Accounting Changes, Error Corrections & Fair Value Measurement

Question 1

Changes in Accounting Estimate

Answer 1

• Change in a accounting estimate occurs when there is a revision of an estimate due to changes in circumstances. usually treated prospectively
• Examples of Changes in Accounting estimates
• Change in service lives or salvage values of depreciable assets
• Change in the percentage of uncollectible receivables.
• Change in warranty obligations
• Obsolescence of Inventory
• Settlement of Litigation
• Material. non-recurring IRS adjustments
• Changes in Depreciation, Amortization, and Depletion methods that are changes in Accounting principle inseparable from a change in estimate and treated as change in accounting estimate.

Question 2

Accounting form Changes in accounting estimate

Answer 2

• Prospective application
• Change is applied to the current period and all future periods, but prior periods remain unaffected.
• Disclosure
• The effect in income from continuing operations, net income, and earnings per share (EPS) of the current period must be disclosed.

Question 3

Changes in accounting Principle

Answer 3

-Consistency
*Accounting principles should be applied consistently across accounting periods.

Justified Change
* A Change in accounting principle is allowed if one of the following applies:
- Change is required by GAAP
- Change results in better accounting
- Change in accounting principle refers to a shift from one acceptable accounting principle to another, such as a change from one GAAP method to another.

Examples of Changes in Accounting Principles include:
- Change in inventory flow method ( FIFO, LIFO)
- Change in construction accounting methods (e.g. Percentage of completion to completed contract)

Question 4

Accounting for Changes in accounting principles

Answer 4

-Retrospective Application
* Adjust cumulative effect of periods before those presented by adjusting the opening balances of Retain Earnings, Assets, and liabilities for the earliest period presented.
* Adjust financial statements for periods presented
* apply the changes to current and future periods
* Only the direct effects of the change, including related income tax effects, are accounted for retrospectively. Indirect effects are reported in the period of the change.

• Disclosure Requirements
• Nature of the change
• Method of applying the change
• Effects on Financial Statements

Question 5

Changes in Reporting Entity

Answer 5

• A Change in the reporting entity refers to a modification in the structure or composition of the entity whose financial statements are being presented.
• This change essentially results in the financial statements reflecting those of a different reporting entity.
• Common scenarios for change in reporting entity
• presenting consolidated or combined financial statements
• Changing specific subsidiaries in consolidated financial statements
• Changing the entities included in combined financial statements.

Question 6

Accounting for changes in reporting entity

Answer 6

-Retrospective application

-Disclosure requirements
* Nature of the change
* Reason for the change
* Effect on income and equity

Question 7

Error Correction

Answer 7

• Error correction in accounting refers to the process of identifying and rectifying mistakes or inaccuracies in previously issued Financial statements.
• Error correction is not considered an accounting change but is handled retrospectively.
• Types of errors
• Mathematical mistakes
  *Mistakes in applying accounting principles
• Oversight or misuse of facts
• Changes from Non-GAAP to GAAP

Question 8

Accounting for error correction

Answer 8

Retrospective application
* Adjust cumulative effect of periods before those presented by adjusting the opening balances of retained earnings, assets, and liabilities for the earliest period presented.
* Adjusted financial statements for periods presented.

• Disclosure requirements
• Nature of the error
• Effect on financial statements
• Cumulative effect on Retained Earnings

Question 9

Fair Value Measurement

Answer 9

Description
- fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly arm’s length transactions between market participants at the measurement date. This is often referred to as the exit price.

Application
- Investments in stocks and bonds
- Derivative instruments
- Commodity inventories
- Impairment testing
- Employee stock options
- Financial assets and liabilities

Question 10

Fair Value Measurement Process

Answer 10

Step #1
Determine the principal or most advantageous market
* Use principal market, if the principal market is not known use the most advantageous market.

Step #2
- Determine appropriate Valuation technique
* Market Approach
* Income Approach
* Cost Approach

Step #3
FV inputs
- Level 1 inputs
* Level 1 inputs are quoted prices in active markets for identical assets or liabilities that the entity can access at the measurement date.

Level 2 inputs
* Level 2 inputs include quoted prices for similar assets or liabilities in active markets, interest rates, yield curves, credit risks, etc.

Level 3 inputs
- level 3 inputs include unobservable inputs for the asset or liability, reflecting the entity’s assumption about the assumptions that market participants would use in pricing the asset or liability.

Step #4
Calculate the FV of the asset or liability.

Question 11

Fair Value Disclosure

Answer 11

• Extent of FV usage
  -Inputs and valuation techniques
• Reconciliation for level 3 inputs
  -effect on earnings
• Financial instruments