Accounting Changes and Error Corrections

Question 1

T/F: a change is accounting estimate occurs when it is determined that the estimate previously used by the company is incorrect

Answer 1

True; also, changes in accounting principle that are inseparable from a change in estimate are now treated as a change in estimate

changes are accounted for prospectively (current and future periods); they do not affect previous periods (no effect on previously reported retained earnings)

if a change in accounting estimate affects several future periods (a revision of service lives of depreciable assets), the effect on income from continuing operations, net income, and the related per share information for the current year should be disclosed in the notes to the financial statements; changes in ordinary accounting estimates (AFDA and inventory adjustments) usually made each period do not have to be disclosed unless they are material

Question 2

T/F: a change in accounting principle is a change in accounting from one acceptable accounting principle to another

Answer 2

True; an accounting principle may be changed only if required by GAAP or if the alternative principle is preferable and more fairly presents the information

the direct effects of a change in accounting principle are adjustments that would be necessary to restate the financials statements of prior periods

the indirect effects of a change in accounting principle are differences in nondiscretionary items based on earnings (bonuses) the would have occurred if the new principle had been used in prior periods

Question 3

What are some reporting changes in an accounting principle?

Answer 3

the general rule is that changes in accounting principle should be recognized by adjusting beginning retained earnings in the earliest period presented for the cumulative effect of the change, and if prior period (comparative) financial statements are presented, they should be restated (retrospective application)

exceptions to the general rule: impracticable to estimate (handled prospectively like a change in estimate…an example would be changing inventory cost flow assumption to LIFO) and change in depreciation method (applies to amortization and depletion as well; handled as a change in estimate which means no retroactive or retrospective calculations should be made and no adjustment should be made to retained earnings)

Question 4

Facts on changes in accounting entity (retrospective application)

Answer 4

under U.S. GAAP, a change in accounting entity occurs when the entity being reported on has changed composition; examples include consolidated or combined financial statements that are presented in place of statements of the individual companies and changes in the companies included in the consolidated or combined financial statements from year to year

if a change in accounting entity occurs in the current year, all previous financial statements that are presented in comparative financial statements alone with the current year should be restated to reflect the information for the new reporting entity

full disclosure of the cause and nature of the change should be made, including changes in income from continuing operations, net income, and retained earnings

Question 5

T/F: error corrections are not accounting changes

Answer 5

True; changes from a non-GAAP method of accounting to a GAAP method of accounting (cash basis to accrual basis) is a specific correction of an error

if comparative financial statements are presented and financial statements for the year with the error are presented, merely correct the error in those prior financial statements

if comparative financial statements are presented and financial statements for the year with the error are not presented (error goes back too far in years), adjust (net of tax) the opening retained earnings of the earliest year presented

if comparative financial statements are not presented, the error correction should be reported as an adjustment to the opening balance of retained earnings (net of tax)