ACC327_CH22_Notes

ACC327_CH22_Notes - Chapter 22 Accounting Changes and Error...

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Chapter 22 Accounting Changes and Error Analysis 1. The FASB identifies three types of accounting changes. A. Change in accounting principle B. Change in accounting estimate C. Change in reporting entity 2. Changes in accounting principle - involve a change from one generally accepted principle to another generally accepted accounting principle (e.g., changing from the FIFO inventory valuation method to LIFO). A. Changes in principle should not occur often because they impair the consistency of a company's financial reporting between years. 1. A change in principle is considered appropriate only when the company demonstrates that the new principle is preferable to the existing one. A change in principle caused by the adoption of a new FASB standard automatically qualifies as a change to a preferable method. a."Preferable" often means providing a better matching of revenues and expenses or providing more relevant valuations of balance sheet accounts. 1. For example, changing from FIFO to LIFO inventory valuation is an easily justified change because LIFO provides better matching of current costs and revenues. Alternatively, changing from LIFO to FIFO could also be argued as a preferable change because FIFO provides more relevant values of inventory (i.e., inventory on the balance sheet is presented at the more recent purchase prices).
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B. A change in principle is not considered to result when a new principle is adopted in recognition of events that have occurred for the first time or that were previously immaterial (e.g., capitalizing leases whereas previously leases were not capitalized because they were not material). C. If the principle previously used was not acceptable or if the principle was applied incorrectly , a change to a generally accepted principle is considered a correction of an error -- not a change in principle. An example would be a change from capitalizing R & D costs to expensing it. D. The FASB considered three approaches to reporting changes in principle. 1. Retrospectively : A retroactive adjustment of previous years' fin. stmts. presented for comparative purposes is made as if the new principle had been used all along. The cumulative effect of the change on prior years’ income is presented as an adjustment to beginning retained earnings of the earliest period presented. 2. Currently : The cumulative effect of the new principle is computed and reported in the current year's income statement, but no restatement of prior periods' fin. stmts. occurs. 3. Prospectively : No change is made in previously reported results. Effects of change are "spread out" over current and future years.
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E. Which one did the FASB choose? 1. In general, the FASB requires that the retrospective approach be used for changes in principle. a. The retrospective approach was chosen because it results in the
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This note was uploaded on 04/10/2011 for the course ACC 327 taught by Professor Sign during the Spring '11 term at S. Alabama.

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ACC327_CH22_Notes - Chapter 22 Accounting Changes and Error...

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