Accounting Changes Methods of accounting for changes Appropriate method for specific situations

Accounting Changes  “The only constant in this world is change”  Accounting is no different.  How do changes affect financial statements?  How should decision makers respond to accounting changes?

Accounting Change Events  Error - books are wrong  Change in principle - LIFO to FIFO  Change in estimate - useful life of assets  Change in entity - firms merge

Three Methods to Account for Changes  Retrospective method  Current method  Prospective method

Retrospective method  completely restate the financial statements as if the new method or information had been used from the day the company first opened for business  adjust beginning Retained Earnings and permanent accounts for earliest year presented

Current method  change current period’s financial statements but leave the prior statements alone  cumulative effect of change appears as nonrecurring item in financial statements  prior year statements are not changed; however, pro forma disclosure may be required (for disclosure only - no formal entry)

Prospective method  use the new information or new method in preparing current and future financial statements  no entry to adjust for cumulative effect  no adjustment to prior statements for comparative purposes

Which method should be used?  Correction of an error retrospective method  Change in estimate prospective method  Change in principle retrospective method if change due to new FASB - the standard will tell which method to use

Examples  (1) Decide which type of change is involved.  (2) Determine the method to be used for the change.

Accounting Changes/Errors  Change in plant asset’s salvage value. Estimate – prospective  Change due to overstatement of inventory. Error – retrospective  Change from FIFO to LIFO inventory Principle – retrospective  Change to consolidation of subsidiaries Entity – retrospective

Accounting Changes/Errors  Change from SYD to SL depreciation method. Estimate effected by principle change – prospective  Change in rate used to compute warranty costs. Estimate – prospective  Change from an unacceptable accounting principle to an acceptable principle Error - retrospective

Company A  Acquired asset in 2006 for $500,000  Used SL depreciation, 10 yr life, no salvage  In 2009, change to SYD depreciation

Type of Change and Approach  switch from SL to SYD change in estimate prospective approach

Change in Depreciation Method Method SL Depr Bal, A/D Book Value (2009)=500, ,000 = 350,000 SYD Depr (2009) = 350,000 x 7/28 = 87,500 Record $87,500 in depreciation in 2009

Company B  In 2008, switched inventory method from FIFO to Average Cost  Net income under both methods is: FIFOAverage Cost ,00024, ,00025, ,00027, ,00030,000

Type of Change and Approach  Switch from FIFO to Average Cost Change in accounting principle Retrospective approach

Journal Entry in 2008  ,000 – 24,000=2,000  ,000 – 25,000=5,000  ,000 – 27,000=1,000 8,000  Retained Earnings8,000  Inventory8,000

Reported Net Income Net income 30,000 27,000 25,000 24,000

Company C  Acquired asset in January 2005 for $140,000  $140,000 was debited to expense rather than PPE  In 2009, begin using SL depreciation, 10 yr life, no salvage

Type of Change and Approach  expensed purchase of machine in 2006 correction of an error retrospective approach

Correction of an Error  Machine should have a balance of $140,000  A/D should have a balance of 4 x 14,000 = $56,000  Adjust Retained Earnings and accounts Machine 140,000 A/D56,000 Ret Earnings 84,000