FAR 2019 F1 M6: Accounting Changes and error corrections

Per IFRS 1 (first time adoption of International Financial Reporting Standards), an entity's financial statements should include at least:

- 3 balance sheets (statement of financial position) - 2 statements of comprehensive income - 2 separate income statements - 2 statements of cash flows, - 2 statements of changes in equity, and - related notes, including comparative information

comparative vs noncomparative financial statements

1. If there is comparative financial statements, prior period adjustments require retroactive treatment for the years presented. If there is no past year data, the adjustment is made in current year.

how should error be reported?

1. The cumulative effect of the error in error years should be reflected in the carrying amounts of assets and liabilities as of the beginning of year the errors were found. 2. past financial statements must be restated to correct an accounting error.

how should a change in accounting estimate be accounted for?

1. a change in accounting estimate affects only the current and subsequent (future) periods, if the change affects both, it does not affect prior periods nor retained earnings. 1a. change in estimate will be reported in income/loss from continuing operations. 2. handled prospectively. 3. Example: happens when you obtain new information and can make better quality financial reports. better matching principle.

Under IFRS, what are the disclosure requirements related to correction of material prior period error?

1. amount of correction at beginning of the earliest period presented. 2. the impact of the correction on basic and diluted earnings per share for each period presented is a disclosure under IFRS when a material prior period error is being reported. 3. Under IFRS, the nature error must be disclosed where there is a correction of a material prior period error. Following are not requirements: 1. IFRS does not require a description of internal controls put in place to prevent the occurrence of error in future periods.

Error correction (prior period adjustment)

1. error corrections are not accounting changes. 2. error corrections include: corrections of errors in recognition, measurement, presentation, or disclosure in financial statements resulting from math error, mistake in application of US GAAP, or oversight or misuse of facts that existed at the time the financial statements were prepared; changes from non-GAAP method of accounting to a GAAP method of accounting (e.g. cash basis to accrual basis), which is a specific correction of an error. 3. An error correction is accounted for by restating all prior periods presented up to year of error that is corrected.

exception for change in depreciation method

1. it is no longer an error. 2. depreciation is no longer considered to be a change in accounting principle. A change in depreciation method is now considered both a change in method and a change in estimate. These changes should now be accounted for as a change in estimate and handled prospectively. 2a. No adjustment to retained earnings is necessary. 3. The new depreciation method should be used as of the beginning of the year of change and should start with the current book value of the underlying asset. 4. No retroactive or retrospective calculation should be made, and no adjustment should be made to retained earnings. 5. Cumulative effect should not be reflected on the income statement any more.

How should change in reporting entity be reported in financial statements?

1. retrospectively, including note disclosures, and application to all prior period financial statements presented. (must be reported currently, but also retrospectively if comparative financial statements are presented.) 2. change in entity happens when acquisition or consolidation. Need to report as if it has always been that way. So need retrospective changes. 3. Under GAAP restatement from change in entity is referred to as a "retrospective adjustment."

amount of prior period adjustment for wrong depreciation taken.

1. should be net of tax. 2. A prior period adjustment needs to be made in the year the error is found. 3. prior period adjustment = (incorrect amount minus correct amount) * (1 - tax rate).

LIFO vs weighted average

1. when making changes from WA to LIFO, no adjustment needs to be made. Not reported. 2. when making changes from LIFO to weighted average, cumulative effect of method change is reported on the financial statement. 3. The cumulative effect of a change in accounting principle is now reported as an adjustment to beginning retained earnings when it is considered practicable to calculate the cumulative effect. 4. Under US GAAP, when making a change to LIFO, it is generally considered impracticable to calculate the cumulative effect of the change (in most cases, data on the historical LIFO layers ins not available). In a change to LIFO, the beginning inventory dollar amount becomes the first LIFO layer. No cumulative effect adjustment is made. The change is accounted for prospectively. 5. In a change from LIFO to WA, there is no such impracticability. The cumulative effect is computed and the change is handled retrospectively.

cumulative effect of accounting principle changes

1b. the cumulative effect of a change in accounting principal (net of tax) is shown as an adjustment to beginning retained earnings of the PRIOR YEAR (January 1 of prior year) or earliest year in statement of stockholder's equity. 2. If the comparative financial statements are not presented, the cumulative effect of change in accounting principle is determined as of the beginning of the year of change. (end of prior year before year of change.) For balance sheet items. 3. For income statement item: Need to look at all past years in the aggregate. This will allow us to arrive at the adjustment to obtain the amount of retained earnings that would have been reported at the beginning of the period of change if the new accounting principle had been used for all prior periods.

depreciation for the year equals

= (depreciable cost - salvage value) / remaining useful life.

Accumulated Depreciation

The sum of all the depreciation expense recorded to date for a depreciable asset. 1. = ((depreciable cost - salvage value) / remaining useful life ) * years elapsed (when useful life does not change.)

Change in accounting principle (accounting change)

Use of an accounting principle in the current year different from the one used in the preceding year. 1. Ordinarily, need to go back in time to fix it. retrospective changes and up to current year. 1a. Exception for inventory change to LIFO: gets current and prospective treatment. 2. examples of changes in principle: changes in inventory methods, change in FASB standards, 3. A change in accounting principle is not acceptable if it is done in order to increase earnings and the stock price of the company. There will be no accounting change when this happens.

How to adjust net income for correcting errors

add the following to net income: 1. unrealized loss on market value of available for sale investments in debt. 2. adjustments to profits prior years for errors in depreciation.

When there is a "change in entity" (such as resulting from 1. changing companies in consolidated financial statements. 2. Consolidated financial statements versus previous individual financial statements),

financial statements of all prior periods presented should be restated.

If a change in accounting estimate cannot be distinguished from a change in accounting principle,

the change is considered a change in accounting estimate treated as a change in accounting principle and is accounted for prospectively.

When the effect of a change in accounting principle is inseparable from the effect of a change in accounting estimate (i.e. change from installment method to immediate recognition method because uncollectible accounts can no be estiamted.)

the reporting treatment for the overall effect is as a change in estimate. 1. Thus, the effect is reported prospectively as a component of income from continuing operations.