ACC 302 EXAM 3

Three types of accounting changes

• Change in accounting principle

• Change in accounting estimate

• Error correction

Reporting approach for a change in accounting principle

Retrospective (with limited exceptions such as change to LIFO)

Reporting approach for a change in accounting estimate

Prospective

Reporting approach for error corrections

Retrospective

Definition of retrospective approach

Revises prior financial statements as if the new method had always been used

Definition of prospective approach

Applies the change only to current and future periods

What is the modified retrospective approach?

Apply the new standard only to the adoption period and adjust beginning retained earnings

How are changes in accounting estimates reported?

Prospectively

Why are depreciation method changes treated as estimate changes?

Because they affect an estimate (depreciation expense), even though they technically involve a principle

What is an example of a change in accounting estimate?

Changing warranty expense from 2% to 3% of sales.

Do only prior periods get revised for a change in estimate?

No, only current and future periods reflect the change

How are changes in depreciation method handled?

Prospectively — compute new depreciation based on remaining book value, residual value, and remaining life

What are the three steps in correcting an accounting error?

1. Journal entry to fix incorrect accounts

2. Restate prior financial statements

3. Adjust beginning retained earnings if affected

What must be included in the disclosure note for an error correction?

Nature of the error, impact on each financial statement line item, and per‑share effects for each period presented

How are errors involving unrecorded sales revenue corrected?

Increase sales revenue and retained earnings for the period in which revenue should have been recorded

What is a prior period adjustment?

A correction to beginning retained earnings for errors affecting prior‑year net income

How are errors discovered in the same period handled?

Reverse the incorrect entry and record the correct one — no retrospective restatement needed

Primary purpose of the statement of cash flows

To explain the change in the cash balance during the period

Key usefulness of cash flow information

Helps assess profitability, risk, financing, sources, and how cash in generated and used

Definition of cash equivalents

Short-term, highly liquid investments readily convertible to cash with little risk of loss

Operating activities definition

Cash flows related to transactions affecting net income

Investing activities definition

Cash flows from acquiring and disposing of long-term assets and investments

Financing activities definition

Cash flows from external financing such as issuing stock, borrowing, and paying dividends

Direct method starting point

Net income

Direct method operating cash flows

Reports specific cash inflows and outflows such as cash from customers and cash paid to suppliers

Example of an investing cash outflow

Purchasing property, plant, and equipment

Example of financing cash flow

Issuing common stock or issuing debt

Definition of non-cash investing and financing activities

Transactions that do not involve cash, such as acquiring equipment by issuing a note