Accounting Changes and Error Corrections

Flashcards covering the three types of accounting updates, reporting approaches (Retrospective, Prospective, Modified Retrospective), and error correction procedures.

Accounting Categories of Updates

The three categories covered in Chapter 20: accounting changes in principle, changes in estimate, and error corrections.

Change in Accounting Principle

A change from one generally accepted accounting principle to another, such as switching from LIFO to FIFO inventory costing.

Change in Accounting Estimate

A revision of a previous prediction about future events or outcomes, such as updating the percentage used for warranty expense or changing the residual value of a machine.

Retrospective Approach

A reporting approach that requires revising financial statements issued in previous years as if the new method had been applied all along.

Prospective Approach

A reporting approach that reflects effects of a change only in the current and future years, used for changes in estimates and most depreciation method changes.

Modified Retrospective Approach

An approach where a new standard is applied only to the adoption period with a cumulative adjustment to the beginning balance of retained earnings.

Retained Earnings Adjustment

In a retrospective change, the cumulative effect of the change is presented as an adjustment to the beginning balance of this account.

LIFO Reporting Exception

The primary exception to the retrospective approach for a change in accounting principle because it is often base-year dependent and practically impossible to calculate retrospective effects.

Depreciation, Amortization, and Depletion Changes

Changes in these methods are handled prospectively because they are considered a change in estimate achieved by a change in principle.

Prior Period Adjustment

An addition to or reduction in the beginning retained earnings balance to correct an error that occurred in a prior year.

Error Correction Step 1

Make a journal entry to correct any incorrect account balances.

Error Correction Step 2

Retrospectively restate the incorrect previous years' financial statements.

Self-Correcting Error

An error that resolves itself over time; if not discovered until after the self-correction occurs, no journal entry is needed, though prior statements are still restated.

Consistency

The practice of choosing accounting methods from year to year to ensure comparability of financial statements over time.

Warranty Estimate Update (Math)

Example where Universal Semiconductors changes its estimate from $2\%$ to $3\%$ of sales; handled prospectively with no prior period adjustments.

Asset Correction Calculation ($7$ million)

If a $\$7$ million asset with a 5-year life was expensed in 2025, the accumulated depreciation that should have been recorded by the end of 2026 is $\$2.8$ million ($\$7 \div 5 \times 2$ years).

Retained Earnings Credit (Tax Impact)

If a change to FIFO has a cumulative pre-2027 COGS difference of $\$384$ million and a $25\%$ tax rate, the credit to Retained Earnings is $\$288$ million ($\$384 \times (1 - 0.25)$).

Inventory Principle Change Formula

The adjustment to Retained Earnings (ignoring taxes) is the cumulative difference in cost of goods sold for all prior years.