A company changed its inventory valuation method from FIFO to weighted-average during the current fiscal year. This change was made to provide more relevant and reliable information in its financial statements. Which of the following best describes the accounting treatment for this change under U.S. GAAP?
- ARetrospective application, with prior period financial statements restated and a cumulative effect adjustment to beginning retained earnings of the earliest period presented.
- BProspective application, with no restatement of prior periods and no cumulative effect adjustment.
- CProspective application, with the cumulative effect of the change recognized in the current year's income statement.
- DRetrospective application, with only the current year's financial statements adjusted and a disclosure note.
Show answer & explanationAnswer & explanation
Correct answer: A. Retrospective application, with prior period financial statements restated and a cumulative effect adjustment to beginning retained earnings of the earliest period presented.
A change in inventory valuation method (e.g., FIFO to weighted-average) is considered a change in accounting principle. Under U.S. GAAP (ASC 250, Accounting Changes and Error Corrections), changes in accounting principle are generally accounted for by retrospective application. This means prior period financial statements presented for comparative purposes are restated to reflect the new accounting principle, and the cumulative effect of the change on periods prior to those presented is recognized as an adjustment to the beginning balance of retained earnings of the earliest period presented.
Why the other options are wrong
- B. This describes a change in accounting estimate, not a change in accounting principle.
- C. This describes the treatment for certain changes in accounting principle (e.g., LIFO to other methods, or a change in depreciation method) or changes in estimate, but not FIFO to weighted-average.
- D. Retrospective application requires restatement of all prior periods presented, not just current year adjustment, and a cumulative adjustment to beginning retained earnings.
Change in Accounting Principle (Retrospective)
A change from one generally accepted accounting principle to another (e.g., FIFO to Weighted-Average) requires retrospective application, restating prior periods and adjusting beginning retained earnings for the cumulative effect.
- Applies to changes like inventory methods (FIFO/WA).
- Prior periods are restated for comparability.
- Cumulative effect adjusts beginning retained earnings of the earliest period shown.
Memory trick: Principle changes look back to the start, but estimates only play a future part.