Financial Accounting and Reporting-CPA Practice Exam

An adjustment affecting retained earnings due to a new accounting principle is known as what?

1. Retrospective Adjustment

2. Current Adjustment

3. Pro Forma Adjustment

4. Estimates Adjustment

The correct answer is: Retrospective Adjustment

An adjustment affecting retained earnings due to a new accounting principle is known as a retrospective adjustment. This approach requires that prior periods' financial statements be restated as if the new accounting principle had always been applied. The purpose of this retrospective approach is to provide users of the financial statements with a consistent basis for comparison over time. When a company adopts a new accounting principle, it must adjust its retained earnings to reflect the cumulative effect of applying this principle to prior periods. This ensures that users of the financial statements can accurately assess trends and changes in the company's financial position and performance. A retrospective adjustment also enhances the comparability of financial statements across periods, which is a fundamental concept in financial reporting. In contrast, other options do not accurately describe this process. A current adjustment typically refers to changes made in the current reporting period that do not impact prior periods. Pro forma adjustments are often used in financial projections or to represent what financial results would have looked like under certain scenarios or assumptions, rather than reflecting a change in accounting principles. Estimates adjustments deal with changes in accounting estimates, which are different from the cumulative adjustments necessary when changing accounting principles.