Understanding Accounting Changes and Error Corrections

1. Accounting Changes and Error Corrections Sid Glandon, DBA, CPA Associate Professor of Accounting The University of Texas at El Paso

2. Types of Accounting Change • Change in Accounting Principle • Change in Accounting Estimates • Change in Reporting Entity • Correction of errors

3. Changes in Accounting Principle • Change from one generally accepted principle to another • Adopt a new FASB standard • Change methods of inventory costing • Change to, or from, cost method to equity method • Change to, or from, completed contract to percentage-of-completion

4. Change in Accounting Estimate • Revision of an estimate because of new information or experience • Change in accounting principle • Depreciation, amortization, depletion methods • Change estimate of useful life • Change estimate of residual value • Change estimate of bad debt percentage • Change actuarial estimates regarding pension plan liability

5. Change in Reporting Entity • Change from reporting as one type of entity to another type of entity • Consolidate a subsidiary for the first time • Replace individual financial statements with consolidated financial statements

6. Correction of an Error • Correction of error in prior period • Math errors • Inaccurate physical count of inventory • Chance from cash basis to accrual basis • Failure to record an AJE • Incorrectly classifying and recording assets or expenses • Fraud or gross negligence

7. Approaches to Reporting Accounting Changes • Retrospective approach • Improves consistency and comparability • Revise comparative financial statements • Report cumulative effect on prior years’ income • AJE to adjust general ledger accounts • Disclose in notes to financial statements • Prospective approach • Implementation in current year • Effects reflected in current and future years

8. Change in Accounting Principle • Retrospective approach • Revise comparative financial statements • Adjust general ledger accounts • Disclose in notes to financial statements • Prospective approach • When retrospective approach is impracticable • Mandated by FASB • Change to LIFO inventory method • Change depreciation, amortization or depletion methods

9. Change in Accounting Estimate • Prospective Approach • A consequence of having to use estimates • Change is reflected in current and future periods • Disclose in notes to financial statements

10. Change in Reporting Entity • Retrospective approach • Restatement of all prior periods reported • Consolidation of financial statements • Disclose in notes to financial statements

11. Correction of an Error • Retrospective approach • Revise prior years’ statements • Report cumulative effect on prior years’ income • AJE to adjust general ledger accounts • Disclose in notes to financial statements

12. Prior Period Adjustment • Adjustment to beginning retained earnings of the earliest period reported • Cumulative effect of correction of error