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Accounting Changes and Error Corrections

Chapter 20 Review Notes

The accounting profession has identified two main categories of accounting changes:

1. Change in accounting estimate: these are considered to be part of the normal accounting process, not corrections or changes of past periods. Examples of changes in accounting estimates include bad debt expense, depreciation, residual values, and warranty obligations. A change in depreciation method is considered a change in estimate. 2. Change in accounting principle: these involve changes from one generally accepted principle or method to another. They do not include the initial adoption of an accounting principle as a result of transactions or events that had not occurred (or were immaterial) in previous periods. Changes from principles that are not generally accepted to principles that are, count as error corrections, not changes in accounting principle.

The accounting treatment for changes in accounting estimates reflects the effect of the change only in the current and future periods. No retrospective restatement of prior periods’ financial statements is made. The treatment of changes in accounting principle, by contrast, does retrospectively restate the financial statements in accordance with the change in principle for those years included in the current year’s comparative financial statements; moreover, the change in net income for still earlier years is shown as an adjustment to the beginning balance of retained earnings for the earliest year reported. This treatment results from FASB Statement No. 154, which was adopted in May 2005 in order to make the U.S. approach to accounting for accounting changes and error corrections agree with International Accounting Standard 8. See pp. 1175 – 1184.

A business combination can drastically change the size and economic

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