The change game: a review of FASB Statement no. 154.EXECUTIVE SUMMARY * FASB FASB See: Financial Accounting Standards Board FASB See Financial Accounting Standards Board (FASB). HAS ISSUED STATEMENT NO. 154 PROVIDING rules for how companies should treat changes in accounting principle. The statement requires retrospective LAW, RETROSPECTIVE. A retrospective law is one that is to take effect, in point of time, before it was passed. 2. Whenever a law of this kind impairs the obligation of contracts, it is void. 3 Dall. 391. application in all comparative financial statements for prior years. * UNDER THE IMPRACTICABILITY Substantial difficulty or inconvenience in following a particular course of action, but not such insurmountability or hopelessness as to make performance impossible. EXCEPTION, when companies can't determine either the period-specific or cumulative effects of a change on all prior periods presented, Statement no. 154 requires retrospective application at the beginning of the earliest period practicable practicable adj. when something can be done or performed. . * COMPANIES SHOULD APPLY A CHANGE in accounting principle in an interim period retrospectively ret·ro·spec·tive adj. 1. Looking back on, contemplating, or directed to the past. 2. Looking or directed backward. 3. Applying to or influencing the past; retroactive. 4. . A change in accounting estimate is accounted for prospectively. Accounting changes that result in financial statements of a different reporting entity are reported prospectively by restating all prior periods. * CPAs FACE A VARIETY OF IMPLEMENTATION ISSUES In the Business world, companies frequently set-up a connection between which they transfer data. When the connection is being set-up, it is referred to as implementation. When issues occur during this phase, they are known as implementation issues. when applying Statement no. 154, including how to properly apply the impracticability exception and how to properly word disclosures of accounting changes to avoid giving the impression the change stems from an error or fraud. * ACCOUNTANTS MUST MOVE QUICKLY TO GAIN a working knowledge of the guidance in Statement no. 154 because the effective date is imminent Impending; menacingly close at hand; threatening. Imminent peril, for example, is danger that is certain, immediate, and impending, such as the type an individual might be in as a result of a serious illness or accident. . At the same time they will need to guard against having the financial markets misunderstand mis·un·der·stand tr.v. mis·un·der·stood , mis·un·der·stand·ing, mis·un·der·stands To understand incorrectly; misinterpret. why they are restating prior earnings based on mandatory Peremptory; obligatory; required; that which must be subscribed to or obeyed. Mandatory statutes are those that require, as opposed to permit, a particular course of action. vs. discretionary accounting Discretionary Account An account that allows a broker to buy and sell securities without the client's consent. Sometimes referred to as a managed account. The client must sign a discretionary disclosure with the broker as documentation of the clients consent. changes. In a major shift, FASB now requires retrospective application of all comparative financial statements for accounting principle changes. Statements for prior years must be restated as if the company had always used the new principle. While there are potential financial reporting benefits in this standard, CPAs may find it challenging to implement some of its requirements. In September September: see month. 2002 FASB and the International Accounting Standards Board  An editor has expressed concern that this article or section is .Please help improve the article by adding information and sources on neglected viewpoints, or by summarizing and made a long-term Long-term Three or more years. In the context of accounting, more than 1 year. long-term 1. Of or relating to a gain or loss in the value of a security that has been held over a specific length of time. Compare short-term. commitment to converge con·verge v. con·verged, con·verg·ing, con·verg·es v.intr. 1. a. To tend toward or approach an intersecting point: lines that converge. b. their accounting standards. They later identified how companies report accounting changes as one of the areas where FASB could improve its guidance by converging con·verge v. con·verged, con·verg·ing, con·verg·es v.intr. 1. a. To tend toward or approach an intersecting point: lines that converge. b. it with the provisions of IAS See iPlanet Application Server. 1. (computer) IAS - The first modern computer. It had main registers, processing circuits, information paths within the central processing unit, and used Von Neumann's fetch-execute cycle. 8, Accounting Policies, Changes in Accounting Estimates and Errors. The result of this effort is FASB Statement FASB Statement A standard set by the Financial Accounting Standards Board regarding a financial accounting and reporting method. Essentially, FASB statements determine the acceptable accounting practices that Certified Public Accountants use in reporting no. 154, Accounting Changes and Error Corrections, which was issued in 2005. The new statement replaces APB Opinion APB opinion A determination by the former Accounting Principles Board regarding the way a certain financial transaction is to be treated for reporting purposes. no. 20, Accounting Changes, and FASB Statement no. 3, Reporting Accounting Changes in Interim Financial Statements. It focuses on how companies should treat a change in accounting principle. Previous guidance required CPAs to account for most changes by including the cumulative effect of changing to the new principle in net income. Comparative statements of prior years did not have to be restated. With implementation approaching at yearend, CPAs have only a short time left to understand Statement no. 154. This article outlines the important provisions of the new standard and possible implementation issues companies and their financial reporting staff will face. THE NEW REQUIREMENTS The major types of accounting changes CPAs may encounter are listed below with the required accounting treatment under Statement no. 154. Examples of various accounting changes and error corrections are shown in exhibit 1, at right. Change in accounting principle. The new statement requires what FASB calls "retrospective application" for all changes in accounting principle. Retrospective application refers to adjusting the opening balance of retained earnings Retained Earnings The percentage of net earnings not paid out in dividends, but retained by the company to be reinvested in its core business or to pay debt. It is recorded under shareholders equity on the balance sheet. or other components of equity (such as other accumulated ac·cu·mu·late v. ac·cu·mu·lat·ed, ac·cu·mu·lat·ing, ac·cu·mu·lates v.tr. To gather or pile up; amass. See Synonyms at gather. v.intr. To mount up; increase. comprehensive income) for the cumulative effect of the change on all prior periods rather than reporting it on the income statement. For example, a change from the Lifo inventory valuation method to Fifo likely would result in an upward adjustment of inventory and retained earnings. In addition, prior-year statements should be restated as if the new standard had been used for all periods presented. CPAs should use retrospective application for "voluntary" changes in accounting principle--that is, discretionary changes companies initiate INITIATE. A right which is incomplete. By the birth of a child, the husband becomes tenant by the curtesy initiate, but his estate is not consummate until the death of the wife. 2 Bouv. Inst. n. 1725. themselves because the new method is preferable. It also applies to changes required by an accounting pronouncement in the unusual instance the pronouncement does not include specific transition provisions. When a pronouncement includes specific provisions, CPAs should follow them. Companies must make a reasonable effort to apply a change in accounting principle retrospectively before concluding it is impracticable to do so. Impracticability exception. When it is not practical to determine either the period-specific effects or the cumulative effect of the change to all prior periods presented, the statement requires companies to apply the new accounting principle to asset and liability balances as of the beginning of the earliest period for which retrospective application is practicable and to make a corresponding adjustment to the opening balance of retained earnings (or other component of equity) for that period. Companies must disclose the method used to report the change and the reason why retrospective application is impracticable. Determining impracticability. CPAs and their employers or clients must decide when retrospective application isn't is·n't Contraction of is not. isn't is not isn't be practicable. This is the case only when any of the following conditions exist: * After making every reasonable effort to do so, the entity is unable to apply the requirement. * Retrospective application would require assumptions about management's intent in a prior period that cannot be independently substantiated. * Retrospective application would require significant estimates of amounts, and it is impossible to distinguish objectively the information about those estimates that * Provides evidence of circumstances CIRCUMSTANCES, evidence. The particulars which accompany a fact. 2. The facts proved are either possible or impossible, ordinary and probable, or extraordinary and improbable, recent or ancient; they may have happened near us, or afar off; they are public or that existed on the date(s) at which those amounts would be recognized, measured or disclosed dis·close tr.v. dis·closed, dis·clos·ing, dis·clos·es 1. To expose to view, as by removing a cover; uncover. 2. To make known (something heretofore kept secret). under retrospective application. * Would have been available when the financial statements for that prior period were issued. Indirect effects of retrospective application. Retrospective application includes only the direct effects of a change in accounting principle, net of any related income tax effects. Indirect effects a company would have recognized had the newly adopted accounting principle been followed in prior periods are not included. Indirect effects can arise when a change in accounting principle affects cash flows from contractual obligations (such as current or future cash payments related to a profit-sharing plan Profit-Sharing Plan A plan that gives employees a share in the profits of the company. Each employee receives into an account, a percentage of those profits based on their earnings. Also known as "deferred profit-sharing plan" or "DPSP". in a prior period). If a company actually incurs and recognizes indirect effects, it should report them in the period the accounting change is made--not in the prior period. Interim periods. Companies should use retrospective application to report a change in accounting principle made in an interim period. The impracticability exception, however, may not be applied to prechange interim periods of the fiscal year in which the change is made. When retrospective application to prechange interim periods is impracticable, the desired change may be made only as of the beginning of a subsequent fiscal year. Change in accounting estimate. These changes are accounted for prospectively--in (a) the period of change if the change affects that period only or (b) the period of change and future periods if the change affects both. No prior periods are restated or adjusted and no pro forma As a matter of form or for the sake of form. Used to describe accounting, financial, and other statements or conclusions based upon assumed or anticipated facts. The phrase pro forma amounts are disclosed. Under Statement no. 154, CPAs must account for a change in depreciation method as a change in accounting estimate--not a change in accounting principle. Thus, a switch from an accelerated method of depreciation to the straight-line straight-line adj. 1. Lying in a straight line. 2. Relating to a device whose linkage produces or copies motion in straight lines. 3. method-would be accounted for the same way as a change in estimated useful life or salvage value Salvage Value The estimated value that an asset will realize upon its sale at the end of its useful life. Notes: For example, the value of a computer after it depreciates over the number of years specified by the IRS. . FASB describes this as a change in accounting estimate effected by a change in accounting principle. CPAs must disclose why the change in depreciation is preferable. Change in reporting entity. Accounting changes that result in financial statements of a different reporting entity are reported retrospectively by restating all prior periods. For example, when a company presents consolidated con·sol·i·date v. con·sol·i·dat·ed, con·sol·i·dat·ing, con·sol·i·dates v.tr. 1. To unite into one system or whole; combine: or combined financial statements Combined financial statement A financial statement that merges the assets, liabilities, net worth, and operating figures of two or more affiliated companies. A combined statement is distinguished from a consolidated financial statement of a company and subsidiaries, which must in place of statements for individual entities, a change in reporting entity has occurred. Error corrections. Errors arise from mathematical mistakes, errors in applying accounting principles and misuse of facts that existed at the time the financial statements were prepared. CPAs must be able to distinguish between an error correction CORRECTION,punishment. Chastisement by one having authority of a person who has committed some offence, for the purpose of bringing him to legal subjection. 2. It is chiefly exercised in a parental manner, by parents, or those who are placed in loco parentis. and a change in accounting estimate. The latter comes about from discovering new information or subsequent developments. A change from an accounting principle that is not GAAP GAAP See: Generally Accepted Accounting Principles GAAP See generally accepted accounting principles (GAAP). to one that is is considered an error correction. CPAs should report an error in the financial statements of a prior period discovered after their issuance as a prior-period adjustment by adjusting the asset and liability balances of the first period presented. An offsetting adjustment is made to the opening balance of retained earnings for that period. The prior-period financial statements are restated for the period-specific effects of the error. When financial statements are restated to correct an error, CPAs should disclose its nature. The following disclosures also are required: * The effect of the correction on each financial statement line item and any per-share amounts for all prior periods presented. * The cumulative effect of the restatement Restatement A revision in a company's earlier financial statements. Notes: The need for restating financial figures can result from fraud, misrepresentation, or a simple clerical error. on retained earnings or other components of equity as of the beginning of the earliest period presented. * A statement that previously issued financial statements have been restated. EFFECTIVE DATE Statement no. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December December: see month. 15, 2005. Early adoption is permitted for changes and corrections made in fiscal years beginning June June: see month. 1, 2005. As stated earlier, the statement does not change the transition provisions of any existing pronouncements, including those in transition as of Statement no. 154's effective date. IMPLEMENTATION ISSUES CPAs will need to familiarize themselves with the new requirements and terminology The terminology used in the computer and telecommunications field adds tremendous confusion not only for the lay person, but for the technicians themselves. What many do not realize is that terms are made up by anybody and everybody in a nonchalant, casual manner without any regard or in Statement no. 154. Exhibit 2, below, compares the major provisions and terminology of Opinion no. 20 with those of the new FASB standard. Key terms are defined in a glossary A term used by Microsoft Word and adopted by other word processors for the list of shorthand, keyboard macros created by a particular user. See glossaries in this publication and The Computer Glossary. on page 72. One implementation issue relates to the impracticability exception. According to according to prep. 1. As stated or indicated by; on the authority of: according to historians. 2. In keeping with: according to instructions. 3. the new statement, a company must make "every reasonable effort" to apply a change in accounting principle retrospectively before concluding it cannot determine the effects of the change. Yet, FASB has not clearly defined "reasonable effort" CPAs and their employers or clients wil1 have to use their professional judgment. If CPAs cannot estimate restated amounts in prior periods due to inadequate records--as might happen with a change in inventory valuation method--retrospective application should be used starting with the first period practicable. The new standard likely will increase the number of accounting changes applied retrospectively. As a result CPAs will need to carefully word the disclosure of why the company is restating prior periods. Restatement for an error correction or SEC-mandated adjustment sends a significantly different message from that of a discretionary change in accounting principle; some investors or analysts could confuse con·fuse v. con·fused, con·fus·ing, con·fus·es v.tr. 1. a. To cause to be unable to think with clarity or act with intelligence or understanding; throw off. b. retrospective application of an accounting change with restatements stemming from errors or fraud. Exhibit 3, page 71, illustrates the retrospective application of a change in accounting principle. Exhibit 4, below, illustrates the reporting for an accounting change when determining the cumulative effect for all prior years is not practicable. Exhibit 4: Reporting an Accounting Change Assume BBB Co. changed its accounting principle for inventory measurement from Fifo to Lifo effective January 1, 2005, based on the rationale that the Lifo method is preferable. The company reports its financial statements on a calendar yearend basis and has used the Fifo method since its inception. BBB Co. determines that it is impracticable to determine the cumulative effect of applying this change retrospectively because records of inventory purchases and sales no longer are available for all prior years. However, the company has all of the information necessary to apply the Lifo method on a prospective basis beginning in 2002. Therefore, BBB Co. should present prior periods as if it had (a) carried forward the 2001 ending balance in inventory (measured on a Fifo basis) and (b) applied the Lifo procedures to its existing inventory layers beginning January 1, 2002. FASB acknowledged there will be costs involved with retrospective application of a change in accounting principle beyond those previously required to develop pro forma disclosures of the effects on prior periods. Roughly half the exposure draft respondents In the context of marketing research, a representative sample drawn from a larger population of people from whom information is collected and used to develop or confirm marketing strategy. said the costs of retrospective application to preparers would outweigh out·weigh tr.v. out·weighed, out·weigh·ing, out·weighs 1. To weigh more than. 2. To be more significant than; exceed in value or importance: The benefits outweigh the risks. the benefits to users. CPAs should be aware these may include (a) costs of amending previous reports with the SEC, (b) costs of reaudits due to predecessor predecessor - parent auditor auditor n. an accountant who conducts an audit to verify the accuracy of the financial records and accounting practices of a business or government. A proper audit will point out deficiencies in accounting and other financial operations. issues and (c) time and effort necessary to apply the new accounting method to prior periods. Implementation costs could even be a disincentive dis·in·cen·tive n. Something that prevents or discourages action; a deterrent. disincentive Noun something that discourages someone from behaving or acting in a particular way Noun 1. for a company to make a voluntary change to a preferable accounting method. SOME CONTROVERSY REMAINS Some observers are concerned wholesale retrospective restatements will dilute di·lute v. To reduce a solution or mixture in concentration, quality, strength, or purity, as by adding water. adj. Thinned or weakened by diluting. public confidence in financial statements. Because of the recent accounting scandals Accounting scandals, or corporate accounting scandals are political and business scandals which arise with the disclosure of misdeeds by trusted executives of large public corporations. , the markets tend to punish pun·ish v. pun·ished, pun·ish·ing, pun·ish·es v.tr. 1. To subject to a penalty for an offense, sin, or fault. 2. To inflict a penalty for (an offense). 3. companies that restate re·state tr.v. re·stat·ed, re·stat·ing, re·states To state again or in a new form. See Synonyms at repeat. re·state prior earnings. Will the market distinguish between mandatory and discretionary accounting changes? In its comment letter on the ED Lockheed Martin For the former company, see . Lockheed Martin (NYSE: LMT) is a leading multinational aerospace manufacturer and advanced technology company formed in 1995 by the merger of Lockheed Corporation with Martin Marietta. said: "Mandating restatements by every company each time a significant accounting standard changes ... does not lead to an expectation of increased investor confidence. Nor will it ever result in achievement of the Holy Grail Holy Grail: see Grail, Holy. A very desired object or outcome that borders on a sacred quest. There are several Holy Grails in the computer business. of comparability over time." Then there is the provision that companies can implement retrospective application in a limited form. If it is not practicable to determine either the period-specific or cumulative effect of the change on prior years, the Years, The the seven decades of Eleanor Pargiter’s life. [Br. Lit.: Benét, 1109] See : Time company may apply the new principle prospectively as of the earliest date practicable. Some fear the impracticability exception could produce false comparability--users may believe they are comparing financial information prepared on the same basis when actually, companies may have retrospectively applied a new accounting principle differently based simply on their ability to do so. LEARNING CURVE CPAs must move quickly since they have only the remainder of 2005 to obtain a working knowledge of Statement no. 154. The major change it imposes is the retrospective application of a change in accounting principle. Especially challenging will be restating prior financials for the period-specific effects of the change. CPAs will need to help their employers and clients determine when retrospective application is impracticable. FASB may find it necessary to issue additional guidance on this part of its new standard. Whether Statement no. 154 enhances the comparability of financial statements at a reasonable cost remains to be seen. Glossary of Key Terms Accounting change. A change in an accounting principle, an accounting estimate or the reporting entity. Change in accounting principle. A change from one generally accepted accounting principle to another when there are two or more such principles that apply or when the principle formerly used is no longer generally accepted. A change in the method of applying an accounting principle also is considered a change in accounting principle. Change in accounting estimate. A change that has the effect of adjusting the carrying amount of an existing asset or liability or altering the subsequent accounting for existing or future assets or liabilities. A change in accounting estimate is a necessary consequence of the assessment, in conjunction with the periodic presentation of financial statements, of the present status and expected future benefits and obligations associated with assets and liabilities. Changes in accounting estimates result from new information. Change in accounting estimate effected by a change in accounting principle. A change in accounting estimate that is inseparable in·sep·a·ra·ble adj. 1. Impossible to separate or part: inseparable pieces of rock. 2. Very closely associated; constant: inseparable companions. from the effect of a related change in accounting principle. Change in reporting entity. A change that results in financial statements that effectively are those of a different reporting entity. Direct effects of a change in accounting principle. Recognized changes in assets or liabilities necessary to effect a change in accounting principle. Error in previously issued financial statements. An error in recognition, measurement, presentation or disclosure in financial statements resulting from mathematical mistakes, mistakes in the application of GAAP or oversight
Oversight may refer to:
Indirect effects of a change in accounting principle. Any changes to current or future cash flows of an entity that result from making a change in accounting principle that is applied retrospectively. Restatement. The process of revising previously issued financial statements to reflect the correction of an error in those statements. Retrospective application. Applying a different accounting principle to one or more previously issued financial statements, or to the statement of financial position at the beginning of the current period, as if that principle had always been used, or a change to financial statements of prior accounting periods to present the statements of a new reporting entity as if it bad existed in those prior years. Background of Accounting Changes Prior to APB Opinion no. 9, Reporting the Results of Operations, a variety of approaches were generally accepted to account for a change in accounting principle, practice or method. Companies could handle such a change retroactively ret·ro·ac·tive adj. Influencing or applying to a period prior to enactment: a retroactive pay increase. [French rétroactif, from Latin (prior-period adjustment), prospectively (no adjustment, but with current and futures years' amounts reallocated) or currently with a lump-sum adjustment to income. In Opinion no. 9, the APB APB See Accounting Principles Board (APB). required prospective treatment for changes in estimates, while requiring the retroactive Having reference to things that happened in the past, prior to the occurrence of the act in question. A retroactive or retrospective law is one that takes away or impairs vested rights acquired under existing laws, creates new obligations, imposes new duties, or attaches a approach for prior-period adjustments. In Opinion no, 20, the APB adopted the lump-sum adjustment (cumulative effect adjustment to income) method for accounting principle changes, but also outlined some exceptions to the general rule that received retroactive treatment: changes involving Lifo; long-term construction contracts; the full-cost method in the extractive extractive /ex·trac·tive/ (-tiv) any substance present in an organized tissue, or in a mixture in a small quantity, and requiring extraction by a special method. ex·trac·tive adj. 1. industries and issuance of financial statements by a company for the first time to obtain additional equity capital, to effect a business combination or to register securities. Opinion no. 20 also carried forward the Opinion no. 9 requirements for changes in estimate (prospective treatment) and prior-period adjustments (retroactive treatment). Under Opinion no. 20, a change in an asset's remaining estimated useful life without changing the depreciation method was viewed as a change in accounting estimate. A change from deferring certain expenditures (such as advertising costs) to expensing them as incurred (because future benefits were uncertain) was considered a change in estimate effected by a change in accounting principle. Thus, it too, was regarded as a change in estimate. Statement no. 3 amended a·mend v. a·mend·ed, a·mend·ing, a·mends v.tr. 1. To change for the better; improve: amended the earlier proposal so as to make it more comprehensive. 2. Opinion no. 20 and provided guidance on cumulative-effect-type changes in principle in interim periods. Changes in accounting principle made in other than the first interim period resulted in the restatement of financial information for the earlier interim periods of that year. PRACTICAL TIPS * Use caution when applying the impracticability exception. Because FASB has not clearly defined what constitutes a "reasonable effort" in deciding whether to apply a change in accounting principle retrospectively, CPAs will have to use their best professional judgment. * Word the disclosure of why a company is restating prior-period financial statements carefully. Some investors or analysts could confuse the required retrospective application of an accounting change with restatements stemming from errors or fraud. * Carefully monitor the costs of retrospective application of a change in accounting principle, including costs of amending previous SEC reports, reaudits due to predecessor audit issues and the time required to apply a new accounting method to prior periods to make sure the costs don't don't 1. Contraction of do not. 2. Nonstandard Contraction of does not. n. A statement of what should not be done: a list of the dos and don'ts. outweigh the benefits.
Reflecting Change
Of 600 companies surveyed, here's how many made accounting
changes and error corrections affecting the income and retained
earnings statements:
Number of companies
2003 2002 2002 2000
Income statement:
Cumulative effect of
accounting change 118 179 103 43
Adjustments to the opening
balance of retained earnings:
Prior-period adjustments 4 6 2 5
accounting change 4 5 1 2
Source: Accounting Trends & Techniques, AICPA,
www.aicpa.org.
Exhibit 1: Accounting Changes and Error Corrections
Type of change Examples
Change in accounting principle * Change in inventory valuation
method
* Change in method of accounting for
long-term construction contracts
* Change to or from the full-cost
method in the extractive industry
Change in accounting estimate * Change in the estimated useful life
or salvage value of a plant asset
* Change in depreciation method
* Change in estimated bad debts
expense
* Change in estimated warranty
expense
* Estimating inventory obsolescence
Change in reporting entity * Presenting consolidated or combined
financial statements in place of
financial statements of individual
entities
* Changing specific subsidiaries that
make up the group of entities for
which consolidated financial
statements are presented
* Changing the entities included in
combined financial statements
Correction of errors * Mathematical mistakes
* Mistakes in the application of GAAP
* Oversight or misuse of facts that
existed at the time the financial
statements were prepared
* A change from an accounting
principle that is not generally
accepted to one that is generally
accepted
Exhibit 2: Comparison of APB Opinion no. 20 and FASB Statement
no. 154
Accounting change Opinion no. 20 Statement no. 154
Change in accounting * Current method * Retrospective
principle (cumulative effect of application method
change recognized in (cumulative effect
net income) of change adjusts
beginning retained
* Included change earnings)
in depreciation,
amortization or * Does not include
depletion method change in
depreciation,
* Retroactive/ amortization or
prospective method depletion method
for certain exceptions
* Prior financials
* Prior financials restated
not restated, but
supplemental pro forma * Impracticable
disclosure required exception: Apply at
the earliest date
practicable
Change in accounting * Prospective method * Prospective method
estimate
* Includes change in
depreciation,
amortization or
depletion method
Change in reporting * Retroactive method * Retrospective
entity application method
Correction of errors * Retroactive method * Restatement method
in prior periods
* Prior-period * Prior-period
adjustment adjustment
* Prior financials * Prior financials
restated restated
Exhibit 3. Retrospective Application of a Change in
Accounting Principle
BBB Co. decides to change from the Lifo method of inventory
valuation to the Fifo method on January 1, 2006. The company
had used the Lifo method for financial and tax purposes
since its inception on January 1, 2004. The effects on the
change in accounting principle on inventory value and cost
of goods sold are presented below:
Inventory value determined by Cost of sales determined by
Date Lifo method Fito method Lifo method Fito method
1/12004 $ 0 $ 0 $ 0 $ 0
12/31/2004 400 500 1,600 1,500
12/31/2005 600 800 2,000 1,900
12/31/2006 800 1,100 2,200 2,100
For each year presented, sales are .$5,000 and operating expenses
are $1,000. The effective income tax rate is 40% and there is no
difference between financial and taxable income.
BBB Co.'s annual report for 2005 showed the following
comparative income statements (originally reported under
the Lifo
2005 2004
Sales $5,000 $5,000
Cost goods sold 2,000 1,600
Operating expenses 1,000 1,600
Income before income taxes $2,000 2,400
Income taxed (40%) 800 960
Net income $1,200 $1,440
The company's annual report for 2006 shows the following comparative
income statements reflecting the retrospective application of the
accounting change from the Lifo method to the Fifo method:
2005
2006 As adjustment (Note A)
Sales $5,000 $5,000
Cost goods sold 2,100 1,900
Operating expenses 1,000 1,000
Income before income taxes $1,900 $2,100
Income taxed (40%) 760 840
Net income $1,140 $1,260
BBB Co.'s disclosure of the accounting change is presented below:
Note A: Change in method of accounting for inventory valuation.
On January 1, 2006, BBB Co. elected to change its method of valuing
its inventory to the Fifo method, whereas in all prior years
inventory was valued using the Lifo method. The new method of
accounting for inventory was adopted (state justification for
the change in accounting principle) and comparative financial
statements of prior years have been adjusted to apply the new
method retrospectively. The following financial statement line
items for fiscal years 2006 and 2005 were affected by the change
in accounting principle.
2006 Income Statement
As computed As reported Effect of change
under Lifo under Fifo
Sales $5,000 $5,000 $ 0
Cost of goods sold 2,200 2,100 (100)
Operating expenses 1,000 1,000 0
Income before income $1,800 $1,900 $100
taxes
Income taxes (40%) 720 760 40
Net income $1,080 $1,140 60
2005 Income Statement
As computed As reported Effect of change
under Lifo under Fifo
Sales $5,000 $5,000 $ 0
Cost of goods sold 2,000 1,900 (100)
Operating expenses 1,000 1,000 0
Income before income $2,000 $2,100 $100
taxes
Income taxes (40%) 800 840 40
Net income $1,200 $1,260 60
(In note A, the company must show all line items affected in
the income statement. Entities are not required to disclose
effects on totals and subtotals other than income from continuing
operations and net income. The company also would show appropriate
schedules for the effect of the change on the balance sheet and
statement of cash flows for years 2006 and 2005.)
As a result of the accounting change, retained earnings as of
January 1, 2005, increased from $1,440 as originally reported using the
Lifo method to $1,500 using the Fifo method.
JOSEPH L. MORRIS, PhD, CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. (inactive in·ac·tive adj. 1. Not active or tending to be active. 2. a. Not functioning or operating; out of use: inactive machinery. b. ), is associate professor of accounting, Southeastern Louisiana University Southeastern Louisiana University is a state-funded public university that is located in the city of Hammond, Louisiana. It was originally founded in 1925 by Linus A. Sims, the principal of Hammond High School, as Hammond Junior College, located in a wing of the high school , Hammond Hammond. 1 City (1990 pop. 84,236), Lake co., extreme NW Ind., bounded by Lake Michigan, the Ill. state line, and the Little Calumet River, and traversed by the Grand Calumet River; settled 1851, inc. 1884. . His e-mail address See Internet address. e-mail address - electronic mail address is jmorris@selu.edu See .edu. (networking) edu - ("education") The top-level domain for educational establishments in the USA (and some other countries). E.g. "mit.edu". The UK equivalent is "ac.uk". . |
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