Accounting Changes & Error Corrections

Classify first

Change	Method
Principle (first-in, first-out (FIFO) ↔ average)	Retrospective; cumulative effect to opening retained earnings of earliest period
Estimate (life, salvage, credit loss rate)	Prospective
Depreciation method	Prospective (estimate effected by principle)
Reporting entity	Retrospective
Error, including a switch from a non-Generally Accepted Accounting Principles (GAAP) method to GAAP	Restate; prior period adjustment net of tax

Change to last-in, first-out (LIFO): usually prospective (impracticable).

Formulas

• New depreciation = (carrying amount − salvage) ÷ remaining life.
• Prior period adjustment = error × (1 − tax rate).

Counterbalancing

Inventory, accruals, and prepaid errors self-correct after 2 years — retained earnings right, individual years wrong.

Doubt?

If unsure whether principle or estimate → treat as estimate.

Exam traps

• A change in estimate is never restated, however large — only errors produce a prior period adjustment.
• An inventory error found during year 2, before the books close, still needs a prior period adjustment; once both years are closed it has counterbalanced and needs no entry.
• Indirect effects of a change in principle (such as a profit-based bonus) are recognized in the period of the change, not applied retrospectively.