ASC 250: Changes in Principle, Changes in Estimate and Error Corrections Compared

A client values inventory differently in the current year than in the prior year. Is that a change in accounting principle, a change in estimate or the correction of an error? The answer sets the whole presentation: retrospective restatement of prior periods, a prospective adjustment in the current year, or a restatement with a reissued report. Getting the label wrong is itself a misstatement.

This guide gives the test for each category, the entries, the choice between restating and revising prior statements, and the audit procedures.

What are the three categories?

ASC 250 governs accounting changes and error corrections. An accounting change results from a change in accounting principle, a change in estimate or a change in reporting entity. The correction of an error in previously issued financial statements is not an accounting change, but it is covered in the same topic because it requires adjusting prior statements in a similar way.

• Change in principle. A move from one acceptable method to another, such as a change in an inventory valuation method. It is allowed only if the new method is preferable, and it is applied retrospectively by recasting prior periods.
• Change in estimate. A result of new information or revised estimating techniques that affects the carrying amount of an asset or liability at the change date, such as updated inputs for uncollectible receivables. It is applied prospectively.
• Error. The misapplication of information that was available, or could have been available, when the earlier statements were issued. Mathematical mistakes, misapplied GAAP and overlooked facts are errors. A move from a method that is not GAAP to one that is GAAP is also an error correction.

How do you tell them apart?

Ask five questions of the client:

1. What was the reason for the change?
2. Did the estimation model change, or only its inputs?
3. Why did the inputs change, and when did the new inputs become supportable?
4. Is the method now applied to new business or balances, or to items it should have covered before?
5. If results moved significantly, can developments in the business support the change?

Inputs that changed because of events in the current year point to an estimate. A model that was wrong in prior years points to an error.

What if a change is both a principle and an estimate?

When the effect of a change in principle cannot be separated from the effect of a change in estimate, it is accounted for as a change in estimate. A change in depreciation method is the usual example, because it changes the estimated pattern of consumption of the asset. The change still has to be preferable, and disclosures for both are required.

Worked entries

Change in principle (retrospective). A client changes an inventory method in the current year. The cumulative effect on the carrying amount of inventory at the start of the earliest period presented is $50,000, and the prior-year effect on income is $20,000. Ignore income taxes. The opening balance of retained earnings of the earliest period presented absorbs the cumulative effect, and the prior-year column is adjusted for its own effect.

The entry is a recast of the comparative statements.

Change in estimate (prospective). Equipment cost $100,000 has a 10-year life and has been depreciated for 4 years, leaving a carrying amount of $60,000. Management now estimates 8 remaining years. No prior period is touched. Depreciation for the current and future years is $60,000 / 8 = $7,500.

Error correction. An unrecorded compensation obligation adds $30,000 of expense to each of the four prior years. Reported income was $1,000,000 in each year, and current-year income before any correction is $1,000,000. If the correction is made in the books at the start of the current year, the cumulative effect on opening retained earnings is $120,000.

Restate or revise?

The materiality assessment decides the presentation. Evaluate the error individually and in aggregate against each prior period in which it arose and against the current period, for every affected statement, line item and disclosure. Both quantitative and qualitative factors apply. See /us/blog/sab-99-materiality-quantitative-and-qualitative-factors.

SEC registrants use two views together, as SAB 108 (Topic 1.N) requires: the staff says registrants must quantify an error under both approaches and adjust if either measure is material. The rollover view measures the income statement error that originated in each prior period. The iron curtain view measures the balance sheet error that remains at the end of the period. In the illustration above, the rollover error is $30,000 a year, or 3% of income, and the iron curtain error at the start of the current year is $120,000, or 12% of income.

• Restatement. If the error is material to any previously issued statement, the cumulative effect goes to the carrying amounts at the start of the earliest period presented, the offset goes to opening retained earnings, and each prior period presented is adjusted for its own effect. Corrected statements are labeled as restated, either by reissuing the earlier statements or by restating the comparatives in the next set issued, and users are told not to rely on the earlier statements.
• Revision. If the prior statements are not materially misstated, the error may be corrected through an out-of-period adjustment in the current period, with disclosure, or by revising the prior statements the next time they are presented. If the out-of-period amount would be material to current operations or the trend of earnings, the prior statements are revised when next issued. Revised columns are not labeled as restated.

Disclosures for a restatement include the nature of the error, the effect on each affected line item and per-share amount for each prior period, and the cumulative effect on retained earnings at the start of the earliest period presented.

For a change in principle, disclose the nature and reason for the change, why the new principle is preferable, the method of application, and the effect on income and affected line items. For a change in estimate that affects several periods, disclose the effect on income from continuing operations and net income. Routine estimates such as uncollectible accounts need no disclosure unless the effect is material.

Audit angle

1. Identify every change. Compare accounting policies, estimation models, useful lives and reserve methods to the prior year. Ask management to list changes and read the minutes.
2. Classify each one. Apply the five questions above and document why each change is a principle change, an estimate or an error.
3. Test preferability. For a voluntary principle change, obtain management's written justification and evaluate whether the new method is preferable, not only different.
4. Recompute retrospective adjustments. Agree the cumulative effect and period-specific effects to supporting schedules, and agree comparative amounts to the recast ledgers.
5. Test a prospective estimate change. Check that the change rests on facts that arose in the period, and recompute the current-year effect.
6. Accumulate errors across years. Keep a schedule of identified misstatements by year, evaluate with both the rollover and iron curtain views, and decide whether correction is a restatement or a revision.
7. Check labels and disclosures. Use restated only for the correction of a material error, and check that the footnote covers the effect on each line item.
8. Assess controls. For a restatement, assess the effect on internal control over financial reporting. See /us/standards/asc-250-accounting-changes-error-corrections.

Common misstatements: an estimate change presented as a principle change to avoid recasting, a prior-year error buried in the current period without evaluation, and a revision labeled as restated.

CORAA prepares ready-to-review audit files for US CPA firms from QuickBooks books; you review and sign. See /us.

Sources

• PwC Viewpoint, Financial statement presentation guide, 30.3 Differentiating changes in principle, estimate and error: https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/financial_statement_/financial_statement___18_US/chapter_30_accountin_US/303_differentiating__US.html
• PwC Viewpoint, Financial statement presentation guide, 30.4 Change in accounting principle: https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/financial_statement_/financial_statement___18_US/chapter_30_accountin_US/304_change_in_accoun_US.html
• PwC Viewpoint, Financial statement presentation guide, 30.5 Change in accounting estimate: https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/financial_statement_/financial_statement___18_US/chapter_30_accountin_US/305_change_in_accoun_US.html
• PwC Viewpoint, Financial statement presentation guide, 30.7 Correction of an error: https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/financial_statement_/financial_statement___18_US/chapter_30_accountin_US/307_correction_of_an_US.html
• SEC, Staff Accounting Bulletin No. 108 (rollover and iron curtain approaches): https://www.sec.gov/rules-regulations/staff-guidance/staff-accounting-bulletins/staff-accounting-bulletin-no-108
• Wipfli, ASC 250 Correcting financial statement errors (restatement versus revision, retrospective correction): https://www.wipfli.com/insights/articles/aa-asc-250-correcting-financial-statement-errors
• Deloitte DART, Roadmap: IFRS and US GAAP comparison, 4.4 Changes in accounting principle, changes in accounting estimate, and error corrections: https://dart.deloitte.com/USDART/home/publications/deloitte/additional-deloitte-guidance/roadmap-ifrs-us-gaap-comparison/chapter-4-presentation/4-4-changes-in-accounting-principle

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error