Powerpoint slides by: Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Michael L. Hockenstein Commerce Department Vanier College Intermediate Accounting

Powerpoint slides by:

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

Michael L. Hockenstein Commerce Department • Vanier College

Intermediate Accounting

Thomas H. BeechySchulich School of Business, York University

Joan E. D. ConrodFaculty of Management

Dalhousie University

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 22-2

Accounting Changes

Chapter 22


Types of Accounting Changes There are three general types of

accounting changes:changes in accounting policy

- voluntary, at the option of management or at the request of a user

- involuntary, to comply with new CICA Handbook recommendations

changes in accounting estimatescorrection of an error in previous

periods’ financial statements


Changes in Policy

A change in accounting policy is a change in the way that a company accounts for a particular type of transaction or event, or for the resulting asset or liability

A change in accounting policy must not be confused with adopting a new accounting policy

The following are not changes in accounting policy: the initial adoption or alteration of an accounting policy

necessitated by events or transactions that are clearly different in substance from those previously recognized

the initial adoption of an accounting policy in recognition of events or transactions occurring for the first time or that were previously immaterial in effect


Changes in Policy (cont.)

Accounting policies can be voluntary or involuntarya change is voluntary when management

decides to make a change from one generally accepted method of accounting to another

a change is involuntary when the AcSB issues a new or revised recommendation in the CICA Handbook which requires GAAP-constrained companies to alter its policy to conform to the new recommendations


Changes in Estimate

A change in accounting estimates is a change in the application of an accounting policy to a specific transaction or event

Accounting measurements are based extensively on future expectationsuncollectable accounts receivable recoverable value of an asset criteria for capitalizing development costs


Changes in Estimate (cont.)

We can never predict future outcomes with certainty and therefore accounting estimates often need revision

Examples of changes in accounting estimates include:a revision in the estimate of uncollectable ARa revision in the estimated recoverable value of an

asset, such as inventory or investmentsa change in management’s judgement concerning

one or more of the criteria for capitalizing development costs


Changes in Estimate (cont.) Changes in accounting estimates can occur for

several reasons: the company’s economic environment has changed,

requiring a re-evaluation of the assumptions underlying many of management’s accounting estimates

auditors have raised questions about the application of the company’s accounting policies and have requested substantiation for (or modification of) management’s estimates

there has been a shift in the nature of the company’s business operations, so that past estimates may need adjustment to fit current business strategies


Correction of an Error On occasion, a company (or its auditors) discovers

that there was an accounting error in a prior period If the error was material, the error must be

corrected even if it has washed out over the long run inventory overlooked when the physical count

was taken failed to accrue commission liabilities that had not

been paid by the end of the fiscal year routine repairs were capitalized instead of being

expensed


Correction of an Error (cont.)

Errors do not arise from a change in estimate or a change in policy---they are simply mistakes

Accounting errors require restatement of prior periods results, in order to comply with the qualitative criteria of comparability and consistency, even if there is no impact on the period in which the error was discovered


Summary: Types of Changes

Basically, we can summarize an accounting change as being:a change in estimate if it is the result of new

information that was not known previouslya change in policy if the change was motivated by

different reporting circumstances of the enterprise and there has been no material change in economic circumstances


Summary: Types of Changes (cont.)

application of a new policy if the transactions or events are materially different from those reported previously

correction of an accounting error if information has come to light that was reasonably determinable in the period in which the transaction or event was initially reported


Summary: Types Of Changes (cont.)

Discerning the nature of the change is important for two reasons: the reporting approach for changes in accounting

estimates is different from that for changes in accounting policies and corrections of errors

changes in accounting estimates and error corrections normally are not disclosed and, in effect, are ‘buried’ in the financial statements, while changes in accounting policies must be disclosed in the notes to the financial statements


Summary: Types Of Changes (cont.)

When there is doubt as to whether a change is a change in policy or a change in estimate, the CICA Handbook suggests that the change should be treated as a change in estimate


Accounting for Changes

There are three ways of reporting accounting changes in the financial statements: retroactive application with restatement of prior

periods retroactive application without restatementprospective application


Reporting Accounting Changes

1. Retroactive application with restatement of prior periods

The new accounting policy is applied to events and transactions from the date of origin of each event or transaction

The financial statements for each prior period that are presented for comparative purposes are restated to reflect the new policy


Reporting Accounting Changes (cont.)

All summary financial information for earlier periods, such as net income, total assets, earnings per share, etc., are restated as well

All reported financial results after the change look as though the new policy had always been in effect



2. Retroactive application without restatement (also called the current approach)

The new accounting policy is applied to events and transactions from the date of origin of such items and a cumulative adjustment representing the effect of the change is made in the period in which the change is made



Comparative information for prior periods is not restated, either in the comparative financial statements or in five- or 10-year summaries of key financial figures (e.g., earnings per share)

The summary impact of the change is stated as a one-line adjustment to retained earnings in the current period



3. Prospective application

The change in accounting is applied only to events and transactions occurring after the the date change

Previously reported results are not restated, and there is no cumulative catch-up adjustment


Exhibit 22-1


Exhibit 22-1


Disclosure Requirements

Accounting changes affect the consistency and comparability of financial statements, and therefore their reliability

When significant changes in accounting policies or measurement occurs, readers should be warned about the changes and their impacts


Disclosure Requirements (cont.)

The CICA Handbook recommends specific disclosures for accounting policy changes:for each change in accounting policy in the

current period, the following information should be disclosed:

- a description of the change- the effect of the change on the financial

statements of the current period


Disclosure Requirements (cont.) when a change in an accounting policy has been

applied retroactively and prior year periods have been restated, the fact that the financial statements of prior periods that are presented have been restated and the effect of the change on those prior periods should be disclosed

when a change in an accounting policy has been applied retroactively but prior periods have not been restated, the fact that the financial statements of prior periods that are presented have not been restated should be disclosed

- the cumulative adjustment to the opening balance of the retained earnings of the current period should also be disclosed


Disclosure Requirements (cont.)when a change in accounting policy has not been

applied retroactively, this fact should be disclosedThe disclosure of particulars, including dollar

amounts, applies to each change in an accounting policy

- it is not appropriate to net items when considering materiality

a change in accounting policy that does not have a material effect in the current period but is likely to have a material effect in future periods should be disclosed


Disclosure Requirements (cont.) The AcSB’s recommendations for reporting an

error correction are similar to those for a change in accounting policy

When there has been a correction in the current period of an error in prior period financial statements, the following information should be disclosed:a description of the error the effect of the correction of the error on the

financial statements of the current and past periods

the fact that the financial statements of prior periods that are presented have been restated


Prior Period Adjustments Prior to 1996, companies were permitted, under

certain circumstances, to make prior period adjustments

A prior period adjustment was a gain or a loss that was credited or charged directly to retained earnings instead of appearing in the income statement

Since 1996 all charges and credits must flow through the income statement

The only adjustments that can be made directly to retained earnings are for retroactively applied changes in accounting policy and for corrections of errors in prior periods


Accounting Changes: An Evaluation

Many people believe that all changes in accounting policy should be applied retroactively

They worry about the effect of changes on comparability

Accounting changes, even those applied retroactively, may cause confusion and reduce the predictive ability of accounting information

For example, at least one study has found that the accuracy of analysts’ earnings forecasts declined when accounting changes are made


Accounting Changes: An Evaluation (cont.)

One criticism of the retroactive approach is that the cumulative effect on prior years’ income cannot be accurately computed

Another concern is that three approaches to reporting accounting changes (retroactive treatment with restatement, retroactive treatment without restatement, and prospective treatment) are endorsed in current Canadian standards

Some contend that both of the retroactive approaches (with and without restatement) are inappropriate and believe that once an income item is reported, it is final

Documents

Powerpoint slides by: Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Michael L. Hockenstein Commerce Department Vanier College Intermediate Accounting