A company changed its inventory valuation method from FIFO to weighted-average during the current year. This change is considered preferable and material. How should this change in accounting principle be reported in the company's financial statements under U.S. GAAP?
- AAs a prior period adjustment, directly to the beginning balance of retained earnings.
- BProspectively, with the cumulative effect of the change reported in the current period's income statement.
- CRetrospectively, by restating prior period financial statements presented.
- DAs a change in accounting estimate, applied prospectively from the date of change.
Show answer & explanationAnswer & explanation
Correct answer: C. Retrospectively, by restating prior period financial statements presented.
A change in accounting principle, such as changing inventory valuation methods, is generally accounted for retrospectively under U.S. GAAP. This means prior period financial statements presented for comparative purposes should be restated to reflect the new accounting principle, and the cumulative effect of the change on periods prior to those presented should be recognized in the beginning balance of retained earnings of the earliest period presented.
Why the other options are wrong
- A. Prior period adjustments are for correction of errors, not for changes in accounting principle.
- B. The prospective method with cumulative effect in current income is generally disallowed for changes in accounting principle, except for certain difficult-to-implement changes.
- D. A change in inventory method is a change in accounting principle, not an estimate. Changes in estimates are applied prospectively.
Change in Accounting Principle
A change from one generally accepted accounting principle to another generally accepted accounting principle when there are two or more alternatives (e.g., inventory methods).
- Generally accounted for retrospectively.
- Prior period financial statements are restated.
- Cumulative effect on periods prior to those presented adjusts beginning retained earnings of earliest period presented.
- Requires justification that the new principle is preferable.
Memory trick: Principle rewind, estimate forward finds, error adjust behind.