Question

1. When are accounting changes likely to be applied retrospectively (resulting in restatement of prior years’ financial statements), and when are they likely to be applied prospectively?

1. Also provide two examples of when there are or were retrospective application of accounting changes.
2. Also provide two examples of when there are or were prospective application of accounting changes.

Answer 1

Changes in application of accounting principles can be done only when it is required by the applicable accounting framework (US GAAP, IFRS, etc) or when the usage of new principle can be justified.

Changes can be prospective or retrospective.

Retrospective means implementation of accounting policies for transactions, events and other circumstances as if it had been already implemented. In other words, retrospective application will effect the financial statements of prior period as well.

In case of Retrospective changes, the following steps are to be followed:

1. Include the cumulative effect of change of prior period to those presented in carrying amounts of assets and liabilities as of the beginning of the first period in which the financial statements are presented.

2. Further, effect should be given to retained earning in the form of offset at beginning of the first period in which the financial statements are presented.

3. Adjustment of all presented financial statements to reflect the changes of the new accounting policies.

Examples of Retrospective Application

1. Change of Inventory valuation method from FIFO to weighted average or vice versa.

2. Material prior period errors are adjusted retrospectively.

Prospective changes in accounting policies for transactions, events and other circumstances after new policies or estimation has already been implemented.

Examples of Prospective Application

1. Change of useful life of an asset

2. Change in rate of depreciation of an asset