feb 14 113.pptx - Footnote and Justification Principle...

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1 Footnote and Justification: Principle Changes The firm must describe the change, and explain how the accounting principle change is preferable to the previous principle (or if mandated by new GAAP), in the footnotes. Also, the effect of the change on all line items in the financial statements which change, especially income from continuing operations and net income, must be disclosed for all years reported. Same goes for all per share amounts. This applies to changes in depreciation methods even though the prospective approach is applied.
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2 Direct Effects Only Only direct effects of the principle change are recognized retrospectively—the changes in assets or liabilities necessary to effect the change. Indirect effects are changes in current or future cash flows resulting from making a change in accounting principle applied retrospectively. Certain contractual cash flows may be tied to the amount of reported earnings. Such changes are recognized in the period of change . Prior period financial statements are not adjusted.
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3 Example of Indirect Effect of Principle Change An accounting principle change in 20x5 causes 20x4 income to be retroactively restated and increased. As a result, the 20x4 CEO bonus is increased. The firm pays the 20x4 bonus increase in 20x5. The payments are recognized as an expense in 20x5, not retrospectively (no cumulative effect entry, no recasting of 20x4 income or bonus).
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4 Continued Why are indirect effects not retrospectively applied?
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5 Continued Answer : The accounting change is considered to be the event causing the indirect effect (subsequent cash flow). Therefore, the indirect effect should be recognized in the period of change.
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6 Full Example: Principle Change A publicly traded firm in existence 40 years (as of 1/1/x8) changed its method of inventory valuation from WA to FIFO in 20x8.
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