Which of the following is a change in accounting estimate quizlet?
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Background and Summary Show A. Accounting Changes and Error Corrections -- GAAP specifies how to account for changes in accounting. The four items addressed: 1. Accounting principle changes (example: change from FIFO to weighted-average method); 2. Accounting estimate changes (example: change the useful life of a plant asset); 3. Changes in reporting entity (example: change in the composition of the subsidiary group in a consolidated enterprise); 4. Corrections of errors in prior financial statements (example: discover that an item expensed in a prior year should have been capitalized and amortized). B. Error corrections are not considered an accounting change but the procedures for recording are the same as for accounting principle changes and thus are covered in this set of lessons. Accounting Approaches are Specified for Accounting Changes and Errors A. Retrospective - application of a principle to prior periods as if that principle had always been used. The procedure records the effect of the change on prior years as an adjustment to the beginning balance in retained earnings for the year of change rather than in income; prior year financial statements reported comparatively with the current year statements are adjusted to reflect the new method. The result is that the financial statements of all periods presented reflect the same (new) accounting principle. Retrospective application enhances comparability (a quality from the conceptual framework) across the financial statements of different years reported comparatively. Therefore the term "retrospective application" implies that the company applied the new standard it adopted to all periods shown unless it was impracticable to determine the cumulative effect or the period-specific change. When there is retrospective application the entity must disclose the effects on income and income taxes. Accounting Approaches are Specified for Accounting Changes and Errors B. Prospective - apply the change to current and future periods only; prior year statements are unaffected. C. Restatement is the term reserved specifically for error changes. Restatement requires correcting the comparative financial information presented along with correcting the opening retained earnings balance. The entity must disclose the nature of the error and the effect on current and prior periods. Summary of Accounting Summary of Accounting The following summarizes the types of items found in the accounting changes area, and the associated accounting approach. Accounting Change or Item Accounting Approach Accounting
principle change Retrospective *includes changes in depreciation, amortization and depletion methods which are treated as a change in estimate effected by a change in accounting principle **this is the same accounting procedure as retrospective but the difference in terminology highlights the distinction between a voluntary accounting principle change and the correction of an error, called a "prior period adjustment." Accounting For Principle Changes - Retrospective Application A Change in Accounting Principle : A change from one generally accepted accounting principle to another when there are at least two acceptable principles, or when the current principle used is no longer generally accepted. A change in the method of applying a principle is also considered a change in accounting principle. Example: Accounting For Principle Changes - Retrospective Application Example: Changing inventory cost flow assumption (LIFO to FIFO); changing the accounting for long-term construction contracts (completed contract to percentage of completion), change in method of applying LCM to inventory (individual, group, aggregate). Accounting For Principle Changes - Retrospective Application A. Changes in depreciation method, amortization method, and depletion method are treated as estimate changes. B. The following are not accounting principle changes: 1. Initial adoption of a new principle to new events for the first time or for events that were immaterial in their effect in the past; Example: Capitalizing interest for the first time because in the past the firm was not involved in construction activities to a significant extent. This is not an accounting principle change. 2. Adoption or modification of a principle for transactions that are clearly different in substance from those in the past; 3. A change in method that is a planned procedure as part of the normal application of a method (example: the change to the straight-line method late in the life of an asset depreciated on the double-declining balance method); 4. The change from a principle that is not generally accepted to one that is accepted (treat as an error correction). C. Retrospective Application -- The following steps are performed to implement retrospective application of an accounting principle change. C. Retrospective Application -- The following steps are performed to implement retrospective application of an accounting principle change. 1. The cumulative effect of the change on periods before those presented is reflected in the carrying amounts of affected assets and liabilities as of the beginning of the earliest period presented, along with an offsetting adjustment to the opening balance of retained earnings for that period. 2. The financial statements for prior periods presented comparatively are recast to reflect the period-specific effects of applying the new principle. Each account affected by the change is adjusted as if the new method had been used in those periods. 3. Through a journal entry, the beginning balance of retained earnings in the year of the change is adjusted to reflect the use of the new principle through that date. The amount of this cumulative effect is generally not the same amount as that for step 1 above because different periods are covered in each. Example: Retrospective Application Example: In 20x5, a firm changes from the weighted-average (WA) method of accounting for inventory to FIFO. The 20x3 and 20x4 reports reissued comparatively with 20x5 will now reflect the FIFO method even though in those prior years the WA had been used. The journal entry to record the change will adjust beginning 20x5 inventory and retained earnings to the amounts that would have been in those accounts at that date had FIFO always been used (this is the cumulative effect recorded in the entry - through 1/1/x5). In the retained earnings statement, the beginning balance in retained earnings for 20x3 will be adjusted for the effects of the change on income for all years before 20x3 (this is the cumulative effect reported in the retained earnings statement - through 1/1/x3). The two cumulative effect amounts cover different numbers of years. Justification for Principle Change D. Justification for Principle Change -- An accounting principle change can be made only if the change is required by a new pronouncement, or if the entity can justify the use of an allowable new principle on the basis that it is preferable in terms of financial reporting. The allowable new principle must improve financial reporting given the environment of the firm. Common justifications include changing business conditions, and better matching of revenues and expenses. 1. Caution: When new accounting standards are adopted, retrospective application may not be required, even though the standard may require that a new accounting principle or method be applied. In such cases, the transitional guidance of the new standard is to be followed. Direct and Indirect Effects E. Direct and Indirect Effects -- 1. Indirect effects are changes in current or future cash flows resulting from making a change in accounting principle applied retrospectively. Such changes are recognized in the period of change. Prior period financial statements are not adjusted although a description of the effects, amounts and per share amounts are disclosed in the footnotes. Example: A change in a nondiscretionary profit-sharing plan resulting from a principle change affecting earnings causes the firm to increase profit-sharing payments in the current period as a result of restating prior period income. The payments are recognized as expense in the current year, not retrospectively. 2. Litigation settlements from lawsuits initiated in previous years but paid or received in the current year are also not treated retrospectively. They are considered an event of the period of settlement and included in that period's earnings. Disclosures for Principle Changes F. Disclosures for Principle Changes -- Disclosures in the year of change and also the interim period of change include the following. Subsequent financial statements need not repeat these disclosures. 1. Nature and reason for the change including why the new change is preferable (a change caused by the adoption of a new standard is sufficient justification). 2. Method of applying the change. 3. For current and prior periods retrospectively adjusted, the effect of the change on income from continuing operations and net income, and all other affected line items (for income statement, balance sheet and statement of cash flows), and any affected per share amounts. A firm may provide only the line item information, or may disclose the entire statements as adjusted, in the notes. Disclosures for Principle Changes Continued 4. The cumulative effect on retained earnings (or other relevant equity accounts) as of the beginning of the earliest period presented. 5. If it was not practicable to apply the retrospective method to all periods, the reasons why and a description of the alternative method used report the change. 6. Summaries of financial results (such as major financial statement subtotals for the previous ten years) as reported in the notes are also retrospectively adjusted for the change. (The Start of CPAexcel Flashcards) What is a change in accounting principle? A change from one generally accepted accounting principle to another when there are at least two acceptable principles or when the current principle used is no longer generally accepted. List the three types of accounting changes. 1. Change in accounting principle; How is a change in method that is indistinguishable from a change in estimate accounted for? Change in estimate. What concept is displayed when there is restatement of prior year financial statements? Comparability What accounting approach is used for a change in reporting entity? Retrospective method. List the two accounting approaches for recording accounting changes. 1. Retrospective; What accounting approach is applied to principle changes? Retrospective. What accounting approach is applied to estimate changes? Prospective. What accounting approach is applied to error corrections? Retrospective (Restatement). What is the date of application used by firms for accounting changes? First day of the year of change. What type of changes and events are comparative financial statements of prior periods changed for? Accounting principle changes and error corrections. (Start of CPAexcel Exam Questions) Is the cumulative effect of an inventory-pricing change on prior years' earnings reported as an adjustment to retained earnings for LIFO to weighted average FIFO to weighted average? Both changes in inventory method are changes in accounting principle for which a cumulative effect on prior earnings is computed. The effect on earnings of all prior years is recorded as an after-tax adjustment to the beginning retained earnings in the year of the change. How should a company report its decision to change from a cash-basis to an accrual-basis of accounting? The accrual basis of accounting is required by GAAP. A change from an inappropriate method to the correct method is treated as an error correction. The procedure requires retrospective application, resulting in an after-tax cumulative adjustment to prior years' earnings (called a Prior period adjustment) to the beginning balance in retained earnings. Lore Co. changed from the cash basis to the accrual basis of accounting during 2005. The cumulative effect of this change should be reported in Lore's 2005 financial statements as a The cash basis of accounting is not acceptable under GAAP. Therefore, the change to the accrual basis is a change from an unacceptable method or basis of accounting to an acceptable method or basis. Such a change is treated as an error correction, which is reported as a Prior period adjustment. This adjustment is to the beginning balance in retained earnings for the current year. The effect of a change in accounting principle that is inseparable from the effect of a change in accounting estimate should be reported When an accounting principle change cannot be distinguished from an estimate change, it is accounted for as an estimate change. Changes in accounting estimate are accounted for currently and prospectively and are reported in income from continuing operations. The relevant accounts affected by the change are adjusted for the current and future years. The change is not retroactively applied. The cumulative effect of a change in accounting principle should be recorded as an adjustment to retained earnings, when the change is: Accounting-principle changes such as this one are recorded by retroactively restating prior-year financial statements. The entry to record the change results in an adjustment to the beginning balance of retained earnings in the year of the change. Foy Corp. failed to accrue warranty costs of $50,000 in its December 31, 2003 financial statements. In addition, a change from straight-line to accelerated-depreciation made at the beginning of 2004 resulted in a $30,000 decrease in income for the year. Both the $50,000 and the $30,000 are net of related income taxes. What amount should Foy report as Prior period adjustments in 2004? The failure to accrue warranty expense is an accounting error. It gives rise to a Prior period adjustment in the year of discovery (2004). Prior period adjustments are limited to corrections of errors affecting prior-year net income. They adjust the beginning balance of retained earnings in the year of correction. The change in depreciation method is an estimate change, which is reported in earnings. It is not a Prior period adjustment.
In 2005, Brighton Co. changed from the individual-item approach to the aggregate approach in applying the lower of FIFO cost or market to inventories. The cumulative effect of this change should be reported in Brighton's financial statements as a This accounting change is a change in the application of an accounting principle, which merits the reporting of a cumulative effect of accounting principle change. Accounting-principle changes, as well as changes in the application of principles, are accounted for using the retrospective approach, which recognizes the effect of the change on all prior years affected as an adjustment to retained earnings at the beginning of the year of change. (Start of TBS) Read other side for directions Firms make several types of accounting changes, and other types of items appear to be accounting changes but are not accounted for as such. The ability to distinguish these items, and the approaches used to account for them are necessary for accurate reporting. Several items appear below. For each item in the first column, choose the appropriate accounting approach by double clicking on the shaded cell in the Accounting Approach column and selecting from the list provided. Choose only one response for each item. Item: Change in method of inventory valuation Accounting Approach: Retrospective Item: Correction of error affecting prior period income Accounting Approach: Restatement Item: Change in percentage of credit sales for bad debt expense recognition Accounting Approach: Prospective Item: Change from declining balance method to straight-line method late in the life of a plant asset (normal application) Accounting Approach: Not a change Item: Change from specific method of capitalizing interest to weighted average method Accounting Approach: Retrospective Item: Change in method of amortizing intangibles Accounting Approach: Prospective Item: Change from direct write off method of accounting for bad debts to allowance method Accounting Approach: Retrospective Item: Correction of error in prior period balance sheet: current liability was reported as noncurrent Accounting Approach: Restatement Item: Change in estimate of plant asset useful life; estimate did not consider important facts available at the time of estimation Accounting Approach: Restatement Item: Change to LIFO; computation of prior year income effects impracticable Accounting Approach: Prospective Item: Adoption of LIFO for a newly acquired subsidiary; parent company uses FIFO Accounting Approach: Not a change Item: Change in method of computing depletion of natural resources Accounting Approach: Prospective Item: Change from cash basis to accrual method for warranties; the expense was probable and estimable in the past Accounting Approach: Restatement Item: Capitalization of interest for the first time; interest was immaterial in the past and was expensed Accounting Approach: Not a change Item: Change in the composition of a consolidated group of companies Accounting Approach: Retrospective Item: Change from total approach of applying LCM to the individual unit approach Accounting Approach: Retrospective Which of the following is a change in an accounting estimate?Examples of Changes in Accounting Estimate
Allowance for doubtful accounts. Reserve for obsolete inventory. Changes in the useful life of depreciable assets. Changes in the salvage values of depreciable assets.
Which of the following is a change in accounting estimate achieved by a change in accounting principle?A change in depreciation method is treated as a: change in estimate achieved by a change in accounting principle. When it is impracticable to determine the cumulative effect of prior years of a voluntary change in accounting principle, then the new method is applied beginning ? in the earliest year practicable.
Which of the following is a change in accounting?a change from LIFO to FIFO. The change in the method of inventory costing is considered to be a change in accounting principle.
Which of the following is the characteristic of a change in accounting estimate?A change in accounting estimate is an adjustment of the carrying amount of an asset or liability, or related expense, resulting from reassessing the expected future benefits and obligations associated with that asset or liability.
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