1. ACCOUNTING CHANGES AND ERROR CORRECTIONS Chapter 20 © 2009 The McGraw-Hill Companies, Inc.

2. McGraw-Hill /Irwin Slide 2 Accounting Changes

3. McGraw-Hill /Irwin Slide 3 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 accounted 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 accounted 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.

4. McGraw-Hill /Irwin Slide 4 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.

5. McGraw-Hill /Irwin Slide 5 Retrospective Approach 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.

6. McGraw-Hill /Irwin Slide 6 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. Prospective Approach – Some Changes in Principle Most changes in principle are reported by the retrospective approach, but:

7. McGraw-Hill /Irwin Slide 7 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. Prospective Approach – Change in Accounting Estimate

8. McGraw-Hill /Irwin Slide 8 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.

9. McGraw-Hill /Irwin Slide 9 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 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 net income, income before extraordinary items, and related per share amounts should be shown for all periods presented.

10. McGraw-Hill /Irwin Slide 10 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. 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. Error Correction

11. McGraw-Hill /Irwin Slide 11 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. Correction of Accounting Errors

12. McGraw-Hill /Irwin Slide 12 Counterbalancing error discovered in the second year. Noncounterbalancing error discovered in any year. Use the retrospective approach Prior Period Adjustment Required Prior Period Adjustments

13. McGraw-Hill /Irwin Slide 13 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)

14. McGraw-Hill /Irwin Slide 14 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.

15. McGraw-Hill /Irwin Slide 15 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.

16. McGraw-Hill /Irwin Slide 16 Summary of Accounting Changes and Errors

17. McGraw-Hill /Irwin End of Chapter 20 © 2008 The McGraw-Hill Companies, Inc.