Intermediate Chapter 22 Notes
Intermediate Chapter 22 Notes 3310
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This 3 page Class Notes was uploaded by Emily Sears on Saturday January 30, 2016. The Class Notes belongs to 3310 at Auburn University taught by Dr. Duane Brandon in Spring 2016. Since its upload, it has received 29 views. For similar materials see Intermediate Accounting I in Accounting at Auburn University.
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Date Created: 01/30/16
CHAPTER 22: Accounting for Changes and Errors Types of Accounting Changes 1. Change in an Accounting Principle. This type of change occurs when a company adopts a GAAP different from the one used previously for reporting purposes 2. Change in an Accounting Estimate. This type of change is required because an earlier estimate has proven to require modifying as new events occur, more experience is acquired, or additional information is obtained. 3. Change in a Reporting Entity. This type of change is caused by a change in the entity being reported. Note, Error Corrections (aka “prior-period adjustments” or “restatements”) are accounted for similar to a change in accounting principle Methods of Reporting Accounting Changes Two general methods of reporting accounting changes: 1. The retrospective application of a new accounting principle (ex: restate its financial statements of prior periods, sometimes referred to as a retrospective adjustment or restatement) 2. Adjust for the change prospectively (ex: currently and going forward) Know Terminology! Rules for Accounting Changes A change in an accounting principle is accounted for by the retrospective application of the new accounting principle. A change in an accounting estimate is accounted for prospectively A change in a reporting entity is accounted for by the retrospective adjustment so that all the financial statements presented are for the same entity An error is accounted for as a prior period adjustment (prior period adjustment) Change in Accounting Principle A change in accounting principle is accounted for by the retrospective application of the new accounting principle to all prior periods presented Recall, the SEC requires the following in annual reports (ex: 10-Ks) Complete comparative financial statements presenting three years for income statement and two years for balance sheet and Summary financial data for previous five years Exception: a change in the amortization or depreciation method is treated as a change in an estimate under GAAP It may not be feasible to determine the effect of applying a change in accounting principle to any prior period (ex: change to LIFO). In this case, GAAP requires a company to apply the new accounting principle as if the change was made prospectively as of the earliest date practicable When a company changes an accounting principle, management must justify the change on the grounds that the new principle is preferable to the old. The SEC requires that the auditor submit a letter indicating whether the change is to an alternative principle that, in the auditor’s judgment, is preferable under the circumstances. FASB provides transition rules that define the accounting method a company uses when it changes an accounting principle to conform to a new principle required by the issuance of new GAAP How do we Account for a Change in Accounting Principle? A change in accounting principle includes: Change from one generally accepted accounting principle to another generally accepted accounting principle Change in accounting principle because an Accounting Standard Update has been issued and the former principle is no longer generally accepted Change in the method of applying an accounting principle A change in accounting principle does not include: Initial adoption of a generally accepted accounting principle because of events or transactions occurring for the first time or that were previously immaterial Adoption or modification of an accounting principle for transactions or events that are clearly different in substance from those previously occurring Change to a generally accepted accounting principle from a principle that is not generally accepted. This would be treated as a correction of an error Retrospective Adjustment Method A company accounts for a change in accounting principle by the retrospective application of the new accounting principle to all prior periods as follows: Step 1. Compute the cumulative effect of the change to the new accounting principle as of the beginning of the first period presented. Step 2. Prepare a journal entry to adjust the book values of the assets and liabilities (including income taxes) that are affected by the change so that their balances reflect the amounts that would have existed under the newly adopted accounting principle. An offsetting adjustment is made to the beginning balance of Retained Earnings for the cumulative effect of the change (net of taxes). Step 3. Adjust the financial statements of the current period and each prior period to reflect the specific effects of applying the new accounting principle. Therefore, the comparative financial statements would appear as if the newly adopted accounting principle was used in every period presented. Step 4. Disclose the following information: Nature and reason for the change in accounting principle, including an explanation of why the new principle is preferable. Description of the prior-period information that has been retrospectively adjusted. Effect of the change on income, earnings per share, and any other financial statement line item for the current period and the prior periods retrospectively adjusted. Cumulative effect of the change on retained earnings (or other appropriate component of equity) at the beginning of the earliest period presented. A change in Principle Distinguished froma Change in anEstimate Sometimes it is difficult for a company to distinguish between a change in an accounting principle and a change in an estimate. For example, a company may change from capitalizing and amortizing a cost recording it as an expense when incurred because future benefits associated with the cost have become doubtful The company adopted the new accounting method because of the change in estimated benefits, and therefore, the change in method is inseparable from the change in estimate The company is required to account for such a change as a change in estimate. This is often referred to as a change in accounting estimate affected by a change in accounting principle Change in Reporting Entity A change in reporting entity is accounted for as a retrospective adjustment. A change in reporting entity occurs 1. When a company presents consolidated or combined statements in place of the statements of individual companies 2. When there is a change in the specific subsidiaries that make up the group of companies for which a company presents consolidated financial statements 3. When the companies included in combined financial statements change Correction of Errors A company accounts for the correction of a material error of a past period that it discovers in the current period as a prior restatement (adjustment). Thus, the accounting treatment is similar to a change in accounting principle. Error examples include: 1. The use of an accounting principle that is not generally accepted 2. The use of estimate that was not made in good faith 3. Mathematical miscalculations 4. The omission of a deferral or accrual Required steps for correcting anerror: 1. Analyze the original erroneous journal entry and determine all the debits and credits that are recorded 2. Determine the correct journal entry and the appropriate debits and credits 3. Evaluate whether the error has caused additional errors in other accounts 4. Prepare the correcting entry (or entries)
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