CHAPTER 22
Accounting Changes and Error Analysis
LEARNING OBJECTIVES
1. Discuss the types of accounting changes and the accounting for changes in accounting
policies.
CHAPTER REVIEW
1. Chapter 22 discusses the different procedures used to report accounting changes and error
corrections. The use of estimates in accounting as well as the uncertainty that surrounds
Types of Accounting Changes
2. (L.O. 1) The IASB has established a reporting framework for reporting the two types of
accounting changes:
Errors in Financial Statements
3. Errors necessitate changes in accounting, but errors are not considered accounting
changes. Errors result from mathematical mistakes, mistakes in applying accounting
policies, or oversight or misuse of facts that existed when preparing financial statements.
Changes in Accounting Policy
4. A change in accounting policy is not a result of the adoption of a new policy in recognition
of events that have occurred for the first time or that were previously immaterial. For
5. Three approaches are suggested for recording the effect of changes in accounting policies:
6. Treating a change in accounting policy currently requires computation of the cumulative
7. Retrospective Application refers to the application of a different accounting policy to
8. Prospective treatment of a change in accounting policy requires no change in previously
reported results. Opening balances are not adjusted and no attempt is made to compensate
Retrospective Changes
9. There is a presumption that once an accounting policy is selected, it should not change.
The IASB permits companies to change accounting policies if: (a) it is required by IFRS;
10. When a company makes a change in accounting policy, the major disclosure
requirements include (a) nature of the change in policy, (b) reasons why the new policy
11. A direct effect of a change in accounting policy should be retrospectively applied. An
example of a direct effect is the change in the inventory balance as a result of changing
12. When a company cannot determine the prior period effects using every reasonable effort
to do so, it is considered impracticable and the company should not use retrospective
application. If any one of the following conditions exists, a company should not use
Changes in Estimates
13. (L.O. 2) The IASB requires that changes in estimates (for example, uncollectible
receivables, useful lives, and salvage values of assets) should be handled prospectively.
14. For example, if an asset with a cost of £250,000 and no salvage value were originally
depreciated on a straight-line basis for the first 7 years of its 25-year useful life, the book
value of the asset at the end of year 7 would be £180,000 (£250,000 – £70,000). If the
estimated useful life was revised at the end of year 7, and the asset was assumed to
Corrections of Errors
15. (L.O. 3) The IASB requires that corrections of errors be (a) treated as prior period
adjustments, (b) recorded in the year in which the error was discovered, and (c) reported in
16. Errors include:
a. A change from an accounting policy that is not generally accepted to an accounting
policy that is acceptable.
17. The text includes a Summary of Guidelines for Accounting Changes and Errors (Illustration 22-21).
This summary indicates the accounting to be accorded an accounting change or changes
Motivations for Change of Accounting Policy
18. Managers might have varying motives for reporting income numbers. Research shows some
Error Analysis
19. (L.O. 4) Errors occurring in the accounting process can result from mathematical mistakes,
bad faith accounting estimates, misapplication of accounting policies, as well as numerous
20. Counterbalancing errors are errors that occur in one period and correct themselves in
the next period. Noncounterbalancing errors take longer than two periods to correct
themselves and sometimes may exist until the item in error is no longer a part of the entity’s
1. The books have been closed.
2. The books have not been closed.
a. If the error has already counterbalanced and we are in the second year, an entry
21. Some examples of counterbalancing and noncounterbalancing errors are presented here:
Counterbalancing Errors
a. Failure to record accrued revenues or expenses.
Noncounterbalancing Errors
a. Failure to record depreciation.
22. To demonstrate a counterbalancing error assume a building owner received a rent payment
for the 2019 rent of €24,000 on December 31, 2018. The following entry was made on
12/31/18 and no adjustment was recorded:
23. In situations where a great many errors are encountered, use of a worksheet, as demon–
strated in the text, can facilitate analysis and ultimate correction of account balances.
LECTURE OUTLINE
The material in this chapter can be covered in two class periods. Students are better able to
differentiate the various types of accounting changes if the journal entries and reporting of
each type are demonstrated.
A. (L.O.1) Two Types of Accounting Changes.
B. Changes in Accounting Policy.
2. A change is not a result of the adoption of a new policy in recognition of events that
3. If the accounting policy previously followed was not acceptable, or if the policy was
4. Changes in accounting policy are considered appropriate only when the enterprise
5. Three approaches for reporting such changes have been considered:
a. Report changes currently. The cumulative effect of the change is reported in the
current year’s income statement as an irregular item.
6. IASB requires the use of the retrospective approach.
a. Provides information that is more useful to statement users.
C. Retrospective Accounting Change Approach.
1. Procedures required:
a. Adjust financial statements for each prior period presented.
2. Major disclosure requirements:
a. The nature of the change in policy and reasons why the new policy provides reliable
3. Direct and indirect effects of changes in accounting policy
D. (L.O.4) How to Account for Impracticable Changes.
1. The retrospective approach should not be used if any one of the following conditions exists:
2. Apply the prospective approach as of the earliest date practicable, if the retrospective
approach is deemed impracticable.
3. Disclosures.
E. (L.O. 2) Changes in Accounting Estimate.
1. Changes in accounting estimates are reported prospectively.
2. When it is impossible to tell whether a change in policy or a change in estimate has
occurred, the change is considered a change in estimate.
F. (L.O. 3) Correction of an Error.
1. Record and report as prior period adjustments.
2. Types of errors include:
a. A change from an accounting policy that is not acceptable to an accounting policy
that is acceptable.
e. The incorrect classification of a cost as an expense instead of an asset, and vice
versa.
G. Management’s Motivation for Accounting Changes.
2. Capital structure: Companies with high debt-to-equity ratios are more likely to select
accounting methods that will increase net income.
in income.
H. (L.O. 4) Error Analysis.
1. Statement of Financial Position Errors. Only affect assets, liabilities, and/or equity:
Example: A misclassification of an asset.
3. Statement of Financial Position and Income Statement Effect.
(1) If the books have been closed:
(2) If the books have not been closed:
(a) If error already counterbalanced and company is in second year, need entry to
(3) If comparative statements presented, restatement of the amounts is necessary
even if a correcting entry is not required.
b. Noncounterbalancing errors are those that take longer than two periods to correct