ACCOUNTING CHANGES
Types of Accounting Changes
1. Change in accounting principle-Change from one generally accepted accounting
principle to another.
2. Change in accounting estimate-Revision of an estimate because of new information or
new experience.
3. Change in reporting entity-Change from reporting as one type of entity to another type
of entity.
4. Correction of an error-Correction of an error caused by a transaction being recorded
incorrectly or not at all.
CHANGE IN ACCOUNTING PRINCIPLE
Changing from one acceptable accounting principle to another acceptable accounting principle is
accounted for as a change in accounting principle. This does not include the adoption of a new
accounting principle because the entity has entered into transactions for the first time that require
specific accounting treatment. It also does not include the change from an inappropriate
accounting principle to an acceptable accounting principle. The later would be classified as the
correction of an error.
The types of changes that might be included in a change in accounting principle are:
Adoption of a new FASB accounting standard
Change in the method of inventory costing
Change to, or from, the cost method to the equity method
Change to, or from, the completed contract to percentage-of-completion method
CHANGE IN ACCOUNTING ESTIMATE
At the end of each accounting period there are a number of estimates made in order to prepare
the financial statements. These estimates are based on the facts and circumstances that exist at
the time. These facts and circumstances will change from one accounting period to the next. It
is not practical to restate the financial statements every time there is new information that makes
the prior estimates incorrect. Therefore, on an ongoing basis management applies its best
judgment and modifies such estimates as the facts and circumstances change in each subsequent
accounting period. A change in accounting estimate is handled on a prospective basis.
CHANGE IN REPORTING ENTITY
Under certain circumstances management is required to restate the financial statements of all
prior periods. These circumstances relate to a change in the reporting entity. Such changes
include:
Presenting consolidated financial statements for the first time.
Changing specific subsidiaries for which consolidated financial statements are presented.
Changing companies included in combined financial statements
Change in the cost, equity, or consolidation method used for accounting for subsidiaries
and investments.
CORRECTION OF AN ERROR
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2003
$1,050
683
368
231
137
27
$109
Revenue
Cost of goods sold (LIFO)
Gross profit
Operating expenses
Income before tax
Income tax
Net income
2002
$980
637
343
216
127
25
$102
Years
Prior to
2002
$3,800
2,470
1,330
836
494
99
$395
The following are the inventory amounts reported in the balance sheet at the end of each of the
years 2001 through 2003.
Balance Sheets
2003
$150
Inventory (LIFO)
2002
$130
2001
$120
The cumulative effect of the change from LIFO to FIFO for the two years ended December 31,
2003, and all years prior to 2002 is presented below.
2003
$683
478
$205
2002
$637
446
$191
Years
Prior to
2002
$2,470
1,729
$741
$1,137
227
$909
$932
186
$746
$741
148
$593
The company adopted the change in accounting principle in 2004 so therefore the financial
statements must be recast for 2003 and 2002, assuming that three year comparative financial
statements are going to be presented. We assume that the change took effect on January 1, 2004
so there is no recasting of the 2004 financial statements but rather they reflect the results of the
change. The following are the recast income statements for the three years.
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Revenue
Cost of goods sold (FIFO)
Gross profit
Operating expenses
Income before tax
Income tax
Net income
2004
$1,200
624
576
264
312
62
$250
2003
$1,050
478
572
231
341
68
$273
2002
$980
446
534
216
319
64
$255
The change in inventory method will result in changes in the balance sheet amounts as well.
Inventory, deferred income taxes and retained earnings are all effected by this change in
accounting principle.
The adjusted inventory and the cumulative effect of changes on deferred income taxes and
retained earnings are presented below.
Inventory (LIFO)
AJE (cumulative effect of changes)
Adjusted inventory (FIFO)
2003
$150
1,137
$1,287
2002
$130
932
$1,062
$227
909
$1,137
$186
746
$932
Because we assume that the change in accounting principle took place on the first day of 2004 an
adjusting journal entry is required to bring the accounting records into alignment with this
change. The following adjusting journal entry reflects the adjustment to the accounting records.
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Debit
$1,137
Credit
$909
227
$1,900
593
$2,493
Year
2001
2002
2003
2004
Beginning
Ending
Book
Accumulated
Book
Value DDB % Depreciation Depreciation Value
$500,000 20%
$100,000
$100,000 $400,000
400,000 20%
80,000
180,000 320,000
320,000 20%
64,000
244,000 256,000
256,000 20%
51,200
295,200 204,800
Using the prospective approach the following reflects the depreciation that will be taken in 2004
and in subsequent years.
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$500,000
244,000
256,000
50,000
206,000
7
$29,429
DATE
ACCOUNT
12/31/2002 Depreciation expense
Accumulated depreciation
Analysis of revised depreciation expense:
Original cost
Original salvage value
Depreciable base
Original service life
Annual depreciation
Years in service before change in estimate
Accumulated deprecation
Book value
Revised salvage value
Depreciable base
Revised service life (4 total, 2 left)
Revised annual depreciation expense
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DEBIT
$19,000
CREDIT
$19,000
$60,000
$18,000
42,000
7
6,000
2
12,000
48,000
10,000
38,000
2
$19,000
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DEBIT
$75,000
CREDIT
$30,000
13,500
31,500
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$75,000
0
75,000
5
15,000
2
$75,000
30,000
45,000
30%
13,500
$31,500