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Chapter 20

Accounting Changes and Error Corrections. Chapter 20. Accounting Changes. Correction of an Error. Error Corrections and Most Changes in Principle. Retrospective. Revise prior years’ statements (that are presented for comparative purposes) to reflect the impact of the change.

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Chapter 20

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  1. Accounting Changesand Error Corrections Chapter 20

  2. Accounting Changes

  3. Correction of an Error

  4. Error Corrections and Most Changes in Principle Retrospective • Revise prior years’ statements (that arepresented for comparative purposes) to reflectthe impact of the change. • The balance in each account affected is revised to appear as if the newly adopted accounting 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. TwoReporting Approaches Prospective

  5. Changes in Estimates andSome Changes in Principle • The change is implemented in the current period, and its effects are reflected in thefinancial statements of the current andfuture years only. • Prior years’ statements are not revised. • Account balances are not revised. Retrospective TwoReporting Approaches Prospective

  6. Motivation for Accounting Choices Effect on Compensation Changing Conditions Motivations for Change Effect on Debt Agreements Effect on Union Negotiations New AccountingStandard Issued Effect on Income Taxes

  7. Disclosure Notes In the first set of financial statements after thechange is made, a disclosure note is needed to Providejustification for the change. Point out thatcomparativeinformation hasbeen revised. Report any pershare amountsaffected for thecurrent and allprior periods.

  8. The prospective approach is used for changes in principle when: It is impracticable to determine some period-specific effects. It is impracticable to determine the cumulative effect of prior years. The change is mandated by authoritative pronouncements. Prospective Approach Most changes in principle are reportedby the retrospective approach, but:

  9. A change in depreciation methodis considered to be achange in accounting estimatethat is achieved by a change in accounting principle. It is accounted forprospectivelyas a change in accounting estimate. Prospective Approach: Change in Accounting Estimate

  10. Change in Reporting Entity A change in reporting entity occurs as a result of  presenting consolidated financial statements in place of statements of individual companies, or  changing specific companies that constitute the group for which consolidated statements are prepared.

  11. Change in Reporting Entity Summary of the Retrospective Approachfor Changes in Reporting Entity Recast all previous periods’ financial statements as if the new reporting entity existed in those periods. In the first financial statements after the change:  A disclosure note should describe the nature of and the reason for the change. • The effect of the change on revenue, net income, income before extraordinary items, and related per share amounts should be shown for all periods presented.

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

  13. Four-step process Prepare a journal entryto correct any balances. Retrospectively restateprior years’ financial statements that were incorrect. Report correction as a prior period adjustmentif retained earnings is one of the incorrect accounts affected. Include a disclosure note. Correction of Accounting Errors

  14. Prior Period Adjustments Prior Period Adjustment Required Counterbalancing error discovered in the second year. Noncounterbalancing error discovered in any year. Use the retrospective approach

  15. Corrected byreversingthe incorrect entry and then recording the correct entry (or by making an entry to correct the account balances) Errors Occurred and Discoveredin the Same Period

  16. Involves incorrect classification of accounts. Requires correction of previously issued statements(retrospective approach). Is notclassified as a prior period adjustment since it does not affect prior income. Disclose nature of error. Errors Not AffectingPrior Years’ Net Income

  17. Requires correction of previously issued statements(retrospective approach). All incorrect account balances must be corrected. Is classified as a prior period adjustmentsince it does affect prior income. Disclose nature of error. Error Affecting Prior Year’s Net Income

  18. Reporting Accounting Changes and Error Corrections

  19. Summary of AccountingChanges and Errors

  20. End of Chapter 20

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