Chapter 21 Accounting Changes and Error Corrections

1. Chapter 21 Accounting Changes and Error Corrections

2. Accounting Changes

3. Accounting Changes

4. Accounting Changes and Error Corrections

5. Accounting changes and error corrections Retrospective approach Revise prior year’s statements that are presented for comparative purposes to reflect the impact of the change. The balance in each account affected is revised to appear as if the newly adopted accounted method had been applied all along or that the error had never occurred. Adjust the beginning balance of retained earnings for the earliest period reported.

6. Accounting changes and error corrections Prospective approach The change is implemented in the current period and its effects are reflected in the financial statements of the current and future years only. Prior years statements are not revised. Account balances are not revised.

7. Motivation for Accounting Choices

8. Most changes in accounting principle are reported retrospectively. Examples are: Change to a principle required by a new pronouncement recognized as GAAP that requires retrospective treatment. Change from LIFO to another inventory method. Change in the method of accounting for long-term construction contracts. Change to or from full-cost method in extractive industries. Changes made when a closely held corporation first issues financial statements to obtain equity financing for registering securities or for effecting a business combination. Example Retrospective Approach

9. Retrospective Approach

10. The prospective approach is used when it is: Impracticable to determine some period specific effects. Impracticable to determine the cumulative effect of prior years. Mandated by authoritative pronouncements. A change in depreciation methods is considered to be a change in accounting estimate that is achieved by a change in accounting principle. It is accounted for prospectively as a change in accounting estimate. Example Prospective Approach

11. Change in Reporting Entity

12. Examples include: Use of inappropriate principle Mistakes in applying GAAP Arithmetic mistakes Fraud or gross negligence in reporting For all years disclosed, financial statements are retrospectively restated to reflect the error correction. Error Correction

13. Prepare a journal entry to correct any balances. Retroactively restate prior years’ financial statements that were incorrect. Report error as a prior period adjustment if retained earnings is one of the incorrect accounts affected. Include a disclosure note. Correction of Accounting Errors

14. Error Discovered in the period ofoccurrence Corrected by reversing the incorrect entry and then recording the correct entry (or by making an entry to correct the account balances).

15. Previous Period Error Not Affecting Net Income Involves incorrect classification of accounts. Requires correction of previously issued statements (retrospective approach). Is not classified as a prior period adjustment since it does not affect prior income. Disclose nature of error.

16. Previous Period Error Affecting Net Income Requires correction of previously issued statements (retrospective approach). All incorrect account balances must be corrected. Is classified as a prior period adjustment since it does affect prior income. Disclose nature of error.

17. Prior Period Adjustments