Intermediate Accounting
Thomas H. Beechy
Schulich School of
Business,
York University
Joan E. D. Conrod
Faculty of Management
Dalhousie University
Powerpoint slides by:
Michael L. Hockenstein  Commerce Department • Vanier College
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Accounting Changes
Chapter 22
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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 estimates
 correction of an error in previous
periods’ financial statements
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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
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Changes in Policy (cont.)

Accounting policies can be voluntary or
involuntary
 a 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
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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 expectations
 uncollectable accounts receivable
 recoverable value of an asset
 criteria for capitalizing development costs
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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 AR
 a revision in the estimated recoverable value of an
asset, such as inventory or investments
 a change in management’s judgement concerning
one or more of the criteria for capitalizing
development costs
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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
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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
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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
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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 previously
 a 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
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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
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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
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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
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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 restatement
 prospective application
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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
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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
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Reporting Accounting Changes (cont.)
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
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Reporting Accounting Changes (cont.)
 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
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Reporting Accounting Changes (cont.)
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
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Exhibit 22-1
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Exhibit 22-1
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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
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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
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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
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Disclosure Requirements (cont.)
 when a change in accounting policy has not been
applied retroactively, this fact should be disclosed
 The 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
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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
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Prior Period Adjustments
 Prior to 1996, companies were permitted, under

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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
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Accounting Changes: An Evaluation
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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
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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
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