Question

2) Compare and contrast the accounting treatment for error corrections, changes in estimates, and changes in accounting principles. Include examples to illustrate how each of these changes should be reported.

Answer 1

Comparison of Accounting Treatment
Point of consideration	Error Correction	Change in Estimate	Change in Accounting Principle
Accounting treatment	"All prior period financial statements presented for comparison, which contain the error, should be corrected and restated"	"In case the change in estimate is in the normal course of operations, no separate disclosure is required for the same. However, if the change in estimate affects several periods, disclosure should be made to show its impact on 'income from continuing operations' of the current period."	"All prior period financial statements presented for comparison should be restated to include the revised accounting principle, unless it is impractical to do so"
	"During the current period, Error correction are not considered accounting change. It should not be included the 'Net Income' for the current period. Infact, it should be charged or credited (net of tax) to the Retained Earnings and be reported as an adjustment in statement of shareholders equity."		"During the current period, if the adoption of a new accounting principle results in a material change in an asset or liability, the adjustment must be reported to the retained earnings opening balance. Additionally, the nature of any change in accounting principle must be disclosed in the footnotes of financial statements, along with the rationale used to justify the change."
Effect	In current year financial statements only	Has a prospective effect	Has a retrospective effect
Example	Error in valuation of inventory of immediate previous year	Change in estimate of inventory obsolescence	Change in closing inventory valuation practice, from cost valuation to fair value valuation
Illustration of disclosure	Previous year: Closing Inventory value is corrected and restated	Previous year: No change	Previous year: Closing Inventory value is restated using fair value valuation
	Current year: Retained Earnings as of 1 Jan 20XX, un-adjusted Add/ (Less): Prior period Adjustment Therefore, Retained Earnings as of 1 Jan 20XX, adjusted	Current year: No additional disclosure	Current year: Footnote to financial statements - Inventory valuation: The closing inventory is valued on fair value basis, unlike the previous years where cost valuation basis was followed. If the cost valuation principle was followed, the Net income would have been $ XXX. Therefore, This change in accounting principle has resulted in increase in Net Income by $ XX.