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Accounting for Changes in Reporting Entity:

A change in reporting entity requires retrospective treatment, which means that any prior periods that will be presented in the current year financial statements need to be restated. A change in reporting entity specifically addresses the fact that the comparable financial periods need to include the financial results for the same legal entities or reporting units.

For example, let’s say that the Year 1 results for Tahoe Ventures did not include the financial results for Truckee Mountain (an unconsolidated subsidiary). However, in Year 2, the results for Truckee Mountain will be included in the consolidated financials for Tahoe Ventures. Tahoe Ventures would need to restate the Year 1 financials to include Truckee Mountain so that the two periods are comparable. The reason this is important is because financial results that are not comparable can mislead investors.

Other examples of situations that would result in a change in reporting entity would consist of a change in the reporting consolidated financial statements in one subsidiary being reported. Universal CPA Review’s visual learning approach breaks this down by using the example of Shark Corp. acquiring an additional 50% of Minnow Corp. (initially owning 25%). This would indicate that Shark Corp. would now have significant influence, meaning they would change the reporting of this subsidiary from the equity method to the acquisition method.


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  • What does a retrospective change to the financial statements mean?

    When there are accounting changes, a company can either approach those changes on a prospective or retrospective basis. The approach ultimately depends on the type of change. When a company prepares it financial statements, there are often historical periods presented next to the current period. If the accounting change requires retrospective treatment, then those historical periods need to be updated to reflect the change so that they are comparable to the current period. The two main changes that require retrospective treatment include a change in accounting principle and a change in reporting entity. Change in Accounting Principle: Let’s say that the company used LIFO in Year 1 and then switched to FIFO in Year 2. Without retrospective treatment, Year 1 and Year 2 inventory balances would be based on a different accounting principle. Therefore, we need to restate Year 1 so that the inventory balance is on a FIFO basis, which makes it comparable to Year 2. The rest of the financial statements would have to reflect this change as well. Change in Reporting Entity: This primarily addresses the fact that two financial periods needs to include the results for the same legal or reporting entities. For example, let’s say that the Year 1 results for Tahoe Ventures did not include the financial results for Truckee Mountain (an unconsolidated subsidiary). However, in Year 2, the results for Truckee Mountain will be included in the consolidated financials for Tahoe Ventures. Tahoe Ventures would need to restate the Year 1 financials to include Truckee Mountain so that the two periods are comparable. Otherwise, there will be an artificial increase in sales/profitability that could mislead investors!

  • What is the a prospective change vs a retrospective change?

    A prospective change means that the change needs to be accounted for on a go-forward basis (only looking forward). For example, if the company changes an estimate, then only the current year financials need to reflect the change and not the prior period financials. A retrospective change means that the change needs to be accounted for in historical periods as well as the current and future periods. For example, if the company changes accounting principles, that requires retrospective treatment. Any prior periods that are included in the current year financial statements need to be updated to be presented consistent with the new accounting principle. The visual below outlines the common accounting changes and whether the change should be accounted for on prospective or retrospective basis.

  • How a Account for Changes in Accounting Principle

    Assuming the change in accounting principle is justified (i.e. makes sense), then the change should be reflected on a retrospective basis. Unlike the prospective treatment for changes in accounting estimate, this means that any prior periods that are included in the current year financial statements need to be restated to reflect the new accounting principle. This is one of the four accounting changes that you can expect to see on the CPA Exam. It is considered impracticable to retrospectively apply the effects of a change in accounting principle under one of the following circumstances:  You make all reasonable efforts to do so but cannot complete retrospective application. Doing so requires knowledge of managements intent in a prior period, which you cannot substantiate.  Doing so requires significant estimates, and it is impossible for you to create those estimates based on information available when the financial statements were originally issued.  For example, let’s say that the company used LIFO in Year 1 and then switched to FIFO in Year 2. Without retrospective treatment, Year 1 and Year 2 inventory balances would be based on a different accounting principle. Therefore, we need to understand the reflect the change to Year 1 so that the inventory balance is on a FIFO basis, which makes it comparable to Year 2. The rest of the financial statements would have to reflect this change as well. So we know that the Year 1 inventory balance is $75 lower on a FIFO basis, but how is this reflected in the financial statements? They would not go back to Year 1 and adjust the numbers, however, they would need to book an adjustment to the Year 2 retained earnings opening balance. Since inventory decreased $75, the company would record a debit to retained earnings for $75 and a credit to inventory for $75.