I would like to record about the key points of the US CPA exam content.
<Create and note the points based on mainly Becker’s workbook>
Change in Accounting Principle
- Retrospective Adjustment: Changes in accounting principles are applied retrospectively to past financial statements. This means previously issued financial statements are revised to reflect the new principles, thus maintaining continuity and comparability of the financial statements.
- Cumulative Effect Adjustment: The effect of the change is recognized in a lump sum adjustment to retained earnings or the appropriate equity accounts at the beginning of the first reporting period in which the change is adopted. This adjustment reflects the cumulative effect as if the change had been made retrospectively.
- Disclosure Requirements: In relation to changes in accounting principles, companies must disclose the reasons for the change, the impact of the change on the financial statements, and the details of any adjustments made to the prior year’s financial statements. This disclosure helps stakeholders understand the overall impact of the change.
- Example of change in accounting principle: A new FASB Standard is implemented. A change from FIFO to LIFO, which is accounted for prospectively like a change in accounting estimate because it is too difficult to calculate the cumulative effect of the change. However, this can be changed only if required by GAAP or if the alternative is preferable and more fairly presents the information.
- A change from LIFO to another inventory cost flow assumption requires a cumulative catch-up adjustment as of the beginning of the year of change. The beginning balance of retained earnings is adjusted, net of tax. 400,000 × (1 − .30) = 280,000. A change from LIFO to another method is reported by restating prior period financial statements in a manner similar to a prior period adjustment.
Changes in accounting estimate
- It usually occurs as a result of new information or better judgment becoming available. Such changes are not processed retrospectively; instead, they are applied prospectively from the point the change is recognized. This means that the change impacts only the financial reporting for the period in which the change is made and future periods, and past financial statements are not amended.
- Example of a change in estimate: new estimate of warranty cost, the tax accrual adjustment.
- When the effect of a change in accounting principle is inseparable from the effect of a change in accounting estimate, the reporting treatment for the overall effect is as a change in estimate. Thus, the effect is reported prospectively as a component of income from continuing operations
- Depreciation method change : As of the beginning of Year 3, the equipment has $3,800 of accumulated depreciation ($1,900 × 2). The new cost basis going into Year 3 is $16,200, and the new useful life of 5 years implies there are only 3 years left. Change in accounting estimate which reflected in current earnings.
- Depreciation method change from accelerated to straight-line in Year4 : $25,600 ($50,000 – $10,000 – $8,000 – $6,400) is the basis going into Year 4, whereas the straight-line method uses salvage value and the remaining useful life of 7 years. Change in accounting principle inseparable from a change in estimate which reflected in current earnings.
- Depreciation method change from specific identification to average cost, change in accounting principle-reflected in beginning related earnings.
Distinguishing between changes in accounting estimates and corrections of accounting errors.
- Change in accounting estimate: A change in accounting estimate is based on new information, additional experience, or better judgment. For example, updating depreciation calculations based on changes in the expected useful life or residual value of an asset is considered a change in estimate. Changes in estimates are applied prospectively from the point they are recognized, and past financial statements are not revised.
- Accounting Error: An accounting error occurs due to misrecognition of facts, mathematical errors, misunderstanding, or incorrect application of accounting principles in previous reporting periods. If an error in the calculation of depreciation is discovered later (for example, due to an incorrect formula or misclassification of an asset), the correction is treated as an accounting error. Corrections of accounting errors are made retrospectively, and all affected periods’ financial statements need to be amended.
Financial statement of all prior periods presented should be restated
- Changing companies in consolidated financial statements: This refers to changes in the group of companies included in consolidated financial statements, such as when a new company is added to the group due to an acquisition or an existing company is removed due to a sale.
- Consolidated financial statements versus previous individual financial statements: This scenario occurs when a company that previously issued only individual financial statements starts issuing consolidated financial statements. The change requires restating previous financial statements to reflect the new reporting standards, as the prior individual financial statements and current consolidated financial statements represent fundamentally different entities.
