How should the effect of a change in accounting estimate be accounted for?
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A. B. C. D. E.C
The effect of a change in accounting estimate must be accounted for as a component of income from continuing operations in the period of change and in future periods.
The correct answer to the question is D. By restating amounts reported in financial statements of prior periods.
When there is a change in accounting estimate, it should be accounted for by restating the amounts reported in the financial statements of prior periods. Let's break down this answer choice and explain the reasoning behind it.
Accounting estimates are used when the exact measurement of an item is not possible, but an approximation is necessary. Examples of accounting estimates include the useful life of an asset, the allowance for doubtful accounts, or the fair value of an investment.
When there is a change in accounting estimate, it means that new information or circumstances have emerged that require a revision to the previous estimate. This change impacts the financial statements of the periods affected by the estimate.
Restating amounts reported in financial statements of prior periods means that the financial statements of those periods are adjusted to reflect the revised estimate. This ensures that the financial information presented is accurate and reliable.
Let's look at the other answer choices and explain why they are incorrect:
A. None of these answers: This answer implies that none of the provided options is correct. However, one of the options is indeed the correct approach for accounting for a change in accounting estimate.
B. By reporting pro forma amounts for prior periods: Pro forma amounts are hypothetical or adjusted amounts that show what the financial statements would have looked like if certain events had occurred or accounting policies had been applied differently. While pro forma statements may be useful in certain situations, they are not the appropriate method for accounting for a change in accounting estimate.
C. In the period of change and future periods if the change affects both: This option suggests that the change in accounting estimate should only be recognized in the period of change and future periods if the change affects both. However, this is not accurate. A change in accounting estimate affects the financial statements of prior periods as well, and they need to be restated accordingly.
E. As prior-period adjustments to beginning retained earnings: Prior-period adjustments to beginning retained earnings are used for correcting errors in financial statements that occurred in previous periods. A change in accounting estimate is different from a correction of an error. Therefore, it should not be treated as a prior-period adjustment to beginning retained earnings.
In summary, the correct approach for accounting for a change in accounting estimate is to restate the amounts reported in the financial statements of prior periods. This ensures that the financial statements provide users with accurate and reliable information.