Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Chapter 20 Accounting Changes and Error Corrections

20-2 Accounting Changes

20-3 Correction of an Error

20-4 Error Corrections and Most Changes in Principle Retrospective Two Reporting Approaches Prospective 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 accounting method had been applied all along or that the error had never occurred.  Adjust the beginning balance of retained earnings for the earliest period reported. 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 accounting method had been applied all along or that the error had never occurred.  Adjust the beginning balance of retained earnings for the earliest period reported.

20-5 Changes in Estimates and Some Changes in Principle Retrospective Two Reporting Approaches Prospective 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.

20-6 Motivation for Accounting Choices Changing Conditions New Accounting Standard Issued Effect on Compensation Effect on Debt Agreements Effect on Union Negotiations Motivations for Change Effect on Income Taxes

20-7 Disclosure Notes 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.

20-8 Prospective Approach The prospective approach is used for changes in principle when:  It is impracticable to determine some period-specific effects.  It is impracticable to determine the cumulative effect of prior years.  The change is mandated by authoritative pronouncements. The prospective approach is used for changes in principle when:  It is impracticable to determine some period-specific effects.  It is impracticable to determine the cumulative effect of prior years.  The change is mandated by authoritative pronouncements. Most changes in principle are reported by the retrospective approach, but:

20-9 Prospective Approach: Change in Accounting Estimate 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.

20-10 Change in Reporting Entity A change in reporting entity occurs as a result of  presenting consolidated financial statements in place of statements of individual companies, or  changing specific companies that constitute the group for which consolidated statements are prepared. A change in reporting entity occurs as a result of  presenting consolidated financial statements in place of statements of individual companies, or  changing specific companies that constitute the group for which consolidated statements are prepared.

20-11 Change in Reporting Entity 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:  A disclosure note should describe the nature of and the reason for the change.  The effect of the change on revenue, net income, income before extraordinary items, and related per share amounts should be shown for all periods presented. Recast all previous periods’ financial statements as if the new reporting entity existed in those periods. In the first financial statements after the change:  A disclosure note should describe the nature of and the reason for the change.  The effect of the change on revenue, net income, income before extraordinary items, and related per share amounts should be shown for all periods presented.

20-12 Error Correction Examples include:  Use of inappropriate principle  Mistakes in applying GAAP  Arithmetic mistakes  Fraud or gross negligence in reporting For all years presented, financial statements are retrospectively restated to reflect the error correction. Examples include:  Use of inappropriate principle  Mistakes in applying GAAP  Arithmetic mistakes  Fraud or gross negligence in reporting For all years presented, financial statements are retrospectively restated to reflect the error correction.

20-13 Correction of Accounting Errors Four-step process  Prepare a journal entry to correct any balances.  Retrospectively restate prior years’ financial statements that were incorrect.  Report correction as a prior period adjustment if retained earnings is one of the incorrect accounts affected.  Include a disclosure note. Four-step process  Prepare a journal entry to correct any balances.  Retrospectively restate prior years’ financial statements that were incorrect.  Report correction as a prior period adjustment if retained earnings is one of the incorrect accounts affected.  Include a disclosure note.

20-14 Counterbalancing error discovered in the second year. Noncounterbalancing error discovered in any year. Use the retrospective approach Prior Period Adjustment Required Prior Period Adjustments

20-15 Errors Occurred and Discovered in the Same Period Corrected by reversing the incorrect entry and then recording the correct entry (or by making an entry to correct the account balances)

20-16 Errors Not Affecting Prior Years’ Net Income Involves incorrect classification of accounts. Requires correction of previously issued statements (retrospective approach). Is not classified as a prior period adjustment since it does not affect prior income. Disclose nature of error. Involves incorrect classification of accounts. Requires correction of previously issued statements (retrospective approach). Is not classified as a prior period adjustment since it does not affect prior income. Disclose nature of error.

20-17 Error Affecting Prior Year’s Net Income  Requires correction of previously issued statements (retrospective approach).  All incorrect account balances must be corrected.  Is classified as a prior period adjustment since it does affect prior income.  Disclose nature of error.  Requires correction of previously issued statements (retrospective approach).  All incorrect account balances must be corrected.  Is classified as a prior period adjustment since it does affect prior income.  Disclose nature of error.

20-18 Reporting Accounting Changes and Error Corrections

20-19 Summary of Accounting Changes and Errors

20-20 End of Chapter 20