F2 M2 Accounting Changes and Error Corrections

change in accounting principle inseparable from change in accounting estimate

when a company changes its accounting method, but the effect of that method cannot be separated from revised estimates; accounted for prospectively, effects current and future periods, and reported in current period income from continuing operations

adjustment of retained earnings for a change in an accounting principle

apply new principle as if it had always been used (retrospective); restate prior financial statements that are presented, beginning retained earnings adjusted for earliest period presented; net of tax; use new principle for current and future period (ex: changes in inventory method, FIFO to weighted-avg.)

adjustment of retained earnings for a change in an accounting estimate

do NOT adjust retained earnings; do NOT restate prior periods; account for the change prospectively in current and future periods; current period’s income changes, NOT retained earnings (ex: extension of life on equipment, going from FIFO to LIFO, etc.)

adjustment of retained earnings for a change in an accounting error

correct retrospectively; restate prior financial statements presented; adjust beginning retained earnings of earliest periods presented; net of tax (ex: using incorrect GAAP method)

revenue overstated

• effect on net income and retained earnings: overstated

• correction: decrease retained earnings, net of tax

revenue understated

• effect on net income and retained earnings: understated

• correction: increase retained earnings, net of tax

expense overstated

• effect on net income and retained earnings: understated

• correction: increase retained earnings, net of tax

expense understated

• effect on net income and retained earnings: overstated

• correction: decrease retained earnings, net of tax

asset overstated

• effect on net income and retained earnings: usually overstated

• correction: decrease the asset and decrease retained earnings, net of tax

asset understated

• effect on net income and retained earnings: usually understated

• correction: increase the asset and increase retained earnings, net of tax

liability overstated

• effect on net income and retained earnings: usually understated

• correction: decrease the liability and increase retained earnings, net of tax

liability understated

• effect on net income and retained earnings: usually overstated

• correction: increase the liability and decrease retained earnings, net of tax

equity overstated

• correction: decrease equity

equity understated

• correction: increase equity