The Pine Corp. learns in July 2018 some new information about a lawsuit that first started in 2015. Pine Corp. had shown a liability of $2,000,000 related to this lawsuit in its December 31 balance sheets for 2015, 2016, and 2017. It now believes the liability will be only $1,500,000. Under GAAP, Pine Corp. should
A) Restate the 2015, 2016, and 2017 statements to show a $1.5 million liability
B) Restate only the 2017 statements to show a $1.5 million liability
C) Not restate any prior year's liability, but reflect a benefit of $500,000 in the 2018 financial statements and disclose the change in estimate
D) Not restate any prior year's liability, but reflect a benefit of $500,000 in the 2018 financial statements. It should not disclose the change in estimate

Question

Quizplus · Accepted Answer

According to GAAP, a change in accounting estimate should be reflected in the financial statements of the period in which the change is made and in future periods affected by the change. Restating prior year's financial statements is only required for material errors or changes in accounting principle (not estimates). Therefore, option A and B are not correct.

Option C reflects the correct treatment. The company should not restate the prior year's liability, but reflect a benefit of $500,000 in the 2018 financial statements and disclose the change in estimate. This treatment appropriately reflects the change in estimate in the current year's financial statements and provides disclosure to the users of the financial statements.

Option D is incorrect as it violates the principle of transparency and full disclosure required by GAAP. The company should disclose the change in estimate in the notes to the financial statements.