Accounting changes & Adjusting Entries

Changes

1. Change in estimate = Prospective

2. Change in principle-general rule = retrospective

3. Change in accounting entity = restate

4. Error corrections are not considered accounting changes

Change from FIFO to LIFO.

Change from FIFO to LIFO is a change in accounting principle, it is generally handled prospectively because it’s often impractical to apply this change retrospectively.

Change in accounting principle

1. A change in accounting principle occurs when an entity adopts a generally accepted principle different from the one previously used.

2. An accounting principle may be changed only if required by GAAP or if justified.

   a. Justified means that the new method more fairly presents the information.

Adjustment for change in accounting principle

Note. If the change is made in the current year, you only need to adjust the beginning balance.

Note: adjustments are NOT made on the Income Statement.

Change in reporting entity

1. changes in reporting entity are applied retrospectively

2. Disclosure requirements: the entity must disclose in the footnotes, the nature of the change, the reason for the change, and its impact on the financial statements. Additionally, the entity should disclose the effect of the change on net income, and any other affected financial statement items for all periods presented, including interim periods.

Error corrections – prior period adjustments

1. Errors include math mistakes, mistakes in applying accounting principles, (using cash basis, instead of accrual basis), and misclassification of accounts, or failure to accrue expenses or revenues when statements were issued.

2. If you are making a correction for depreciation error, remember to adjust accumulated depreciation for the gross amount do not take the tax into effect.

How is beginning retained earnings adjusted?

1. Note: if there are multiple adjustments to beginning retained earnings, they must be listed separately on individual lines.

2. Note the distinction between the affects on Net Income vs Retained Earnings (an adjustment to beginning Retained Earnings is an adjustment to Retained Earnings in the current period)

Statement of retained earnings

1. For publicly traded companies, presenting a statement of retained earnings, is a regulatory requirement.

2. What is the primary purpose of the statement of retained earnings?

   a. To show how retained earnings have changed during a period.

Adjusting journal entries

1. In order for financial statements to be prepared in accordance with the accrual basis of accounting, adjusting entries must be recorded.

2. The purpose of adjusting journal entries is to record, revenues and expenses in the correct periods; not necessarily when cash is received or paid.

3. Note, when preparing journal entries, there will be no impact on cash.

4. A balance sheet account and an income statement account will be impacted.

Unearned, revenues, and prepaid expenses

If expenses have been deferred (prepaid), the company must calculate the amount of expenses that have been incurred through year-end and make the appropriate adjusting journal entry.

1. Journal entry to record, prepaid expense:

   a. Dr Prepaid expense (asset) $xxx

   Cr Cash $xxx

2. Adjusting journal entry to reverse prepaid expense and record incurred expense:

   a. Dr Expense $xxx

   Cr. Prepaid expense $xxx

Accrued revenues and expenses

1. An entity must assess whether the revenues have been earned prior to the cash being received.

2. If so, revenue must be accrued by recording a receivable.

3. Journal entry to record, accrued revenue:

   a. Dr A/R $xxx

   Cr Revenue. $xxx

4. Note: this is not a year end, adjusting entry. Another adjusting entry will be recorded when the cash is received.

Error Corrections

Note: unlike an adjusting entry which only hits one balance sheet account and one income statement account, an error correction could affect any account depending on the specific error made.

1. In some instances, an entity may record cash receipts (disbursement) to a revenue/expense account when they should’ve been recorded to an asset/liability account.

2. An adjusting entry may be required in this case to ensure that the financial statements are in accordance with the accrual basis of accounting.