8.4 Accounting Changes, Errors, and Subsequent Events
Key Takeaways
- The 2026 FAR Blueprint tests accounting changes and error corrections in Area III, including adjustment calculations and prospective or retrospective application.
- Changes in accounting principle are generally applied retrospectively, while changes in accounting estimate are applied prospectively.
- Error corrections generally require restating prior-period financial statements and adjusting opening retained earnings for the earliest period presented.
- Recognized subsequent events provide evidence about conditions that existed at the balance sheet date, while nonrecognized events arise after that date.
- Contingencies are accrued when a loss is probable and reasonably estimable; otherwise they are disclosed or, if remote, generally ignored.
Classification Before Calculation
FAR questions in this area usually provide enough facts to calculate an adjustment, but the calculation is useless unless the event is classified correctly. The 2026 AICPA FAR Blueprint includes accounting changes and error corrections in Area III and asks candidates to calculate required adjustments, decide whether prospective or retrospective application is required, and derive financial statement and note disclosure effects. The same Area includes subsequent events, contingencies, and commitments. Because the wrong classification cascades into every downstream number, label the item before touching the calculator.
Accounting Changes
| Item | Treatment | Typical Example |
|---|---|---|
| Change in accounting principle | Retrospective application unless impracticable. | FIFO to weighted-average inventory costing. |
| Change in accounting estimate | Prospective application. | Revised useful life or salvage value. |
| Change in reporting entity | Retrospective application. | Presenting consolidated statements instead of separate statements. |
| Change from non-GAAP to GAAP | Treat as correction of an error. | Cash-basis statements changed to accrual GAAP. |
A change in accounting principle means the entity moved from one acceptable GAAP method to another acceptable GAAP method. The cumulative effect is reflected by adjusting beginning retained earnings for the earliest period presented, and comparative statements are revised as if the new principle had always been used. Retrospective application is required unless it is impracticable to determine the period-specific or cumulative effect.
A change in estimate happens because new information changes expectations. Do not restate prior periods for a revised useful life, revised bad-debt percentage, or revised warranty rate. Instead, use the current carrying amount and allocate it over the remaining useful life, or apply the revised estimate to current and future periods.
Some changes are both principle and estimate, such as a change in depreciation method. GAAP treats these as a change in estimate effected by a change in principle, so they are applied prospectively, not retrospectively.
Error Corrections
An error is not a new judgment; it means prior financial statements were wrong based on information available at the time. Errors include mathematical mistakes, misapplied GAAP, incorrect classification, overlooked facts, and fraud. Correct material errors by restating prior-period financial statements if presented and adjusting opening retained earnings (a prior-period adjustment) for the earliest period presented. Notes must describe the nature of the error and its effect on relevant financial statement line items, including the effect on earnings per share where applicable.
Subsequent Events
Subsequent events occur after the balance sheet date but before financial statements are issued or available to be issued. The exam distinction is simple but powerful:
- Recognized subsequent events provide additional evidence about conditions that existed at the balance sheet date. Adjust the financial statements.
- Nonrecognized subsequent events relate to conditions that arose after the balance sheet date. Do not adjust, but disclose if material.
A customer's bankruptcy shortly after year-end may require an allowance adjustment if the bankruptcy confirms financial difficulty that existed at year-end (recognized). A fire destroying a warehouse after year-end is usually nonrecognized because the condition did not exist at the balance sheet date, though disclosure may be necessary. The issuance of stock or bonds after year-end is also typically a nonrecognized, disclosure-only event.
Contingencies And Commitments
For loss contingencies, accrue when the loss is both probable and reasonably estimable; if a range is estimable with no best estimate, accrue the low end of the range under U.S. GAAP. Disclose when the loss is reasonably possible, or probable but not estimable. Remote losses usually require no accrual or disclosure, except for certain guarantees. Gain contingencies are generally not recognized until realized. Commitments, such as a purchase obligation, often do not create an immediate liability, but material commitments may require disclosure because they affect future cash flows.
A Worked Error Correction
Suppose a company discovers in 2026 that it failed to record $50,000 of depreciation in 2024. Comparative statements for 2024, 2025, and 2026 are presented. The 2024 statements are restated to add the $50,000 expense, accumulated depreciation rises, and the 2026 opening retained earnings is reduced by the net-of-tax effect carried forward from 2024. If the tax rate is 20 percent, the prior-period adjustment to retained earnings is $50,000 x (1 - 0.20) = $40,000, and a deferred tax effect is recorded for the difference. The current year's income statement is not charged with the prior error; only the affected prior periods are restated.
Contrast this with a change in estimate, where no prior period is ever touched.
Probability Thresholds At A Glance
| Likelihood | Loss Contingency Action | Gain Contingency Action |
|---|---|---|
| Probable and estimable | Accrue and disclose. | Generally not recognized. |
| Probable, not estimable | Disclose only. | Not recognized. |
| Reasonably possible | Disclose only. | Generally not disclosed. |
| Remote | No action (except certain guarantees). | Not recognized. |
The asymmetry between losses and gains reflects conservatism: anticipate probable losses, but wait for gains to be realized. On the exam, a fact pattern that says a lawsuit "may" result in loss usually signals reasonably possible (disclosure), while "will likely" or "expected" signals probable (accrual when estimable).
Exam Workflow
- Label the item: principle, estimate, reporting entity, error, recognized or nonrecognized subsequent event, contingency, or commitment.
- Decide adjustment versus disclosure.
- Calculate the income statement, balance sheet, retained earnings, and tax effects if provided.
- Check whether comparative statements require restatement.
- Draft the note disclosure in plain accounting terms.
A company changes the estimated useful life of equipment from 10 years to 8 years after new maintenance information becomes available. How should the change be reported?
On February 10, before the December 31 financial statements are issued, a major customer declares bankruptcy because of severe financial difficulty that existed at year-end. The customer owed the company $90,000 at December 31. What is the likely accounting treatment?
A company faces litigation where a loss is probable, and management estimates the loss somewhere between $200,000 and $500,000 with no amount within the range more likely than the others. Under U.S. GAAP, what should be accrued?