As part of a company's normal course of business, errors, omissions, and changes occur in the financial statements. Certain items may be reported on the income statement, some may directly adjust the balance in retained earnings, while others do not affect the current period's income statement or retained earnings. Required:

Question

a. Consider a change in estimate, such as the useful life of an asset moving from five to eight years. How is this handled on the income statement and/or through the retained earnings account?
b. Consider an error/omission, such as merchandise inventory being left out of the final yearly count. How is this handled on the income statement and/or through the retained earnings account?

Answer 1

a. A change in estimate such as the useful life is handled in the period of the change (by altering the depreciation expense amount, which is ultimately closed to Retained Earnings) and future periods (also reflected in a different depreciation expense amount). The income statement in the year of the change (and in subsequent years) would reflect the altered depreciation expense.
b. An error/omission such as leaving off ending inventory amounts is handled by directly increasing the retained earnings account in the period the error/omission was discovered. The income statement in the year of discovery is unaffected.