Accounting Changes and Error Correction Flashcards
Name the three types of accounting changes
1) Change in an accounting principle
2) Change in an accounting estimate
3) Change in a reporting entity
What is meant by retrospective treatment?
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.
Define prospective treatment.
The accounting change affects the current and ensuing periods.
How is a change in an accounting estimate reported?
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.
How is a change in the reporting entity reported?
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.
How are corrections of an error reported?
Reported as prior period adjustments to retained earnings and all comparative financial statements presented are restated.
How are changes in accounting principle applied?
Retrospective Application: Prior Periods adjusted Retained Earnings adjusted Ex: Completed Contract to % Completion -OR- LIFO to FIFO
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?
A change of principle.
Applied retrospectively.
Would a change from LIFO to FIFO be a change in accounting principle or a change of estimate?
How would this change be applied?
A change in accounting principle.
Applied retrospectively.
How is a change in accounting estimate applied?
A change in accounting estimate is applied prospectively (going forward).
No backwards adjustment is made.
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?
Change in depreciation method would be a change in accounting estimate.
It is applied prospectively.
How is a correction of an accounting error made?
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.
What are the requirements for a prior period adjustment?
Effect is Material
Is identifiable in Prior Period
Couldn’t be estimated in Prior Periods
How is a change from a non-GAAP accounting method to a GAAP method recorded?
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
How does an inventory error effect the financial statements?
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.
How is a change in entity recorded?
Applied retrospectively.
All prior periods presented for comparative purposes must reflect the change
Footnote disclosures must be made
Changing to Consolidated Statements
Changes from one generally accepted principle to another is what type of accounting change? What approach is used?
Change in accounting principle. Retrospective treatment.
Distinguish between retrospective and retroactive treatment.
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.
What change in treatment removes the accounting change from the income statement and moves it to the statement of retained earnings?
Retrospective treatment
What are some of the footnote disclosures required for a change in accounting principle?
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
What are some of the required disclosures for a correction of an error?
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
What is a self-correcting error?
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.
Do inventory errors correct themselves? After how long?
Yes, ALWAYS after two years.
What is usually the first footnote to financial statements?
Summary of significant accounting policies (revenue recognition, inventory valuation, depreciation method, etc.)
What type of error and accounting treatment is required when changing from the cash method of accounting to the accrual method of accounting?
Correction of an error: retroactive treatment
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?
Yes, any change in which a cumulative effect adjustment is considered impractical to calculate is permitted
If a change in accounting principle is inseparable from a change in accounting estimate, how is it accounted for?
As a change in accounting estimate (prospectively)
Under IFRS, what are changes in accounting principle referred to as?
Change in accounting policies
Under IFRS, what are changes in reporting entity referred as?
Trick question! There is no such thing/concept under IFRS.
Under IFRS, how is a correction of an error treated?
Unlike GAAP, retrospective treatment is conducted as opposed to retroactive
Under IFRS, what is required of an entity when it makes a retrospective restatement?
They must present three balance sheets and two each of the other financial statements
Under IFRS, when are changes in accounting policies permitted?
If the change will result in more a relevant and reliable presentation of the financial statements
