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Flashcards in Ch 22 Deck (47):

FASB established reporting framework for 3 types of accounting changes

1 change in accounting principle

2 change in accounting estimate

3 change in reporting entity


Change in accounting principle

Change in one generally accepted accounting principle
to another

Ex. Company changes inventory valuation from LIFO to
Avg. cost


Change in accounting estimate

Change that occurs as result of new information or
Additional experience

Ex. Company may change its estimate of useful lives of
Depreciable assets


Change in reporting entity

Change from reporting as one type of entity to another
Type of entity

Ex. Company may change the subsidiaries for which it
Prepares consolidated financial statements


4 category that necessitates changes in accounting, though it's not classified as an accounting change

Errors in financial statements


Adoption of a new principle

Recognition of events that have occurred for first time
Or that were previously immaterial

Not an accounting change

Ex. Adopting inventory method for newly acquired items


3 possible approaches for reporting changes in accounting principles

1 report changes currently

2 report changes retrospectively

3 report changes prospectively


Report changes currently

Companies report cumulative effect of change in current
Year's income statement as an irregular item

Effect of change on prior year's income appears only in
Current year income statement


Cumulative effect

Difference in prior year's income between newly adopted
And prior accounting method


Report changes retrospectively: Retrospective application

Refers to application of different accounting principle to
Recast previously issued financial statements

Recast as if new principle had always been used


Report changes prospectively

Principle applied to future financial statements

Current and past financial statements aren't affected


Which of the 3 possible approaches for reporting changes in accounting principles does FASB prefer?

Retrospective approach


When a company changes an accounting principle, what are 2 ways it reports a change applying retrospective application?

1 it adjusts financial statements for each prior period

2 it adjusts carrying amounts of assets and liabilities as
Beginning of first year presented


What happens to the cashflow statement, when accounting principle for reporting inventory is changed from FIFO to LIFO

It stays the same


Example of direct effect

Adjustment to inventory balance as result of change in
Inventory valuation method


Indirect effect

Any change to current or future cashflows of company that
Result from making change in accounting principle that's
Applied retrospectively

Indirect effects do not change prior period amounts


Retrospective application is considered impracticable is a company...

Can't determine prior period effects using reasonable efforts
To do so


Companies should not use retrospective application if 1 of the following 3 conditions exists

1 company can't determine effects of retrospective application
2 retrospective application requires assumptions about
Management's intent in prior period
3 retrospective application requires significant estimates
That can't objectively be verified


When retrospective application is impracticable, what does a company apply?

Company prospectively applies new accounting principle
Of earliest date it's practical to do so


What 7 items require changes in future estimates?

1 uncollectible receivables
2 inventory obsolescence
3 useful lives and salvage values of assets
4 periods benefited by deferred costs
5 liabilities for warranty costs and income taxes
6 recoverable mineral reserves
7 change in depreciation methods


How are changes in accounting estimates reported?

Reported prospectively

Viewed as normal recurring corrections and adjustments


Calculating depreciation charge (equation)

Depreciation charge = book value of asset/remaining service life


Companies account for a change in depreciation methods as a...

Change in estimate effected by a change in accounting


Changes in reporting entity: in such cases companies report Change by...

Changing financial statements of all prior periods presented


4 examples in change of reporting entities

1 consolidated financial statements for individual companies
2 changing specific subsidiaries
3 changing companies in combined financial statements
4 changing cost, equity or consolidation method for
Subsidiary and investments


Accounting error types: Expense recognition

Recording expenses in incorrect period or incorrect amount


Accounting error types: revenue recognition

Improper revenue accounting, including questionable revenue
Recognized, misreported revenue


Accounting error types: misclassification

Misclassifying significant items on BS, IS or Sof Cashflows


Accounting error types: equity

Improper accounting for EPS, restricted stock, warrants
And other equity instruments


Accounting error types: reserves/contingencies

Errors involving bad debts related to A/R, inventory reserves,
Income tax allowances, loss contingencies


Accounting error types: long lived assets

Asset impairments of property, plant, equipment, goodwill
Or other related items


Accounting error types: taxes

Errors involving correction of tax provision, improper
treatment of tax liabilities and other tax related items


Accounting error types: equity-other comprehensive income

Improper accounting for other comprehensive income equity

Includes foreign currency items, unrealized G/L on debt or
Equity or derivatives


Accounting error types: equity-stock options

Improper accounting for employee stock options


Other accounting errors would relate to...

Acquisitions or mergers


Corrections of errors

Recorded as soon as found

Adjustment is made to beginning balance of retained
earnings in current period


Prior period adjustments

Adjustment to beginning balance of retained earnings
In current period



Used for process of revising previously issued financial


Reasons companies prefer certain accounting methods?

1 political costs
2 capital structure
3 bonus payments
4 smooth earnings


Economic consequence arguments

Focus on impact of accounting method on behavior of
Investors, creditors, competitors, governments or company


What is an important element of faithful representation?



Counterbalancing errors

Those that will be offset or corrected over 2 periods

Ex. Failure to record accrued wages is counterbalancing
Error b/c over 2 yr. period error will no longer be present


Non counterbalancing errors

Those that aren't offset in next accounting period

Ex. Failure to capitalize equipment that has useful life of
5 years


If a company has closed the books in the current year: If error is already counter balanced

No entry is necessary


If a company has closed the books in the current year: if error is not yet counterbalanced

Make entry to adjust present balance of retained earnings


If a company has not closed the books in the current year: If error is already counterbalanced

Make entry to correct error in current period

And adjust beginning balance of retained earnings


If a company has not closed the books in the current year: if error is not yet counterbalanced

Make entry to adjust beginning balance of retained earnings