301678 Flashcards
Which of the following examples would require restatement of prior years’ financial statements?
A change from the income tax basis of accounting to the accrual basis
A calculation change of warranty obligations based on updated claim information for the prior year
An insurance premium that was due in the prior year but that lapsed because the policy was not paid
An intangible asset with a remaining estimated amortization period of two years, which is determined to be obsolete
A change from the income tax basis of accounting to the accrual basis
The FASB requires that changes in accounting principle use the retrospective approach, whereby all prior years’ financial statements presented should be restated and the cumulative effect of the change should be reported in the retained earnings statement (or in the statement of changes in stockholders’ equity) as an adjustment of the beginning-of-period balance of retained earnings of the earliest year presented. Changes in estimate are handled on a prospective basis—in the current year and future years; there is no retroactive application.
The only answer choice which is a change in principle requiring restatement is a change from the income tax basis of accounting to the accrual basis.
Accrual Basis Accounting
Accrual basis accounting is a method of accounting that attempts to record the financial effects (substance) of transactions and other events and circumstances in the periods in which they occur rather than only in periods in which cash is received or paid by the entity. Accrual basis accounting recognizes that the earnings process, which consists of buying, selling, producing, distributing, and other operations, often does not coincide with cash receipts and payments. This method of accounting records credit transactions, barter exchanges, nonreciprocal transfers, changes in prices, changes in form of assets or liabilities, and other transactions, events, and circumstances that have eventual cash consequences for the entity but do not involve the concurrent movement of cash. Revenue is recognized when earned and expenses are recognized when incurred, not when cash is received or paid.
SFAC 4.50 and 6.139
Accrual basis accounting uses accrual, deferral, and allocation to attempt to reflect the entity’s performance during a specific period of time, rather than just the receipts and disbursements of cash—to match the recognition of revenues with the related expenses (and the related increases or decreases in assets or liabilities).
Accrual basis accounting makes it possible to recognize expenses and losses at the time that economic benefits are consumed or the loss of future benefits is discovered rather than when payment is made. Accrual accounting uses three expense-recognition principles as appropriate:
Associated cause-and-effect
Systematic and rational allocation
Immediate recognition
SFAC 5.85–.86
Change in Accounting Estimate
A change in accounting estimate is a change that has the effect of adjusting the carrying amount of an existing asset or liability or altering the subsequent accounting for existing or future assets or liabilities. A change in accounting estimate is a necessary consequence of the assessment, in conjunction with the periodic presentation of financial statements, of the present status and expected future benefits and obligations associated with assets and liabilities. Changes in accounting estimates result from new information. Examples of items for which estimates are necessary are uncollectible receivables, inventory obsolescence, service lives and salvage values of depreciable assets, and warranty obligations.
A change in accounting estimate is accounted for in (a) the period of change if the change affects that period only or (b) the period of change and future periods if the change affects both. A change in accounting estimate is not accounted for by restating or retrospectively adjusting amounts reported in financial statements of prior periods or by reporting pro forma amount amounts for prior periods.
FASB ASC 250-10-20
Change in Accounting Principle
A change in accounting principle is a change from one generally accepted accounting principle to another generally accepted accounting principle when there are two or more generally accepted accounting principles that apply or when the accounting principle formerly used is no longer generally accepted. It is expected that accounting pronouncements normally will provide specific transition requirements. However, in the unusual instance that there are no transition requirements specific to a particular accounting pronouncement, a change in accounting principle effected to adopt the requirements of that accounting pronouncement must be reported as a retrospective application of the new accounting principle to all prior periods, unless it is impracticable to do so. Retrospective application requires the following:
- The cumulative effect of the change to the new accounting principle on periods prior to those presented must be reflected in the carrying amounts of assets and liabilities as of the beginning of the first period presented.
- An offsetting adjustment, if any, shall be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period.
- Financial statements for each individual prior period presented shall be adjusted to reflect the period-specific effects of applying the new accounting principle.
A change in the method of applying an accounting principle also is considered a change in accounting principle.
FASB ASC 250-10-20
Prospective Recognition
In prospective recognition of an accounting change:
- the cumulative effect is included in the current and future reporting periods by revising current and future allocations (no cumulative effect is computed or allocated to prior periods),
- prior-period financial statements are carried forward and presented without change, and
- no pro forma data is required.
“Prospective” means forward in time. It is used with changes in accounting estimates.
Note disclosure of the change, with explanation and justification, and of the impact on income and EPS is also required.
Restatement
Restatement is the process of revising previously issued financial statements to reflect the correction of an error in those financial statements.
FASB ASC Glossary
Retrospective Application (Retrospective Approach)
Retrospective application (retrospective approach) is the application of a different accounting principle to one or more previously issued financial statements, or to the statement of financial position at the beginning of the current period, as if that principle had always been used, or a change to financial statements of prior accounting periods to present the financial statements of a new reporting entity as if it had existed in those prior years.
FASB ASC 250-10-20
2311.01
Retrospective Approach
The FASB requires that in the absence of a specific statement by the FASB to the contrary, accounting changes should be accounted for using the retrospective approach. Under this approach, all prior years’ financial statements presented should be restated and the cumulative effect of the change should be reported in the retained earnings statement (or in the statement of changes in stockholders’ equity) as an adjustment of the beginning-of-period balance of retained earnings of the earliest year presented.
FASB ASC 250-10-45-5
