Generally accepted accounting principles should be applied consistently from per
ID: 2415686 • Letter: G
Question
Generally accepted accounting principles should be applied consistently from period to period. However, changes within a company as well as changes in the external economic environment, may force a company to change an accounting method. The specific reporting requirements when a company changes from one generally accepted inventory method to another depend on the methods involved. (chapter 9)
Required: Explain the accounting treatment for a change in inventory method (1) not involving LIFO, (b) from the LIFO method, and (c) to the LIFO method. Explain the logic underlying those treatments. Also, describe how disclosure requirements are designed to address the departure from consistency and comparability of changes in accounting principle.
Explanation / Answer
The event is accounted for normal change in accounting policy for changes not involving LIFO or changes from LIFO method to another. Generally, we report voluntary changes in accounting policy retrospectively. It means revising all the past periods financial statement if new policy were used in the periods. Specifically, we observe those statements if the newly adopted accounting policy had been applied. Also if retained earnings are an account that requires adjustment, we make it to the beginning balance of retained earnings for the period reported in the comparative statements of shareholders equity. Then, journal entry is created to adjust the account balances affected as the date change. The advantage of retrospective application is to enhance the comparability of the statements every year. The recast statements seem that if the newly adopted accounting method is applicable in all past years.
Consistency and comparability indicates that accounting choices made once should be followed consistently every year. Therefore, any change required new method to be justified more appropriately. In the financial statements after the change, a disclosure note is required to provide the justification. The disclosure note should include the comparative information has been revised and report any per share amounts affected for the current period and all previous periods presented, also the cumulative effect of change in retained earnings or components of equity as the starting of the earliest period presented.
When a company changes to LIFO inventory method from another method, it is usually not practice to calculate the cumulative effect of the change. Revising the balances in past years would require what should be the balance. LIFO inventory consists of layers added in past years at costs existing in those years. Accounting records of previous years are not sufficient to report the change retrospectively. Because of the difficulty, a company changing to LIFO does not report the change. Instead, the inventory of base year for the future LIFO computations is the beginning inventory in the year the LIFO method is adopted. The LIFO method is applied from that point prospectively. The disclosure note should include explanation why retrospective application was not practicable.
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