Types of Accounting Changes Part Two

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This blog post delves further into the types of accounting changes addressed in Accounting Standards Codification (ASC 250), Accounting Changes and Error Corrections, specifically addressing the steps in the process of correcting an error in the financial statements.  Part one of this post was published on March 9, 2020.

There is a three-step process to follow to correct an error in the financial statements:

  1. Identify the error

  2. Assess the materiality of the error

  3. Report the correction of the error

Step One: Identify the error

Errors can take several forms including mathematical mistakes, mistakes in the application of Generally Accepted Accounting Principles (GAAP), and an oversight of or misuse of facts that existed at the time the financial statements were prepared.  Changing from a non-GAAP accounting principle to a GAAP account principle is considered an error.  Reclassification of an account balance from an incorrect presentation to a correct presentation is also an error that requires correction.

Step Two: Assess the materiality of the error

The materiality of an error must be assessed qualitatively and quantitatively.  Materiality is often considered subjective depending upon many factors, but for the purposes of financial statement presentation and understanding, an error would be considered material if it can impact the decision making of the users of the statements. 

Step Three: Report the correction of the error

There are three different methods that can be used to correct an error in the financial statements.  The method used depends on the materiality to the prior-period and the current-period financial statements.  

  • Out-of-period adjustment

    • Corrected within the current period

    • Error is considered immaterial to both prior-year and current-year statements

    • Disclosure is not required but may be necessary if the out-of-period adjustment stands out in the financial statements and an explanation would be beneficial

  • Revision restatement or ‘little r’ restatement

    • Error is immaterial to the prior-period financial statements, however, a correction in the current period would cause a material misstatement of the financial statements

    • Correction would be made in the current year comparative financial statements through an adjustment to the prior period information

    • Disclosure of the error required in the financial statement notes

    • Not required to notify users that they can no longer rely on the prior period statements

    • Publicly-filed reports and statements do not have to be amended

    • Auditor’s opinion does not require revision

  • Reissuance restatement or ‘big R’ restatement

    • Error is material to the prior period financial statements

    • Prior year financial statements must be restated and reissued to reflect error correction

    • Users of the financial statements must receive notification that the prior period statements cannot be relied upon

    • Public companies must follow strict SEC reporting requirements regarding financial statement issuance, quarterly and annual filing deadlines, dependent upon the type of error and the length of time needed to make the corrections

    • Financial statement disclosure requirements are detailed in ASC 250

    • Auditor’s opinion will include an explanatory paragraph referencing the misstatement and the footnote disclosure on the correction of the misstatement

    • Impact of the error on the internal controls over financial reporting must be addressed by the company