitted

Question 27

If a change in accounting principle is inseparable from a change in accounting estimate, how is it accounted for?

Answer 27

As a change in accounting estimate (prospectively)

Question 28

Under IFRS, what are changes in accounting principle referred to as?

Answer 28

Change in accounting policies

Question 29

Under IFRS, what are changes in reporting entity referred as?

Answer 29

Trick question! There is no such thing/concept under IFRS.

Question 30

Under IFRS, how is a correction of an error treated?

Answer 30

Unlike GAAP, retrospective treatment is conducted as opposed to retroactive

Question 31

Under IFRS, what is required of an entity when it makes a retrospective restatement?

Answer 31

They must present three balance sheets and two each of the other financial statements

Question 32

Under IFRS, when are changes in accounting policies permitted?

Answer 32

If the change will result in more a relevant and reliable presentation of the financial statements