Accounting Changes & Corrections 101
Accounting Changes and Error Corrections are the methods in which account changes and errors are recorded in financial statements.
An Accounting Change is a revision in accounting principle, accounting estimate or the reporting entity that can trigger changes in the reported revenue or other financial aspects of a business.
An Error Correction is not the same as an Accounting Change.
An Error Correction is the correction of an error in financial statements that were previously issued. Error corrections can be an error in the measurement, recognition, presentation or disclosure in financial statements. These errors are caused by mathematical mistakes, mistakes in applying the Generally Accepted Accounting Principles (GAAP) or oversight of details existing when the financial statements were prepared.
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NOTE: FreshBooks Support team members are not certified income tax or accounting professionals and cannot provide advice in these areas, outside of supporting questions about FreshBooks. If you need income tax advice please contact an accountant in your area.
What Is an Accounting Change?
An accounting change may require notes accompanying the financial statements. This is needed so that the users of the statements can establish the extent to which an accounting change triggered a difference in the financial reports.
As we discussed earlier, there are three different kinds of Accounting Changes. These changes can impact various parts of a business including its revenue.
Here we will discuss these three changes in more detail.
Change in Accounting Principle
This is a change that is made when a business decides to use a different Generally Accepted Accounting Principle (GAAP) than the one they had been previously using. This occurrence is relatively rare. A change in principle doesn’t occur when there is an initial adoption of an accounting principle caused by transactions occurring for the first time.
Change in Account Estimate
Accounting estimates may occur as frequently as every reporting period therefore these changes are more frequently made. This change adjusts the carrying amount of a liability or an existing asset, which changes the accounting for existing or future liabilities and assets on your financial statements going forward. Estimates that are frequently changed include warranty obligation, old inventory, and reserves for uncollectible receivables.
Change in Reporting Entity
This change is a result of financial statements that are of a different reporting entity. This is usually the result of altering the subsidiaries that make up a group of entities whose results are consolidated or changing from individual to consolidated reporting. This change requires the restatement of financial statements because it is a retroactive change.
What Is an Error Correction in Accounting?
Accounting errors are mistakes that are caused by mathematical mistakes, mistakes in applying the Generally Accepted Accounting Principles (GAAP) or oversight of details existing when the financial statements were prepared. These mistakes can include the misclassification of an expense, not depreciating an asset or miscounting inventory.
Errors are retrospective and must include restated financials. Corrections require a period adjustment be made to retained earnings account for the beginning of the current year.
How to Make an Accounting Error Correction
When there is an Error Correction you should get a restatement of your prior period financial statements.
A restatement requires you to:
- Look back at the collective effect of the error in periods prior to those presented in the carting amount of liabilities and assets as of the beginning of the first period presented
- Then for that period, you would make an offset adjustment to the opening balance of retained earnings
- Finally, adjust the financial statements to reflect the error correction in each period presented
Reflect the adjustment in the opening balance of your retained earnings if the financial statements are only presented for a single period.
If you for any interim period, other than the first interim period of a fiscal year, correct an item of profit or loss and some portion of the adjustment relates to the prior interim period, then follow the following steps:
- First, include that portion of the correction related to the current interim period in that period
- Then restate prior interim periods to include that portion of the correction applicable to them
- Finally, record any portion of that related to the prior fiscal years in the first interim period of the current fiscal year