Question

How does the accounting treatment for changes in principle, changes in estimates, and errors differ? Within the answer for errors describe prior period adjustments.

Answer 1

Accounting Principle Change

Accounting principles are general guidelines that govern the methods of recording and reporting financial information. When an entity chooses to adopt a different method from the one it currently employs, it is required to record and report that change in its financial statements.

A good example of this is a change in inventory valuation; for example, a company might switch from a first in, first out (FIFO) method to a specific-identification method. According to the FASB, an entity should only change an accounting principle when it is justifiably preferable to an existing method or when it is a necessary reaction to a change in the accounting framework.

Other notable changes in accounting principles can include matching, going concern, or revenue recognition principles, among others.

Accounting Estimate Change

Accountants use estimates in their reports when it is impossible or impractical to provide exact numbers. When these estimates prove to be incorrect, or new information allows for more accurate estimations, the entity should record the improved estimate in a change in accounting estimate. Examples of commonly changed estimates include bad-debt allowance, warranty liability, and depreciation.

Accounting Errors

Accounting errors are mistakes that are made in previous financial statements. This can include the misclassification of an expense, not depreciating an asset, miscounting inventory, a mistake in the application of accounting principles, or oversight. Errors are retrospective and must include a restatement of financials.

Prior period errors are omissions from, and misstatements in, the entity’s financial statements for one or more prior periods arising from a failure to use, or misuse of, reliable information that:

– Was available when financial statements for those periods were authorized for issue

– Could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements.

Key Differences

Accounting principle changes can also occur when older principles are no longer accepted or when the way the method is applied changes. Changes in accounting principles are required to be applied retroactively—that is, financial statements must be restated to be presented as if the new accounting principle had been applied .

only line items that are directly affected have to be restated. There are cases where a retroactive application doesn’t have to be made, which includes having made all reasonable efforts to do so, which can include not being able to make subjective significant estimates or having to have knowledge of management’s intent.

Estimate changes occur when the carrying values of assets or liabilities are changed. These changes are accounted for in the period of change. Changes in accounting estimates don’t require the restatement of previous financial statements. If the change leads to an immaterial difference, no disclosure of the change is required.

Adjustment for errors are done as follows :

An entity shall rectify material prior period errors retrospectively unless impracticable, after the finding of errors in the first set of financial statements:
(a) for the prior period(s) presented in which the error occurred by restating the comparative amounts; or
(b) if the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior
period presented.