CPA Exam - FAR (Financial Accounting and Reporting)Select TransactionsMedium
A company changed its inventory costing method from FIFO to the weighted-average method. The change was justified as providing a more appropriate presentation of financial position and results of operations. As a result of this change, the company determined that beginning inventory for the current year (January 1, Year 3) would have been $10,000 lower under the weighted-average method, and retained earnings at the beginning of Year 3 would have been $7,000 lower (net of tax). How should this accounting change be reported in the Year 3 financial statements?
- ARetrospectively, by adjusting only the current period's financial statements.
- BProspectively, with no adjustment to prior periods.
- CRetrospectively, by adjusting the beginning balance of retained earnings and restating prior period financial statements.
- DProspectively, with the cumulative effect shown in the current period's income statement.
Show answer & explanationAnswer & explanation
Correct answer: C. Retrospectively, by adjusting the beginning balance of retained earnings and restating prior period financial statements.
A change in accounting principle, such as changing inventory costing methods (FIFO to weighted-average), is generally accounted for retrospectively. This means adjusting the beginning balance of retained earnings for the cumulative effect of the change and restating prior period financial statements as if the new method had always been in use.
Why the other options are wrong
- A. Retrospective application requires restatement of prior period financial statements, not just current period adjustments.
- B. This describes a change in accounting estimate, not an accounting principle.
- D. This describes the treatment for a change in accounting principle under prior GAAP, not current GAAP (ASC 250).
Change in Accounting Principle
A change from one generally accepted accounting principle to another generally accepted accounting principle, requiring retrospective application.
- Example: changing inventory methods (FIFO, LIFO, weighted-average).
- Requires retrospective application: adjust prior period financial statements and beginning retained earnings.
- Justification required for the change.
- Cumulative effect is reflected in the beginning balance of retained earnings.
Memory trick: Principles change, go back in time, estimates just update for the next rhyme.