Retrospective application definition
/What is Retrospective Application?
A retrospective application is the application of a new accounting principle as if that principle had always been applied. The concept is used when the financial statements for multiple periods are being presented. With the retrospective application of accounting principles, the information presented in multi-period financial statements is more comparable. There is no need to impose a retrospective application on financial statements that are earlier than the ones being included in a set of financial statements.
In situations where retrospective application is required, it usually involves an adjustment to the beginning balances of the applicable asset, liability, or equity accounts presented in the financial statements. However, there are practical limitations on this concept that may allow you to avoid making a full retrospective application of an accounting principle.
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Example of Retrospective Application
A company previously recognized revenue from long-term construction contracts using the completed-contract method (recognizing revenue only when the project was completed). Following a change in accounting standards, the company is now required to use the percentage-of-completion method (recognizing revenue as the work progresses). In this case, the company would restate its prior financial statements to reflect what they would have looked like had the percentage-of-completion method been used in those periods. This involves adjusting its reported revenues, expenses, and retained earnings. For the earliest period presented, any cumulative effect of the change is adjusted against the opening balance of retained earnings. This ensures that the financial statements reflect the new policy as though it had always been applied.
In 2025, the company changes its policy. For 2024, the company originally reported $10 million in revenue using the completed-contract method. Under the percentage-of-completion method, revenue for 2024 should have been $15 million. Therefore, the financial statements for 2024 are restated to show $15 million in revenue. Any difference in profits or retained earnings from earlier years (e.g., 2023 or before) is adjusted in the opening balance of 2024 retained earnings. In addition, the company must disclose the nature and reason for the change in policy, the effects of the change on current and prior periods, and any adjustments made to financial statements and retained earnings.
This example illustrates how retrospective application ensures consistency and comparability in financial reporting.