Explain how U.S. GAAP and IFRS distinguish the accounting for (1) corrections of errors, (2) adjustments for changes in accounting principles, and (3) adjustments for changes in accounting estimates

ADJUSTMENTS FOR ERRORS AND ACCOUNTING CHANGES

U.S. GAAP and IFRS distinguish the accounting for (1) corrections of errors, (2) adjustments
for changes in accounting principles, and (3) adjustments for changes in accounting estimates.

Reporting Correction of Errors

Errors result from such actions as miscounting inventories and misapplying accounting principles. U.S. GAAP and IFRS require firms to account for correction of errors, if material, by retrospectively restating net income of prior periods and adjusting the beginning balance
in Retained Earnings for the current period.

Reporting Changes in Accounting Principles

U.S. GAAP and IFRS require firms to retrospectively apply any changes in accounting principle by recalculating the income for prior periods under the new accounting principle, if it at all feasible.

Reporting Changes in Accounting Estimates

Accrual accounting requires frequent, ongoing changes in estimates. As time passes and conditions change, new information becomes available that causes management to change the estimates required to apply accounting principles. Examples of such estimates include the amount of uncollectible accounts and the useful lives of depreciable assets. Firms do not recalculate revenues and expenses of previous periods to incorporate new information involving estimates. Instead, firms report the effect of the change in estimate prospectively, in current and future periods' earnings. For example, rather than adjust Retained Earnings directly, the firm adjusts current and future charges—but not past ones—to take into account the carrying value at the time the new information arrives as well as the new information itself.

Changes in estimates do not always relate to recurring accrual accounting measurements,
such as depreciable lives. Some changes in estimates concern unusual or nonrecurring events.
Consider, for example, a litigation situation in which a court this period finds a firm responsible
for an act that occurred several years previously and caused injury. The damage award differs from the amount that the firm previously recognized with a debit to a loss and a credit
to a liability. The court's decision provides new information regarding measurements made
in previous periods. Even though the events do not recur, U.S. GAAP and IFRS treat them
similarly to changes in estimates for recurring items. Firms report the income effect of these
items in the income statement of the current period, appropriately disclosed, not in retained
earnings as a direct adjustment.