 Hello, and welcome to this session in which we would look at an example for changes in accounting principle. Changes in accounting principle is covered on the CPA exam as well as in your intermediate accounting courses. So you have to be comfortable with this topic. What is changes in accounting principle? It means going from one acceptable gap method, so you're going from one gap to another acceptable gap method. An example will be going from weighted average to FIFO or going from the percentage of completion for revenue recognition to the completed contract method, the old gap method. So let's take a look at this example and try to answer several questions. Again, I'm giving you this in a form of a simulation, a CPA exam simulation or an exercise. This also could be a multiple choice question. Adam Company began operation and they choose the weighted average method for pricing inventory. So this is the old method, the weighted average. In 20x3, they decided to switch to FIFO. The weighted average is a gap, FIFO is gap. Below is a pre-tax income for the following years, X1, X2, X3, and we're going to be assuming a 21% tax rate. So you might be asked to compute the following. What is Adam's net income in 20x3? So simply put, what should they do? How should they report income in 20x3? What is the cumulative effect on the change in the accounting principle? You might be asked to only complete the income statement for 20x3 and you want to show the cumulative effect. How do we show the cumulative effect? And where do we show the cumulative effect? Or you could be asked, how do we show the comparative income statement for the past three years? Or you might be asked, let's assume they want to republish their financial statement for the past three years to have comparative financial statement, X1, X2, X3. What do we have to do under those circumstances? So by answering those three questions, we will have a good idea about how to deal with changing from one accounting principle, which is a gap acceptable principle to another gap acceptable principle. Before we answer the questions, I would like to remind you whether you are an accounting student or a CPA candidate to take a look at my website farhatlectures.com. I don't replace your CPA review course if you are using one. I'm a useful addition. I don't replace your accounting course. My motto is saving CPA candidate and accounting student one at a time by providing resources such as lectures, multiple choice through false and exercises that's going to help you do better. My CPA resources are aligned with your Becker, Roger, Wiley and Gleam, so it's very easy to go back and forth between my material and your CPA review course. I also give you access to 1500 previously released AICPA questions in their original format plus detailed solution. This is a partial list of all the accounting courses that I cover. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation. Like this recording, share it with other. It helps me a lot. Connect with me on Instagram, Facebook, Twitter and Reddit. Please connect with me on Instagram as I'm trying to grow my followers. So assume an attacks rate of 21%. What should be Adam's net income for 20x3? 20x3 is when they switch and their income, pre-tax income under 50440, weighted average which method, which number do we use? We use the new method 440 times 21%. So let's go ahead and do that. So I'm going to take my calculator, take 440,000 times .21. And I'm going to pay in taxes 92 or my taxes are 92,400. My net income will be 440 minus 92,400. And this will be my new net income. And this is how I would report my net income in 20x3. The second question is, what's the cumulative effect on the change in accounting principle? So if you're only showing 20x3, if that's all what you are showing, what's going to happen is you're going to have to compute the cumulative effect and show it in retained earnings. So the cumulative effect, if you're only showing 20x3, will show in retained earnings. First, let's compute the cumulative effect. Well, for 20x1, you have a difference of 30,000. So your net income is higher by 30,000. In 20x2, you have a difference of 40,000. So in total, your net income should have been higher by 70,000. And we're going to be assuming 21% tax rate for the prior two years. Well, what's going to happen is we're going to take 70,000 times .21. Let's do that 70,000 times .21. And that's going to give us 14,700 in taxes. So we're going to take 70,000, 70,000, which is the cumulative change. My fat fingers, 70,000 minus 14,700. And that's going to give us 55,300. So 555,300 will increase the beginning retained earnings. We'll be in adjustment to beginning retained earnings. So the point is, if you're only showing 20x3, what you have to do, you have to compute the cumulative change and show it in beginning retained earnings. So it doesn't affect the income statement. That's for this question. How about how do we show the comparative income statement for the past three years? If we're showing comparative income statement, then what we have to do for x1, x2, and x3, if we're showing comparative, then we have to use the 500,000 times .21%. The 420 times 21%, the 440 times 21%. So if we're showing comparative, for them to be comparative, they all have to be using the same method, 5.0. So those are the three things that you need to be aware of. So this is how you deal with changes in accounting principle. Very important topic. Remember, if you're showing only one year, you have to compute the cumulative effect and the cumulative effect, like in number two, goes into retained earning net of taxes. If you're showing comparative, you have to go back and change the comparative. Now be careful. Don't mix up changes in accounting principle versus changes in estimate. In changes in estimate, you don't have to go back and change anything. So what we did in this situation, we did retrospectively. We went back and we changed the figures. We changed the figures. And obviously, I don't have to mention this. You have to disclose this information in your notes if you have any changes in accounting principle. That's obvious. What should you do now? Go to farhatlectures.com, work additional multiple choice questions, additional exercises that's going to help you do better. Invest in yourself, invest in your career. The CPA exam is a long-term investment. Take it seriously. Good luck, study hard, and of course, stay safe.