CHAPTER 22
ACCOUNTING CHANGES AND ERROR ANALYSIS
1)
Types
of Accounting Changes
b)
Change
in Accounting Estimate
c)
Change
in Reporting Entity
d)
Errors
in Financial Statements
i)
also
necessitate changes in accounting,
ii)
but
this category is not classified as one of the categories of accounting change.
2)
Changes
in Accounting Principle
a)
Is
defined as a change from one generally accepted accounting principle to
another.
b)
Examples
i)
A
change from average cost to LIFO
ii)
A
change from S-Y-D depreciation to straight line
c)
A
change in accounting principle is not considered to result from
i)
the
adoption of a new principle in recognition of events that have occurred for the
first time
ii)
or
that were previously immaterial
d)
If
the accounting principle previously followed was not acceptable, or if the
principle was applied incorrectly, a change to a generally accepted accounting
principle
i)
is
considered a correction of an error
ii)
and
is not considered to be a change in accounting principle.
e)
Changes
in Accounting Principle are classified into three categories:
i)
Cumulative-effect
type accounting changes
ii)
Retroactive-effect
type accounting changes and
iii)
Changes
to the LIFO method of inventory.
f)
Cumulative-Effect
Type Accounting Change
i)
The
general requirement established by the profession was that the current, or
“catch-up,” method should be used to account for changes in accounting
principles.
(1)
The
cumulative effect of the adjustment should be reported in the income statement
between the captions “extraordinary items” and
“net income.”
(2)
Financial
statements for prior periods included for comparative purposes should not be
restated.
(3)
Income
before extraordinary items and net income, computed on a pro-forma basis,
should be shown on the face of the income statement for all periods.
(a)
The
term “pro-forma” means “as if.”
(b)
See
illustration 23-5 on page 1259.
ii)
The
journal entry to recognize the cumulative effect of the change
(1)
May
be made at any time during the year, but
(2)
Is
effective as of the beginning of the year.
g)
Retroactive-Effect
Type Accounting Change
i)
In
certain circumstances, the accounting change is recognized by recasting the
statements of prior years on a basis consistent with the newly adopted
principle.
(1)
Any
part of the cumulative effect attributable to years prior to hose presented is
treated as an adjustment of beginning retained earnings of the earliest year
presented.
ii)
Five
situations require the restatement of all prior period financial statements.
(1)
A
change from LIFO to another method
(2)
A
change in the method of accounting for
long-term construction contracts
(3)
A
change to or from the “full-cost” method of accounting in the extractive
industries
(4)
Issuance
of financial statements by a company for the first time
(a)
To
0btrain addition al equity capital
(b)
To
effect a business combination, or
(c)
To
register securities
(5)
A
professional pronouncement recommends that a change in accounting principle be
treated retroactively.
iii)
In
the case of a change TO LIFO,
(a)
The
base-year inventory for all subsequent LIFO calculations is the opening
inventory in the year the method is adopted
(b)
There
is no restatement of prior year’s income because it is too impractical.
(c)
Disclosure
is limited to showing the effect of the change on the results of operations in
the period of the change.
3)
Changes
in Accounting Estimate
a)
Many
estimates impact the values that appear in the financial statements, for
example
i)
Uncollectable
receivables
ii)
Inventory
obsolescence
iii)
Useful
lives and salvage values of assets
iv)
Periods
benefited by deferred costs
v)
Liabilities
for warranty costs and income taxes and
vi)
Recoverable
mineral reserves
b)
Estimating
requires the use of judgement.
c)
Estimates
will change as
i)
New
events occur
ii)
More
experience is acquired, or
iii)
Additional
information is obtained.
d)
Changes
in estimates must be handled prospectively.
i)
Opening
balances are not adjusted
ii)
No
attempt is made to “catch-up” for prior periods
iii)
No
change is made in previously reported results
iv)
Prior
period financial statement are not restated
v)
Pro-formas
for prior periods are not prepared
e)
The
effect of all changes in estimate are accounted for in
i)
The
period of the change
ii)
And
in future periods, if they too are impacted
4)
Reporting
a Change in Entity
a)
An
accounting change that results in financial statements that are actually the
statements of a different entity should be reported by restating the financial
statements of all periods presented.
b)
Examples
of a change in reporting entity are:
i)
Presenting
consolidated statements in place of statements of individual corporations
ii)
Changing
specific subsidiaries that constitute the group of companies for which
consolidated financial statements are presented
iii)
Changing
the companies included in combined financial statements
iv)
Accounting
for pooling of interest
v)
A
change in the cost, equity or consolidation method of accounting for
subsidiaries and investments.
5)
Reporting
a Correction of an Error
a)
Examples
of errors include:
i)
A
change from an accounting principle that is not generally accepted to one that
is
ii)
Mathematical
mistakes
iii)
Changes
in estimates that occur because the original estimate was not prepared in good
faith
iv)
An
oversight
v)
A
misuse of facts
vi)
The
incorrect classification of a cost as an expense instead of an asset, and vice
versa.
b)
As
soon as they are discovered, errors must be corrected by proper entries in the
accounts and reported in the financial statements.
c)
The
profession requires that corrections of errors be treated as prior period
adjustments.
d)
If
comparative statements are presented, the prior statements affected should be
restated to correct of the error.