Accounting Changes And Error Correction

Accounting Changes and Error Correction refers to guidance on reflecting accounting changes and errors in financial statements.

Accounting Changes and Error Correction is a pronouncement made by the Financial Accounting Standards Board (FASB), being a Statement of Financial Accounting Standards (SFAS). It outlines the rules for correcting and applying changes to financial statements.

This includes requirements for the accounting for, and reporting of, a change in accounting principle, change in accounting estimate, change in reporting entity or the correction of a transaction.

Accounting changes and error correction guidance is laid out by the two primary accounting standards bodies, the FASB and the International Accounting Standards Board (IASB). The two have different interpretations of accounting rules and principles but do work together to create some uniformity when possible.

The FASB’s statement no. 154 addresses dealing with Accounting Changes and Error Correction, while the IASB’s International Accounting Standard 8 "Accounting Policies, Changes in Accounting Estimates and Errors" offers similar guidance.

There are three types of accounting changes. The first is a change in accounting estimate, which includes a change in depreciation method. This is a prospective change, meaning a material change in estimates is noted in the financial statements and the change is made going forward.

The second type of accounting change is a change in accounting principle, such as a change in when and how revenue is recognized. A change from one generally accepted accounting principle (GAAP) to another falls in this category. Companies can generally choose between two accounting principles, such the last in, first out (LIFO) inventory valuation method versus first in, first out (FIFO).

This is a retroactive change that requires the restatement of previous financial statements. Previous financials must be restated to be calculated as if the new principle were used. The only time that financial statements are allowed to not be restated is every possible effort has been made and such a calculation is deemed impracticable.

The third accounting change is a change in the reporting entity. This is also a retroactive change that requires the restatement of financial statements.

Accounting errors are mistakes that are made. This can include the misclassification of an expense, not depreciating an asset or miscounting inventory. Errors are retrospective and must include restated financials. Corrections require a period adjustment be made to retained earnings account for the beginning of the current year.