Types of Accounting Changes

Lesson:

Sometimes companies need to change their accounting. It can do this in two ways:

  • Retrospectively - Accountants go back and change previous financial statements.
  • Prospectively - Accountants only make changes to the current financial statements.

Here's why a change might have to be made:

  • Change in accounting principle - Switching between GAAP-approved methods (voluntary or mandatory) is done retrospectively.
  • Change in reporting entity - If the nature of the firm is fundamentally changed, the financials are updated retrospectively.
  • Change in estimate - If an estimate turns out to be incorrect, changes are made prospectively.
  • Errors - If there was a mistake in the application of accounting rules or a calculation, changes are made retrospectively.

      In other words, all changes are made retrospectively, except changes in estimate.

You're the head accountant for Atomic Industries and are going to make an accounting change.

Here's what you know:

  • The firm's warranty costs appear to be much higher than first predicted.
What should the accounting team do with respect to the change?

Answer:

  • The change should be made prospectively (accountants only need to make changes going forward).

Explanation:

    Remember: This is a change in estimate, so we only make changes going forward.
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