Hello and welcome everyone. Today's lesson, we are going to discuss accounting changes and error corrections. We'll discuss various reasons for which a specific firm, either voluntarily or mandatory, makes changes to the way it accounts for a particular item in its books. Recall that comparability is an enhancing qualitative characteristics of financial reporting. To achieve this attribute of information, accounting choices once made should be consistently followed from year to year. Then obviously it's very legitimate to ask a question now, then why make changes? Let me go over some few reasons why possible reasons for making such any changes that we talk about. Number one, change in economic conditions might prompt a company to change accounting methods. Two, changes within a specific industry can lead actually a company to switch methods, often to adapt to new technology or to be consistent with others in the same industry. 3, a change might be mandated when the FASB codifies a new accounting standard. I summarize different types of changes that the company can make with a definition of each type and examples of each type in the table that will pop up in front of you now. We have three columns. In the first column, I will summarize the type of the change we can have actually change in accounting principle. Second change is change in estimate, and third change is change in the reporting unit. What is a change in accounting principle? This represent change from one generally accepted accounting principles to another. What about the change in estimate? Obviously, if I'm changing an estimate then I'm revising an estimate because new information or new experience just happen. In the change in reporting entity, those changes from reporting as one type of an entity to another type of entity. That's definitely one of the things that for changing and reporting entity, is obviously consolidation or deconsolidation, actually when the company consolidate with others or actually lose one of the subsidiaries being deconsolidated. Let's go to the change in accounting principle. I have listed some of the examples and the change in accounting principle, obviously, with the FASB standard changing methods of inventory costing changes. As I said, those changes can be either voluntary or mandated by the FASB. You have a list of changes that will pop in front of you. As you can see, change in the estimated useful life, change in the depreciation method. Change in depreciation method, isn't that change in principle? We'll talk about that specific case, which is a change in principle but treated as a change in estimate. That particular case is listed as a change in estimate, and that's why I wanted to point it out. That's why I wanted to put it on top of the list of the examples, change depreciation method, all the others as you can see, change in estimate, warranty expense actually benefits in the amortization, the depreciation, or any of those assumptions that I used in the actuarial estimates pertaining to a pension plan. Finally, the change in reporting unit, as I said, it's basically when we have reporting as a consolidated entity and we get together and we combine the financial statements of the parent and the subsidiaries in one, which we refer to as consolidated financial statements or the opposite instead of deconsolidation, when one of those subsidiaries, I lose my ownership that 50 percent or more. I lose my ownership and obviously I deconsolidate the financial statements. One thing that I wanted to point your attention beside the accounting changes are actually error corrections. Because accounting changes and error corrections can be accounted for in one of three ways depending on the nature of the change. First approach is the retrospective approach, where the financial statements issued prior to the change are adjusted to reflect the impact of the change whenever those statements are presented, again for comparative purposes, comparative financial statements. In other words, those statements are made to appear as if the newly adapted accounting method had been applied all along or that the error had never occurred. The prospective approach requires neither a modification of the prior year's financial statement nor a journal entry to adjust account balances. Instead, the change is simply implemented in the period of the change, and its effects are reflected in the financial statements of the period of the change and future periods only. Now we have retrospective approach, prospective approach. In the middle lies a third approach which we refer to as modified retrospective approach, which requires application of the new standard only to the adoption period. That is the current period that we are at, as well as adjustment of the balance of retained earnings as the beginning of the adoption period to capture the cumulative effects of prior periods without actually adjusting the numbers in the prior periods that are reported. Sometimes a lack of information makes it impractical to report a change retrospectively, and that's why we have that modified retrospective approach. In such cases, the change is applied retrospectively as of the earliest year, practical and a footnote disclosure should indicate the reasons why retrospective application was impractical. In summary, I wanted to overview what we talked about in this lesson in the following graphical representation. As you can see, the current year, I have the retrospective approach, meaning that I'm going back to the prior years, and we have the prospective approach meaning that I'm moving ahead to future years. In the past years going back, actually the retrospective approach is implemented when for most the changes in accounting principles, for the change in the reporting entity or actually for correcting errors. On the other side on the prospective approach, we have it's applicable and it's applied in the changes in estimate, including changes in the depreciation method, changes in accounting principle when it's impractical to apply the new standard risk retrospectively. The final one, when changes in accounting principle, when prospective approach is mandated by FASB. This figure summarizes the accounting changes and the different approaches that we use for accounting changes and error corrections. Thank you.
