Accounting Changes Flashcards
Accounting changes include a change in accounting principle, a change in estimate, or a change in the reporting entity. The correction of an error in previous financial statements is not an accounting change. The statement further defines 2 important terms: restatement and retrospective application. A restatement is the process of reviving previously issued financial statements to correct an error. A retrospective application is the application of a different accounting principle to previously issued financial statements, as if that principle had always been used. Retrospective application is required for changes in accounting principle and changes in reporting entity.
Accounting Changes
An entity may change accounting principle only if the change is required by a newly issued accounting pronouncement, or if the entity can justify the use of the alternative accounting method because it is preferable
Change in accounting principle
A change in accounting principle is accounted for through retrospective application of the new accounting principle to all prior periods, unless it is impracticable to do so. Retrospective changes require the following:
Change in accounting principle
1) The cumulative effects of the change are presented in the carrying amounts of assets and liabilities as of the beginning of the first period presented.
2) An offsetting adjustment is made to the opening balance of the retained earnings for that period (the beginning of the first period presented).
Change in accounting principle
3) Financial statements for each individual prior period presented are adjusted to reflect the period-specific effects of applying the new accounting principle
a) Only the direct effects of the changes are recognized in prior periods. An example of a direct effect is an adjustment to an inventory balance due to a change in inventory valuation method. Related changes, such as the effect on deferred taxes or an impairment adjustment, are also considered direct effects and must be recognized in prior periods.
Change in accounting principle
b) Indirect effects are any changes to current or future cash flows that result from making a change in accounting principle. An example of an indirect effect is a change in profit sharing or royalty payment based on revenue or net income. Any indirect effects of the change are reported in the period in which the accounting change is made.
c) If the cumulative effect of applying the accounting change can be determined but the period specific effects on all prior periods cannot be determined, the cumulative effect is applied to the carrying amount of assets and liabilities at the beginning of the earliest period to which it can be applied or calculated. An offsetting adjustment is then made to the opening balance of retained earnings for that period.
Change in accounting principle
If it is impracticable to determine the cumulative effect to any prior periods, the new accounting principle is applied as if the change was made prospectively at the earliest date practicable. It is considered impracticable only if one of 3 conditions are met:
1) After making every reasonable effort to apply the new principle to the previous period, the entity is unable to do so.
2) Retrospective application requires assumptions about management’s intentions in a prior period that cannot be independently substantiated.
3) Retrospective application requires significant estimates, and it is impossible to obtain objective information about the estimates.
Change in accounting principle
Notes to the financial statements to describe a change in accounting principle must include:
a) The nature and reason for the change, and explanation as to why the new method is preferable
b) The method of applying the change
c) A description of the prior period information that is retrospectively adjusted
d) The effect of the change on retained earnings or other components of equity or net assets as of the earliest period presented.
e) If retrospective application is impracticable, the reason, and a description of how the change was reported
f) A description of the indirect effects of the change, including amounts recognized in the current period, and related per share amounts
g) Unless impracticable, the amounts of the indirect effects of the change and the per share amounts for each prior period presented
Change in accounting principle
Disclosures are also required for interim periods. In the year of the change to the new accounting principle, interim financial statements should disclose the effect of the change on income from continuing operations, net income, and related per share amounts for the postchange interim periods
Change in accounting principle
Once the change is disclosed, financial statements in subsequent periods do not need to repeat the disclosures.
Change in accounting principle
Changes in accounting estimates are accounted for on a prospective basis. The financial statements are not restated or retrospectively adjusted. The change is accounted for in the current period and future periods.
Change in accounting estimates
If a change in accounting estimate is effected by changing an accounting principle, (e.g. a change in depreciation method), it is treated as a change in estimate
Change in accounting estimates
In cases where an entity effects a change in estimate by changing an accounting principle, the footnote disclosures required by a change in accounting principle apply and must be included in the notes to the financial statements.
Change in accounting estimates
Another type of accounting change is a change in reporting entity. A change in reporting entity occurs when a change in the structure of the organization is made which results in financial statements that represent a different or changed entity.
Change in reporting entities
Some examples of a change in reporting entity include presenting consolidated statements in place of individual statements, a change in subsidiaries, or a change in the use of the equity method for an investment
Change in reporting entities
