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 ID: 272938
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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 ASPE and IFRS.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 ASPE and IFRS related to accounting changes.
ACCOUNTING CHANGES AND ERROR ANALYSIS
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Accounting Changes
and Error Analysis3Changes in Accounting Policies and Estimates, and ErrorsTypes of accounting changesAlternative accounting methodsAccounting standardsRetrospective application – change in accounting policyRetrospective restatement – correction of errorProspective applicationIFRS/ASPE ComparisonComparison of IFRS and ASPELooking ahead
Analysis
Motivations for change
Interpreting accounting changesSlide4
Types of Accounting Changes
Change in Accounting PolicyChange 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 developments4Slide5
Types of Accounting Changes
Correction of an error in prior period financial statementsOmissions 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 preparedThey may be intentional or an oversight 5Slide6
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)6Slide7
Changes in Accounting Policies
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 certain financial instruments7Slide8
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 immaterial8Slide9
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 immaterial9Slide10
Changes in Accounting Estimates
Future conditions and events and their effects cannot be known with certainty; therefore estimation requires exercise of judgmentUse of reasonable estimates is essential to the accounting process and does not undermine the reliability of financial statements10Slide11
Changes in Accounting Estimates
Examples of items requiring estimates include:Uncollectible receivablesInventory obsolescenceFair value of financial assets/liabilitiesUseful lives and residual values of depreciable assetsLiabilities for warranty costs11Slide12
Changes in Accounting Estimates
Differentiating a change in policy and a change in estimate can be difficultFor 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 estimate12Slide13
Correction of a Prior Period Error
Examples of accounting errors include:Change from non-GAAP to GAAPe.g. change from cash basis of accounting to accrual basisMathematical mistakese.g. incorrect totaling of inventory count sheetsOversighte.g. failure to defer expenses or revenuesMisappropriation of assetse.g. discovery of inventory theft13Slide14
Correction of a Prior Period Error
Distinguishing between correction of an error and a change in estimate can be difficultExample: a lack of a previous year’s accrual of reassessed income taxes – was the information overlooked (i.e. an error) or do we have more information or was there subsequent developments (i.e. an estimate)?General rule: if an estimate was calculated incorrectly due to lack of expertise, it is considered an error; If a careful estimate was made in a previous year which is later determined as incorrect, it is considered a change in estimate14Slide15
Alternative Accounting Methods
Three approaches have been suggested for reporting changes in the accounts:RetrospectiveCurrentProspective15Slide16
Retrospective Treatment
Also known as retroactive applicationRequires 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)16Slide17
Current Treatment
New accounting method or estimate’s cumulative effect on the financial statements at the beginning of the period is calculatedAn adjustment is reported in current year’s income statementPrior years’ financial statements are not restated17Slide18
Prospective Treatment
Previously reported results remain; no change is madeOpening balances are not adjusted and no attempt is made to correct or change past periodsNew policy or estimate is adopted for current and future periods only and applied to balances existing at the date of the change18Slide19
Accounting Standards
Type of Accounting ChangeAccounting Method AppliedChange 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. If impractical, apply prospectively
Change in accounting estimate
Apply prospectively.
Correction of an error
Apply retrospectively.
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Retrospective-with-Restatement
Requirements of this method include:Retroactive application of the new method, including income tax effects using an accounting entryPrior-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 20Slide21
Retrospective-with-Restatement - Example
21Given: Voluntary change to capitalizing all avoidable interest costs on self-constructed assetsCumulative effects at January 1, 2014:Capitalizing interest: $20,000 + $200,000 = $220,000 Income tax effect: $6,000 + $60,000 = $66,000Slide22
Retrospective-with-Restatement - Example
January 1, 2014: To record retroactive changeBuildings 220,000 Deferred Tax Liability 66,000 Retained Earnings 154,00022Slide23
Retrospective-with-Restatement - Example
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Retrospective-with-Restatement - Example
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Retrospective-with-Restatement - Example
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Retrospective with Partial Restatement
Retroactively restating prior years’ financial statements requires information that may be impractical to obtain on a cost-benefit basisSome standards allow for a partial retrospective applicationThe change in policy is applied at the beginning of the earliest period for which restatement is possible 26Slide27
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 2013. The journal entry to record the change in policy is the same as the one made for full restatement:January 1, 2014: To record changeBuildings 220,000 Deferred Tax Liability 66,000 Retained Earnings 154,000However, years prior to 2013 are not restated27Slide28
Retrospective with Partial Restatement
Any comparative financial statements prior to 2013 are not restatedWithout restatement, leaves the comparative financial statements as originally reported and The change’s cumulative effect prior to Jan. 1, 2013 is presented as an adjustment to Jan. 1, 2013 Retained Earnings28Slide29
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 date
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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, andAny reasonably reliable information useful in assessing possible impact on financial statement in the period in which it will be first applied30Slide31
Correction of an Error
Under ASPE, full retrospective adjustment is requiredUnder IFRS, partial retrospective adjustment is allowed if full retrospective restatement is impracticable31Slide32
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 presented.32Slide33
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 requiredEffect of correction on basic and diluted EPS for each period presented33Slide34
Prospective Application
Effects of changes in estimates are handled prospectivelyNo changes are made to previously reported resultsChanges 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 both34Slide35
Disclosure – Change in Estimate
Minimum disclosures are as follows:The nature of the change in estimateThe 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 disclosed35Slide36
Accounting Changes
and Error Analysis36Changes in Accounting Policies and Estimates, and ErrorsTypes of accounting changesAlternative accounting methodsAccounting standardsRetrospective application – change in accounting policyRetrospective restatement – correction of errorProspective applicationIFRS/ASPE ComparisonComparison of IFRS and ASPELooking ahead
Analysis
Motivations for change
Interpreting accounting changesSlide37
Motivations for Change
Political costs – larger firms, larger profits, may become political targets; select policies to reduce profitsCapital structure – debt/equity structure will impact accounting policies due to debt covenantsBonus payments – when bonuses attached to income, managers may select methods that maximize incomeSmooth earnings – gradual increase (decrease) in income to shift attention37Slide38
Interpreting Accounting Changes
Accounting changes often make it difficult to develop trend dataUsers of the financial statements should look at accounting changes closely when they occur and adjust trend data as appropriateSlide39
Accounting Changes
and Error Analysis39Changes in Accounting Policies and Estimates, and ErrorsTypes of accounting changesAlternative accounting methodsAccounting standardsRetrospective application – change in accounting policyRetrospective restatement – correction of errorProspective applicationIFRS/ASPE ComparisonComparison of IFRS and ASPELooking ahead
Analysis
Motivations for change
Interpreting accounting changesSlide40
Looking Ahead
No significant changes are expected in the immediate futureSlide41
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