Financial Accounting:
Liabilities & Equities (FA3)
Module 8
Audio lecture presented by:
Barbara M. Wyntjes, B.Sc., CGA
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Part 1:
Accounting Changes
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Introduction
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Three types of accounting changes
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How to account for changes and errors
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Disclosure
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Types of Accounting Changes
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Three types of accounting changes:
1. Changes in accounting policy
2. Changes in accounting estimate
3. Correction of an error in previous periods’
financial statements
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Accounting Changes
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Changes and errors will occur
Standards set up to account for these
changes
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Accounting Changes
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Decrease consistency and comparability
Manipulation of statements
Financial statement objective
Ethical litmus test
User’s perspective
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Changes in Accounting Policy
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A change in the ‘way’ that a company
accounts for a transaction, event, or the
resulting asset or liability
Voluntary - changes are made as a result of
management decision
Non voluntary - decision is the result of
outside influences (change in the
Accounting Standard recommendations).
Ex: Goodwill
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Changes in Accounting Policy

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Only if new policy is reliable and MORE
relevant
Reasons for voluntary changes:
 reporting objectives
 comply with the industry norm
 change way of doing business
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Changes in Accounting Estimate
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Change is NOT a change in policy if the
change in policy is based on a change in
circumstances, experience or new
information
Example: Regular review of amortization
suggests another method would better
reflect usage
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Changes in Accounting Estimate

Adopting a new accounting policy is not a
change in policy if:
 events or transactions that are clearly
different in substance from those
previously recognized
 recognition of events or transactions
occurring for the first time or that were
previously immaterial in effect
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Change in Accounting Estimate
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Is a change in the application of an
accounting policy to a specific transaction or
event
Accounting measurements are based
extensively on future expectations
Accounting estimates often need revision
because we can never predict future
outcomes with certainty
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Change in Accounting Estimate

Reasons:
 the company’s economic environment
has changed
 a shift in the nature of the company’s
business operations
 new information
 auditors have raised questions
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Change in Accounting Estimate

Examples:
Uncollectable accounts receivable
Useful lives, salvage value
 Fair value
 Recoverable value of an asset
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Correction of Error
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Accidental or intentional mistake
To comply with the qualitative criteria of
comparability and consistency
Require restatement of prior periods results
Even if there is no impact on the period in
which the error was discovered
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Correction of Error

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Examples:
Counterbalancing
 Miscount ending inventory

Failure to accrue liabilities
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Correction of Error
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Examples:
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Failure to accrue assets
Charge to wrong account or wrong
amount
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Correction of Error
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Correction depends on when error is caught
Examples:
 Error in 2007 EI.
 Books not closed vs close
 If error not detected, 2008 BI incorrect
 Books not closed vs close
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Correction of Error

First classify change
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Apply accounting treatment
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Part 2:
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Accounting for Changes

Three ways of reporting accounting
changes in the financial statements:
1. Retroactive application with restatement of
prior period
2. Retroactive application without restatement
of prior period
3. Prospective application
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Retroactive with Restatement
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Recalculate from the period when the
original transaction took place to reflect the
change/error
Restate financial statements that are used
in comparative presentations
Restate summary financial information for
earlier periods (net income, total assets,
EPS)
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Retroactive with Restatement
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Journal entries adjust balance sheet
accounts directly
Opening retained earnings retroactively
restated
Reported financial results appear as though
the new policy had always been in effect or
the error had never occurred
Best method for changing a policy or
correcting an error because it would make
comparative data more relevant.
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Retroactive without Restatement
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Use if Accounting Standards allow, or if the
necessary data is incomplete or excessively
expense to gather.
Calculate the effect of the change from the
period when the original transaction occurred
Journalize a cumulative adjustment to
change all beginning balances on accounts
affected by the change in the period in which
the change is made
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Retroactive without Restatement
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Summary impact of the change for all
periods is adjusted to beginning retained
earnings in the current period
Start applying new policy in current year
Comparative financial statements are not
restated (disclose)
Financial analysis becomes unreliable and
no longer compares consistent data.
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Retroactive Journal Entry
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Adjust balance sheet accounts – before-tax
Adjust retained earnings – after-tax
Difference creates a future income tax
Example: tax rate = 40%
Retained earnings
6,000
Future Income tax
4,000
Accumulated amort.
10,000
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Prospective
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The change in accounting is applied only to
events and transactions occurring after the
the date change
Change in estimate or if Standards allow
Previously reported results are not restated,
and no cumulative catch-up adjustment
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Prospective
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Use for changes in estimates
Use for change in policy when allowed by
Accounting Standards
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 (page 1217 of text)
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Review Exhibit 20-2
See text, page 1221
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Assignment A20-2
See Chapter 20, page 1249
And handout 1, page 1
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Summary

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Change in policy: new reporting objectives,
conform with industry practices, meet user
needs
Change in estimate: new information,
change in circumstances, or experience
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Part 3:
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Disclosure
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Financial statements – communicate
information to outsiders
Accounting changes affect the consistency
and comparability of financial statements
and therefore their reliability
Readers should be warned about the
changes and their impacts
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Disclosure
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Extensive disclosure is needed to inform
financial statement users of the effect on
current and past financial statements
Change in policy
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Disclosure
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Change in estimate
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Correction of errors
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Review page 1234
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Cash Flow
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Accounting changes do not change cash
flow
May affect the way that cash flow are
reported (reclassify)
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All-inclusive Earnings
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Income statement represents all the
changes in net assets = comprehensive
income for the period
Accounting changes would simply be
included in the current income statement
and no adjustment to retained earnings
No restatement of prior periods
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Current Operations
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Income statement should reflect only items
relating to the operations of the current
period (not from prior periods)
Recurring
Predictive power
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Current Operations
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Combination used in Canada
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Part 4:
Assignment A20-8
Req’d 1
See Chapter 20, page 1252
And handout 1, page 2
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Assignment A20-8
Req’d 2
See Chapter 20, page 1252
And handout 1, page 2
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Assignment A20-8
Req’d 3
See Chapter 20, page 1252
And handout 1, page 2
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Part 5:
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Error - expensed capital asset
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Expensed capital asset on date of purchase
Catch-up journal entry: record cost of
capital asset and accumulated amortization
Adjust opening retained earnings for net
increase to date (cost – amortization
expense that should have been recorded to
date)
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Class Example 1
See handout 1, page 3
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Part 6:
Assignment A20-21
Req’d 1
See Chapter 20, pages 1258-1259
And handout 1, page 4
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Assignment A20-21
Req’d 2
See Chapter 20, pages 1258-1259
And handout 1, page 4
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Assignment A20-21
Req’d 3
See Chapter 20, pages 1258-1259
And handout 1, page 4
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Assignment A20-21
Req’d 4
See Chapter 20, pages 1258-1259
And handout 1, page 4
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Part 7:
Assignment A20-24
Req’d 1
See Chapter 20, page 1260
And handout 1, pages 5-6
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Assignment A20-24
Req’d 2
See Chapter 20, page 1260
And handout 1, pages 5-6
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Assignment A20-24
Req’d 3
See Chapter 20, page 1260
And handout 1, pages 5-6
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Assignment A20-24
Req’d 4
See Chapter 20, page 1260
And handout 1, pages 5-6
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Assignment A20-24
Req’d 5
See Chapter 20, page 1260
And handout 1, pages 5-6
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Part 8:
Past Exam Questions:
See Module 8 Handout 2
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Blueprint: 6-10%
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Multiple Choice and long answer
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Past exam questions are NOT changed to
reflect current material
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Multiple Choice
m
See Module 8 Handout 2
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Multiple Choice
n
See Module 8 Handout 2
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Multiple Choice
o
See Module 8 Handout 2
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Question 4a
See Module 8 Handout 2
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Question 4b
See Module 8 Handout 2
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Question 4c
See Module 8 Handout 2
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End of presentation
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