News

FASB Issues SFAS 154, Accounting Changes and Error Corrections

News Brief
June 3, 2005

By: Cydney Posner

It's accounting day. FASB has issued SFAS 154, Accounting Changes and Error Corrections, which will replace APB 20 and FASB Statement No. 3. We are sometimes called upon to look at these particular FASB pronouncements in connection with potential restatements and other changes. The statement will be effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted.

SFAS 154 changes the requirements for the accounting for, and reporting of, a change in accounting principle and applies to all voluntary changes in accounting principle, as well as changes pursuant to accounting pronouncements that do not include transition rules. APB 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. Under SFAS 154, changes in accounting principle must be applied retrospectively to prior periods’ financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The statement also provides guidance for determining whether retrospective application is impracticable (for example, if assumptions about management's earlier intent are necessary, but cannot be independently substantiated). A change in accounting principle is not deemed to include either

  • initial adoption of an accounting principle in recognition of events or transactions occurring for the first time or that previously were immaterial in their effect or
  • adoption or modification of an accounting principle necessitated by transactions or events that are clearly different in substance from those previously occurring.
SFAS 154 also provides that a change in depreciation, amortization or depletion method for long-lived, nonfinancial assets should be accounted for, not as a change in accounting principle, but rather as a change in accounting estimate (effected by a change in accounting principle). Consistent with APB 20, a change in accounting estimate would not require a restatement or retrospective adjustment of amounts reported for prior periods or disclosure of pro forma amounts for prior periods. SFAS 154 outlines the information that must be disclosed for the period is which the change is made, including the nature of and reason for the change in accounting principle (in particular, an explanation of why the newly adopted accounting principle is preferable), the method of applying the change, the effect of the change on various line items and a description of any indirect effects that were recognized. SFAS 154 carries forward the guidance in APB 20 requiring that a change in accounting principle be made only if the change is required by a newly issued accounting pronouncement or if the entity can justify the use of an allowable alternative accounting principle on the basis that it is preferable.

SFAS 154 does not change the guidance contained in APB 20 for reporting the correction of an error in previously issued financial statements. Accordingly, any error, unless immaterial, in the financial statements of a prior period discovered subsequent to their issuance must be reported as a prior-period adjustment by restating the prior period financial statements. Financial statements for each individual prior period presented must be adjusted to reflect correction of the period-specific effects of the error. When financial statements are restated to correct the error, the company must disclose the fact of the restatement along with a description of the nature of the error. The company must also disclose the following:

  • The effect of the correction on each financial statement line item and any per-share amounts affected for each prior period presented; and
  • The cumulative effect of the change on retained earnings or other appropriate components of equity or net assets in the statement of financial position, as of the beginning of the earliest period presented.
In addition, the company must provide the disclosures of prior-period adjustments and restatements required by paragraph 26 of APB. 9, Reporting the Results of Operations. Financial statements of subsequent periods do not need to repeat these disclosures.

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