F2: M2-Accounting Changes and Errors Flashcards
Change in Accounting Entity or Principle
THINK Retrospective
Change in Account Entity (from one structure of reporting to another). Ex. Merger, Acquisition, Divestitures.
Change in Principal (from one acceptable accounting principal to another). Ex. From LIFO to FIFO or from % of completion to completed contract method.
What would a change from non-GAAP to GAAP be considered?
A correction of an error which requires a PPA (prior period adjustment).
How does Overstated/Understated Expenses Impact Net Income?
If expenses are overstated, then net income is understated.
If expenses are understated, then net income is overstated.
This is because expenses reduce net income directly.
🔑 More expenses → Less net income | Less expenses → More net income
How does Overstated/Understated Revenue Impact Net Income?
If revenue is overstated, then net income is overstated.
If revenue is understated, then net income is understated.
This is because revenue directly affects net income, all else being equal.
🔑 More revenue → More net income | Less revenue → Less net income
When the effect of a change in accounting principle is inseparable from the effect of a change in accounting estimate, how is it treated under U.S. GAAP?
Treat the entire change as a change in estimate.
Report the effect prospectively.
Recognize the impact as part of income from continuing operations.
Do not restate prior periods.
🔑 If you can’t split it, treat it as a change in estimate.
How are accounting changes treated?
Change in Accounting Principle → Apply retrospectively (adjust prior periods).
Change in Accounting Estimate → Apply prospectively (current & future periods).
Change in Principle inseparable from Estimate → Treat as a change in estimate → prospective.
Error Correction → Make a prior period adjustment (restatement).
🔑 Prospective = Going Forward | Retrospective = Fix Past | Error = Prior Period Adjustment
How do you correct a** prior period error** (e.g., overstated depreciation) under U.S. GAAP, and what is the effect on retained earnings?
Prior period errors are corrected by adjusting beginning retained earnings in the current year, net of tax.
Overstated expenses in a prior year:
- Caused income to be understated
- So, retained earnings must be increased
Formula:
Adjustment = ErrorAmount × (1-TaxRate)
✅ No restatement goes through current year income
✅ Disclosure is required in the financial statements
What is an impairment, and when is it recognized under U.S. GAAP?
An impairment is a permanent reduction in the value of an asset when its carrying amount (aka book value) exceeds its recoverable (fair) value.
▶ Under U.S. GAAP, it is recognized immediately when the asset is classified as held for sale or when there is a triggering event.
📉** Journal Entry:**
Dr. Impairment Loss (Expense)
Cr. Asset / Accumulated Impairment
Key CPA Points:
* Recognize impairment loss in the period it occurs
* Do not include anticipated future losses from operations
* For discontinued operations, actual losses are recognized as incurred
When do you increase or decrease retained earnings for a prior period error?
