Module 2: Accounting Changes and Error Corrections

Question 1

Changes in Estimate

Answer 1

They are reported on income from continuing operations.
*Estimates affect only the current and subsequent periods (not prior periods and not retained earnings).

Question 2

Change in Entity

Answer 2

Results from:
-Changing companies consolidated financial statements
-Consolidated financial statements vs previous individual financial statements.
*Financial statements of all prior periods presented should be restated when there is a “change in entity”

Question 3

Effect of a Change in Accounting Principle when comparative financial statements are presented

Answer 3

As an adjustment to the beginning Year 2 inventory balance with an offsetting adjustment to beginning Year 2 retained earnings

Question 4

Correction of an error in the financial statements (not presenting comparative financial statements)

Answer 4

Is reported, net of tax, in the current statement of retained earnings as an adjustment of the opening balance.

Question 5

change in depreciation method

Answer 5

Is no longer considered to be a change on accounting principle. A change in depreciation method is now considered to be both a change in method and a change in estimate. This changes should now be accounted for as a change in estimate and handled prospectively.

Question 6

Changing from cash basis of accounting to accrual

Answer 6

Is a correction of an error, since cash is not acceptable under GAAP. The correction of an error from a prior period is reported as prior period adjustment to retained earnings.

Question 7

Error Correction

Answer 7

Adjust beginning retained earnings only
*for a year currently shown
→ Adjust current earnings for that year only.

Question 8

Change in accounting principle

Answer 8

(retrospective change)
→ Adjust beginning retained earnings for the earliest year shown to fix prior years.
→ Also adjust current earnings going forward.

Question 9

Change in Accounting Estimate

Answer 9

(like depreciation method change)
→ No adjustment to beginning retained earnings.
→ Only current and future years’ earnings are affected.

Question 10

Why do we adjust both assets/liabilities and beginning retained earnings when correcting prior period errors?

Answer 10

Because accounting must stay balanced, correcting an error means adjusting the related asset or liability and the beginning retained earnings (equity) together. You can’t adjust retained earnings alone without fixing the underlying balance sheet accounts.