Question

Explain each:

Change in accounting principle

Change in accounting estimate

Change in reporting entity

Correcting an accounting error that occurred in a prior period

Answer 1

1.CHANGE IN ACCOUNTING PRINCIPLE

An accounting principle is a general guideline to be complied with when recording and presenting and reporting the financial transactions. A change in accounting principle happens in the following situations:

• There are two or more accounting principles that are applicable or relevant to a particular situation, and we move towards the other principle; or
• When the accounting principle that was previously applied to the situation is not any more generally accepted; or
• There is a change in the method of applying the principle.

You should only change an accounting principle when that is required by the accounting framework that the organization is using (whether it is GAAP or IFRS), or the organization can justify the advantage of applying the new principle.

Changes in accounting principle to prior periods can be done only if it is practicable to do so.

2. CHANGE IN ACCOUNTING ESTIMATE

Estimates may be required during the course of accounting for the business transactions. In situations where the estimates prove to be incorrect, a change in the accounting estimate is required. A change in estimate is required in situations when the change :

• Affects the carrying amount of an existing or the current assets or liabilities or
• Changes the subsequent accounting for the current or future assets or liabilities.

Changes in estimate are a routine and expected part of the continuing process of appraising and reviewing the current status and future benefits and obligations related to assets and liabilities. A change in estimate emanates from the coming into existence of new information that changes the current situation. On the contrary, there can be no change in estimate when there is no new information that comes in.

A change in estimate, should be accounted for in the period of change itself. If the change affects future periods, then the change will probably have an accounting impact in those periods, as well. A change in accounting estimate does not mandate the restatement of previous financial statements, nor the past adjustments of account balances.

If the effect of a change in estimate is immaterial (as is usually the case for changes in reserves and allowances), do not disclose the alteration. However, disclose the change in estimate if the amount is material. Also, if the change affects several future periods, note the effect on income from continuing operations, net income, and per share amounts.

3.CHANGE IN REPORTING ENTITY

A change in reporting entity happens when two or more entities that were separate in the past are now combined into one entity for the purpose of reporting the financial transactions, or in a situation when there is a alteration or change in the mix of entities that were reported. When this combination happens, the resulting entity must restate any past or earlier financial statements that it is including in its reporting task for comparison purposes. When this is done, the users of the financial statements can more correctly assess the current performance against the past results. The purpose for the change in reporting entity must be detailed in the disclosures that accompany the financial statements.

4.CORRECTING AN ACCOUNTING ERROR THAT OCCURRED IN A PRIOR PERIOD

The general principle in all the applicable standards is that an organisation must, to whatever extent possible, correct a material prior period error retrospectively in the first financial statements authorised for issue subsequent to the finding of the error either by

1. restating the comparative amounts for the earlier period or periods presented in which the error happened, or
2. if the error occurred before the earliest past period presented, restating the opening balances of assets, liabilities and equity for the earliest past period disclosed.

When it is not easily possible to determine the period-specific effects of a material error on comparative information for one or more past periods disclosed, the entity shall restate the opening balances of assets, liabilities and equity for the earliest period for which retrospective restatement is possible.