How do I tell the difference between an error correction, a change in estimate, and a change in principle?

Question

AcadiFi · Accepted Answer

An error correction fixes a mistake such as mathematical errors, misuse of GAAP, or oversight of facts that existed when the statements were prepared. Errors are corrected by restating prior periods and adjusting beginning retained earnings for the earliest period shown. A change in estimate, such as revised useful life or bad debt expectations, is handled prospectively. A change in principle, such as switching inventory methods when GAAP allows it, is usually handled retrospectively unless impracticable or unless a standard says otherwise.

Example: Clear Path Services forgot to record $90,000 of 2025 depreciation. That is an error, so 2026 statements should restate 2025 and reduce beginning retained earnings if comparative statements are presented. If the company later revises the life of a server from 6 years to 4 years, that is a change in estimate handled prospectively. If it changes from weighted-average to FIFO and GAAP permits the switch, that is a change in principle and is generally shown retrospectively.

A good FAR shortcut is to ask whether the old accounting was wrong, based on new information, or a deliberate switch to another acceptable method. Wrong means error. New information means estimate. New acceptable method means principle. Once you identify the category, the journal and disclosure treatment become much easier. Practice more in our CPA FAR question bank.

How do I tell the difference between an error correction, a change in estimate, and a change in principle?

Master FAR with our CPA Course

Related Questions

Practice Questions