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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
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
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.) 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
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
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
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
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
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
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
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