Type of Change Change in Accounting Principle

Description Examples Change from one generally Adopt a new FASB standard. accepted accounting principle Change method of inventory costing. to another. Change from FV method to equity method, or vice versa. Change from completed contract to percentage-of completion, or vice versa.

Two Reporting Approaches: Retrospective

Prospective

Error Corrections and Most Changes in Principle = Retro

Revise prior years statements (that are presented for comparative purposes) to reflect the impact of the change. The balance in each account affected is revised to appear as if the newly adopted accounted method had been applied all along or that the error had never occurred. Adjust the beg bal of retained earnings for the earliest period reported.

Change in Accounting Estimate

Revision of an estimate because of new information or new experience

Change depreciation methods. Change estimate of useful life of depreciable asset. Change estimate of residual value of depreciable asset. Change estimate of bad debt % Change acturial estimates pertaining to a pension plan.

Changes in Estimates and Some Changes in Principle = Prosp

The change is implemented in the current period, and its effects are reflected in the financial statements of the current and future years only. Prior years statements are not revised. Account balances are not revised. Retrospective Treatment: Corrections of errors Most changes in accounting principle Changes in reporting entity Prospective Treatment: Changes in estimates including a change in depreciation methods Chang in acc principle when retro app is not poss (e.g. FIFO to LIFO) Changes in acc principle when prosp application is required by GAAP

Change in Reporting Entity

Change from reporting as one Consolidate a subsidiary not type of entity to previously included in consolidated another type of entity financial statements. Report consolidated financial statements in place of individual statements.

Type of Change Error correction

Description Correction of an error caused by a transaction being recorded incorrectly or not at all

Examples Mathematical mistakes. Inaccuract physical count of inventory. Change from the cash basis of accounting to the accrual basis. Failure to record an adjusting entry. Recording an asset as an expense, or vice versa.

It is impracticable to determine some period- specific effects. It is impract to determine the cumulative effect of prior years.

A change in depreciation method is considered to be a change in accounting estimate that is achieved by a change in accounting principle. It is accounted for prospectively as a change in accounting estimate

Straight Line: $243,000 $3,000 = $24,000 (2006 2009) 10 years $24,000 4 years = $96,000 Accum. Depr. $243,000 $96,000 = $147,000 Book Val $147,000 $3,000 = $72,000 (2011 & 2012) 2 years
Sum-of-the-Years-Digits Depreciaton (millions) Sum-of-the-Years-Digits Depreciaton (millions) 2009 depreciation $ 20 ($60 x 5/15) 2009 depreciation $ 20 ($60 x 5/15) 2010 depreciation 16 ($60 x 4/15) 2010 depreciation 16 ($60 x 4/15) Accumulated depreciation $ 36 Accumulated depreciation $ 36
Calculation of Straight-Line Depreciation ($ in millions) Asset's cost Less accumulated depreciation to date of change Undepreciated cost on January 1, 2011 Less estimated residual value To be depreciated over remaining three years Remaining life Annual straight-line depreciation (2011-2013) $ 63 36 $ 27 3 $ 24 3 years $ 8

Income Statements ($ in millions) 2011 950 370 230 $ 350 140 $ 210 $ 2010 900 365 210 $ 325 130 $ 195 $ 2009 875 360 205 $ 310 124 $ 186 $

Revenues Cost of goods sold (FIFO) Operating expenses Income before tax Less: Income tax expense (40%) Net income

Cost of goods sold (LIFO) Cost of goods sold (FIFO) Difference

Previous 2011 2010 2009 Years $ 430 $ 420 $ 405 $ 2,000 370 365 360 1,700 $ 60 $ 55 $ 45 $ 300

Comparative balance sheets will report 2009 inventory $345 million higher than it was reported in last years statements. Retained earnings for 2009 will be $207 million higher. [$345 million (1 40% tax rate)] Comparative balance sheets will report 2010 inventory $400 million higher than it was reported in last years statements. Retained earnings for 2010 will be $240 million higher. [$400 million (1 40% tax rate)] Comparative balance sheets will report 2011 inventory $460 million higher than it would have been if the change from LIFO had not occurred. Retained earnings for 2011 will be $276 million higher. [$460 million (1 40% tax rate)] On January 1, 2011, the date of the change, the following journal entry would be made to record the change in principle. 40% of $400,000,000 (tax rate) January 1, 2011: Inventory .................................................... 400,000,000 Retained earnings ............................ 240,000,000 Income tax payable ... 160,000,000 To increase inventory, retained earnings, and income tax payable as a result of the change from LIFO to FIFO.

Depreciation expense ..............................8,000,000 Accumulated depreciation ............ 8,000,000 To record depreciation expense. A change in reporting entity occurs as a result of: lidated financial statements in place of statements of ind companies, mpanies that constitute the group for which consolidated statements are prepared. Summary of the Retrospective Approach for 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: ould describe the nature of and the reason for the change. hange on net income, income before extraordinary items, and related per share amounts should be shown for all periods presented.

Examples include: Use of inappropriate principle Mistakes in applying GAAP Arithmetic mistakes Fraud or gross negligence in reporting For all years disclosed, financial statements are retrospectively restated to reflect the error correction.

In the first set of financial statements after the change is made, a disclosure note is needed to Provide justification for the change. Point out that comparative information has been revised. Report any per share amounts affected for the current and all prior periods.