F2 M2 Accounting Changes and Error Corrections Flashcards
Changes in accounting estimates affect financial statements in which periods?
Only the current and subsequent periods (not prior periods and not retained earnings).
Example: In Year 1, Acme estimated its two-year warranty costs based on $100 per unit sold. In Year 2, experience indicated that the estimate should have been based on $110 per unit. The effect of this $10 difference is reported in Year 2 as income from continuing operations–not as an accounting change or an error.
How should a company present changes in accounting that result from a “change in entity,” such as reporting consolidated financial statements versus previously individual financial statements or changing the subsidiaries in consolidated financial statements?
The change should be presented in the current financial statements, in all previous financial statements that appear in current comparative financial statements (i.e. restatement), and in note disclosures.
How is the cumulative effect of a change in accounting principle presented in financial statements?
The cumulative effect of a change in accounting principle is presented net of tax as an adjustment to beginning retained earnings in the statement of stockholders’ equity.
Example: On Jan. 1, Year 3, Acme changed its inventory costing method from LIFO to FIFO. The company’s Year 3 financial statements contain comparative information for Year 2. In its Year 3 comparative financial statements, Acme presents an adjustment to the beginning Year 2 inventory balance with an offsetting adjustment to beginning Year 2 retained earnings.
How should changes from the cost to equity method of accounting for investments–and vice versa–be reported in financial statements?
A change from the cost to equity method requires restatement. A change from the equity to cost method does not require restatement and is accounted for prospectively (in current and subsequent financial statements).
How should the effect of a change in accounting principle that is inseparable from the effect of a change in accounting estimate be reported?
As part of income from continuing operations.
Because the overall effect is a change in estimate.
How should the correction of an error in a prior period be presented in financial statements?
Assume the financial statements present the current period only.
Correction of an error in a prior period should be presented net of income taxes as an adjustment to beginning retained earnings in the current and subsequent periods (i.e. prospectively).
What effect will an overstatement of inventory have on COGS?
COGS will be understated by the same amount inventory is overstated.
