CHAPTER 21: ACCOUNTING CHANGES AND ERROR ANALYSIS - PowerPoint Presentation

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CHAPTER 21:ACCOUNTING CHANGES AND ERROR ANALYSISSlide3

CHAPTER 21: Accounting Changes and Error Analysis

After studying this chapter, you should be able to:

Identify and differentiate among the types of accounting changes.

Identify and explain alternative methods of accounting for accounting changes.Identify the accounting standards for each type of accounting change under IFRS and APSE.Apply the retrospective application method of accounting for a change in accounting policy and identify the disclosure requirements.Apply retrospective restatement for the correction of an accounting error and identify the disclosure requirements.Apply the prospective application method for an accounting change and identify the disclosure requirements for a change in an accounting estimate.Identify economic motives for changing accounting methods and interpret financial statements where there have been retrospective changes to previously reported results.Identify the differences between IFRS and APSE related to accounting changes.Correct the effects of errors and prepare restated financial statements.Slide4

Types of Accounting Changes

Change in Accounting Policy

Change in the choice of “specific principles, bases, conventions, rules, and practices applied by an entity in preparing and presenting financial statements”

Change in Accounting EstimateAdjustment based on a change in circumstances on which a previous estimate was based or as the result of new information, more experience or subsequent developmentsSlide5

Types of Accounting Changes (Cont’d)

Correction of an error in prior period financial statements

Omissions from or mistakes in financial statements of prior periods caused by the misuse or failure to use reliable information that existed at the time financial statements were prepared

They may be intentional or an oversight Slide6

Changes in Accounting Policies

Under IFRS, change in an accounting policy is permitted only when the change:

Is required by a

primary source of GAAP, orResults in portraying reliable and more relevant information about effects of transactions, events or conditions (voluntary)Slide7

Changes in Accounting Policies (Cont’d)

Under ASPE, there is a third type of policy change permitted without having to meet the reliable but more relevant test:

3. Between or among allowed ASPE accounting options for:

Investments in subsidiaries, and investments with significant influence or joint controlsDevelopment phase expenditures on internally generated intangible assetsDefined benefit plansIncome taxesMeasuring equity component of compound financial instrumentsSlide8

Changes in Accounting Policies

Does not

result from adoption of a:

Different policy necessitated by events or transactions clearly different in substance from those previously occurringNew policy that recognizes events that have occurred for the first time or that were previously immaterialSlide9

Changes in Accounting Policies

Examples of situations that are

not changes

in accounting policy:Adopting interest capitalization during construction of own long-term assets, when company had not previously been involved in self-construction Deferral of development expenditures when previously these expenses were expensed as they were immaterialSlide10

Changes in Accounting Estimates

Future conditions and events and their effects cannot be known with certainty; therefore estimation requires exercise of judgment

Use of reasonable estimates is essential to the accounting process and does not undermine the reliability of financial statementsSlide11

Changes in Accounting Estimates

Examples of items requiring estimates include:

Uncollectible receivables

Inventory obsolescenceFair value of financial assets/liabilitiesUseful lives and residual values of depreciable assetsLiabilities for warranty costsSlide12

Changes in Accounting Estimates

Differentiating a change in policy and a change in estimate can be difficult

For example, is a change in depreciation method a change in policy or a change in estimate?

At first glance, a change in depreciation method appears to be a change in accounting policyHowever, it is a change in estimate if it is a change in estimate of the pattern in which company benefits from the assetWhere it is not clear, treat the change as a change in estimateSlide13

Retrospective Treatment

Also known as

retroactive application

Requires calculating the cumulative effect of the change on the financial statements at the beginning of the period, as if the new method or estimate had always been usedAn adjustment is made to the financial statements equal to this cumulative effectResults in restating all affected prior years’ financial statements on a basis consistent with the newly adopted policy (i.e., as if the new accounting policy had always been used)Slide14

Current Treatment

New accounting method or estimate’s cumulative effect on the financial statements at the beginning of the period is calculated

An adjustment is reported in current year’s income statement

Prior years’ financial statements are not restatedSlide15

Prospective Treatment

Previously reported results remain; no change is made

Opening balances are not adjusted and no attempt is made to correct or change past periods

New policy or estimate is adopted for current and future periods only and applied to balances existing at the date of the changeSlide16

Accounting Standards

Type of Accounting Change

Accounting Method Applied

Change in Accounting Policy – Adoption of primary source of GAAPApply method approved in transitional provisions section of the primary source; if none, then use retrospective application (if impractical, apply prospectively)

Change in Accounting Policy

– Voluntary

Apply retrospectively to the extent practicable

Change in accounting estimate

Apply prospectively

Correction of an error

Apply retrospectivelySlide17

Retrospective-with-Restatement

Requirements of this method include:

Retroactive application of the new method, including income tax effects using an accounting entry

Prior-period financial statements included for comparative purposes are restatedDescription of the change and effect on current and prior period financial statements disclosed so that statements remain comparable Slide18

Retrospective-with-Restatement - Example

Given:

Voluntary change to capitalizing all avoidable interest costs on self-constructed assetsCumulative effects at January 1, 2017:Capitalizing interest: $20,000 + $200,000 = $220,000 Income tax effect: $6,000 + $60,000 = $66,000Slide19

Retrospective-with-Restatement - Example

January 1, 2017: To record retroactive change

Buildings 220,000

Deferred Tax Liability 66,000 Retained Earnings 154,000Slide20

Retrospective-with-Restatement - ExampleSlide21

Retrospective-with-Restatement - ExampleSlide22

Retrospective with Partial Restatement

Retroactively restating prior years’ financial statements requires information that may be impractical to obtain on a cost-benefit basis

Some standards allow for a partial retrospective application

The change in policy is applied at the beginning of the earliest period for which restatement is possible Slide23

Retrospective with Partial Restatement - Example

Assume that it was impractical for Denson Ltd. to determine the effects of the change in policy on specific years any further back than 2016. The journal entry to record the change in policy is the same as the one made for full restatement:

To record change January 1, 2017:

Buildings 220,000 Deferred Tax Liability 66,000 Retained Earnings 154,000However, years prior to 2016 are not restatedSlide24

Retrospective with Partial Restatement

Any comparative financial statements prior to 2016 are not restated

Without restatement, this

leaves the comparative financial statements as originally reported and The change’s cumulative effect prior to Jan. 1, 2016 is presented as an adjustment to Jan. 1, 2016 Retained EarningsSlide25

Disclosures – Changes in Accounting Policy

For

changes in policy resulting from initial application of a primary source of GAAP or from a voluntary change,

the following must be disclosed:For first-time application of IFRS or primary source, its title, nature of change and that made in accordance with transitional provisions, and what provisions are (including those that affect future periods)The nature of any voluntary change in accounting policy, and why the new policy results in reliable and more relevant information (under ASPE, some voluntary changes are exempt from this requirement)The amount of the adjustment for each financial statement line item that is affected for current and prior periodsThe reasons it was not practicable for restatement of particular periods, with a description of how the change was applied and from what dateSlide26

Disclosures – Changes in Accounting Policy

IFRS also requires disclosures for new primary sources of GAAP that are not yet effective and have not been applied:

Disclose the fact that new primary source has been issued, and

Any reasonably reliable information useful in assessing possible impact on financial statement in the period in which it will be first appliedSlide27

Correction of an Error

Under ASPE, full retrospective adjustment is required

Under IFRS, partial retrospective adjustment is allowed if full retrospective restatement is impracticable

Errors can be counterbalancing (that self-correct over two periods) or non-counterbalancing (errors that are not offset in the next accounting period). Appendix 21A provides a comprehensive illustration of both of these types of errorsSlide28

Disclosures – Correction of an Error

Where a

change is the result of an accounting error

, companies must disclose that an error occurred in a prior period(s) and disclose, in the year of the correction:The nature of the error;The amount of the correction to each line item on the financial statements presented for comparative purposes;The amount of the correction made at the beginning of the earliest prior period presentedSlide29

Disclosures – Error Correction

IFRS requires additional disclosures:

Where partial retrospective restatement is made on grounds of impracticability, additional information relating to impracticability and adjustment is required

Effect of correction on basic and diluted EPS for each period presentedSlide30

Prospective Application

Effects of changes in estimates are handled prospectively

No changes are made to previously reported results

Changes in estimates are viewed as normal recurring corrections and adjustmentsEffect of a change in estimate is accounted for by including it in net income or comprehensive income as appropriate in:The period of change if the change affects that period onlyThe period of change and future periods if the change affects bothSlide31

Disclosure – Change in Estimate

Minimum disclosures are as follows:

The nature of the change in estimate

The amount of the change in estimate affecting the current period IFRS also requires disclosure of the nature and amount of any change expected to impact future periodsIf it is not practicable to estimate effect, this fact is disclosedSlide32

Motivations for Change

Political costs – larger firms, larger profits, may become political targets; select policies to reduce profits

Capital structure – debt/equity structure will impact accounting policies due to debt covenants

Bonus payments – when bonuses attached to income, managers may select methods that maximize incomeSmooth earnings – gradual increase (decrease) in income to shift attentionSlide33

Interpreting Accounting Changes

Accounting changes often make it difficult to develop trend data

Users of the financial statements should look at accounting changes closely when they occur and adjust trend data as appropriateSlide34

Looking Ahead

The IASB plans to issue an Exposure Draft in 2016 with proposed amendments to IAS 8. The Exposure Draft will deal with the distinction between accounting policies and estimates, and the impact of this distinction on financial reportingSlide35