Accounting Changes and Error Analysis: Tenth Canadian Edition

INTERMEDIATE
ACCOUNTING
TENTH CANADIAN EDITION
Kieso Weygandt Warfield Young Wiecek McConomy
CHAPTER 21
Accounting
Changes and
Error Analysis
Prepared by:
Lisa Harvey, CPA, CA

Rotman School of Management,
University of Toronto
CHAPTE
21
R
ACCOUNTING CHANGES AND ERROR ANALYSIS
After studying this chapter, you should be able to:
Identify and differentiate among the types of accounting changes.
Identify and explain alternative methods of accounting for accounting changes.
Identify the accounting standards for each type of accounting change under ASPE and IFRS.
Apply the retrospective application method of accounting for a change in accounting policy
and identify the disclosure requirements.
Apply retrospective restatement for the correction of an accounting error and identify the
disclosure requirements.
Apply the prospective application method for an accounting change and identify the
disclosure requirements for a change in an accounting estimate.
Identify economic motives for changing accounting methods and interpret financial
statements where there have been retrospective changes to previously reported results.
Identify the differences between ASPE and IFRS related to accounting changes.
Copyright John Wiley & Sons Canada,
Ltd.
Accounting Changes
and Error Analysis
Changes in Accounting
Policies and Estimates,
and Errors
Types of accounting
changes
Alternative accounting
methods
Accounting standards
Retrospective application
change in accounting
policy
Retrospective
restatement correction
of error
Prospective application
Analysis
Motivations for
change
Interpreting
accounting
changes

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IFRS/ASPE
Comparison
Comparison of IFRS
and ASPE
Looking ahead
Types of Accounting
Changes
1. Change in Accounting Policy
Change in the choice of specific principles,
bases, conventions, rules, and practices
applied by an entity in preparing and presenting
financial statements
2. Change in Accounting Estimate

Adjustment based on a change in
circumstances on which a previous estimate
was based or as the result of new information,
more experience or subsequent developments
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Types of Accounting Changes

3.Correction of an error in prior period
financial statements
Omissions from or mistakes in financial
statements of prior periods caused by the
misuse or failure to use reliable information
that existed at the time financial statements
were prepared
They may be intentional or an oversight

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Policies
Under IFRS, change in an accounting
policy is permitted only when the change:
1. Is required by a primary source of GAAP, or
2. Results in portraying reliable and more
relevant information about effects of
transactions, events or conditions (voluntary)

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Policies
Under ASPE, there is a third type of policy change
permitted without having to meet the reliable but more
relevant test:
3. Between or among allowed ASPE accounting options for:
Investments in subsidiaries, and investments with

significant influence or joint controls
Development phase expenditures on internally

generated intangible assets
Defined benefit plans
Income taxes
Measuring equity component of certain financial

instruments
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Policies
Does not result from adoption of a:
1. Different policy necessitated by events or
transactions clearly different in substance
from those previously occurring
2. New policy that recognizes events that have
occurred for the first time or that were
previously immaterial

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Policies
Examples of situations that are not
changes in accounting policy:
Adopting interest capitalization during
construction of own long-term assets, when
company had not previously been involved in
self-construction
Deferral of development expenditures when
previously these expenses were expensed as
they were immaterial
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Estimates
Future conditions and events and their
effects cannot be known with certainty;
therefore estimation requires exercise of
judgment
Use of reasonable estimates is essential
to the accounting process and does not
undermine the reliability of financial
statements
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Estimates
Examples of items requiring estimates
include:
Uncollectible receivables
Inventory obsolescence
Fair value of financial assets/liabilities
Useful lives and residual values of
depreciable assets
Liabilities for warranty costs

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Estimates
Differentiating a change in policy and a change in
estimate can be difficult
For example, is a change in depreciation method a
change in policy or a change in estimate?
At first glance, a change in depreciation method appears to be a
change in accounting policy
However, it is a change in estimate if it is a change in estimate of
the pattern in which company benefits from the asset
Where it is not clear, treat the change as a change in

estimate

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Correction of a Prior Period

Error
Examples of accounting errors include:
Change from non-GAAP to GAAP
e.g. change from cash basis of accounting to
accrual basis
Mathematical mistakes
e.g. incorrect totaling of inventory count sheets
Oversight
e.g. failure to defer expenses or revenues
Misappropriation of assets
e.g. discovery of inventory theft
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Correction of a Prior Period

Error
Distinguishing between correction of an error and a
change in estimate can be difficult
Example: a lack of a previous years accrual of
reassessed income taxes was the information
overlooked (i.e. an error) or do we have more
information or was there subsequent developments (i.e.
an estimate)?
General rule: if an estimate was calculated incorrectly
due to lack of expertise, it is considered an error;
If a careful estimate was made in a previous year which
is later determined as incorrect, it is considered a
change in estimate
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Alternative Accounting
Methods
Three approaches have been suggested
for reporting changes in the accounts:
1. Retrospective
2. Current
3. Prospective

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Retrospective Treatment
Also known as retroactive application
Requires calculating the cumulative effect of the
change on the financial statements at the
beginning of the period as if the new method or
estimate had always been used
An adjustment is made to the financial
statements equal to this cumulative effect
Results in restating all affected prior years
financial statements on a basis consistent with
the newly adopted policy (i.e. as if the new
accounting policy had always been used)
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Current Treatment
New accounting method or estimates
cumulative effect on the financial
statements at the beginning of the period
is calculated
An adjustment is reported in current years
income statement
Prior years financial statements are not
restated
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Prospective Treatment
Previously reported results remain; no
change is made
Opening balances are not adjusted and
no attempt is made to correct or change
past periods
New policy or estimate is adopted for
current and future periods only and
applied to balances existing at the date of
the change
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Accounting Standards
Type of Accounting Change
Accounting Method Applied
Change in Accounting Policy

Adoption of primary source of
GAAP
Apply method approved in

transitional provisions section of
the primary source; if none, then
use retrospective application (if
impractical, apply prospectively).
Change in Accounting Policy

Voluntary
Apply retrospectively. If
impractical, apply prospectively
Change in accounting estimate
Apply prospectively.
Correction of an error
Apply retrospectively.

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Retrospective-withRestatement
Requirements of this method include:
1. Retroactive application of the new method,
including income tax effects using an
accounting entry
2. Prior-period financial statements included for
comparative purposes are restated
3. Description of the change and effect on
current and prior period financial statements
disclosed so that statements remain
comparable
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Retrospective-withRestatement - Example
Given:
Voluntary change to capitalizing all avoidable
interest costs on self-constructed assets
Cumulative effects at January 1, 2014:

Capitalizing interest: $20,000 + $200,000 =
$220,000
Income tax effect: $6,000 + $60,000 = $66,000
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January 1, 2014: To record retroactive
change
Buildings
220,000
Deferred Tax Liability
66,000
Retained Earnings
154,000

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Retrospective with Partial

Restatement
Retroactively restating prior years
financial statements requires information
that may be impractical to obtain on a
cost-benefit basis
Some standards allow for a partial
retrospective application
The change in policy is applied at the
beginning of the earliest period for which
restatement is possible
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Restatement - Example
Assume that it was impractical for Denson Ltd. to
determine the effects of the change in policy on
specific years any further back than 2013. The
journal entry to record the change in policy is the
same as the one made for full restatement:
January 1, 2014: To record change
Buildings
220,000
Deferred Tax Liability
66,000
Retained Earnings
154,000
However, years prior to 2013 are not restated
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Restatement
Any comparative financial statements prior
to 2013 are not restated
Without restatement, leaves the
comparative financial statements as
originally reported and
The changes cumulative effect prior to
Jan. 1, 2013 is presented as an
adjustment to Jan. 1, 2013 Retained
Earnings
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Disclosures Changes in
Accounting Policy
For changes in policy resulting from initial application of a primary

source of GAAP or from a voluntary change, the following must be
disclosed:
For first-time application of IFRS or primary source, its title,
nature of change and that made in accordance with transitional
provisions, and what provisions are (including those that affect
future periods)
The nature of any voluntary change in accounting policy, and
why the new policy results in reliable and more relevant
information (under ASPE, some voluntary changes are exempt
from this requirement)
The amount of the adjustment for each financial statement line
item that is affected for current and prior periods
The reasons it was not practicable for restatement of particular
periods, with a description of how the change was applied and
from what date
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Disclosures Changes in
Accounting Policy
IFRS also requires disclosures for new
primary sources of GAAP that are not yet
effective and have not been applied:
1. Disclose the fact that new primary source has
been issued, and
2. Any reasonably reliable information useful in
assessing possible impact on financial
statement in the period in which it will be first
applied
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Correction of an Error
Under ASPE, full retrospective

adjustment is required
Under IFRS, partial retrospective
adjustment is allowed if full retrospective
restatement is impracticable

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Disclosures Correction of
an Error
Where a change is the result of an accounting
error, companies must disclose that an error
occurred in a prior period(s) and disclose, in the
year of the correction:
The nature of the error;
The amount of the correction to each line item on the
financial statements presented for comparative
purposes;
The amount of the correction made at the beginning
of the earliest prior period presented.
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Disclosures Error
Correction
IFRS requires additional disclosures:
Where partial retrospective restatement is
made on grounds of impracticability, additional
information relating to impracticability and
adjustment is required
Effect of correction on basic and diluted EPS
for each period presented

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Prospective Application
Effects of changes in estimates are handled
prospectively
No changes are made to previously reported results
Changes in estimates are viewed as normal recurring
corrections and adjustments
Effect of a change in estimate is accounted for by

including it in net income or comprehensive income as
appropriate in:
The period of change if the change affects that period only
The period of change and future periods if the change affects
both

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Disclosure Change in
Estimate
Minimum disclosures are as follows:
1. The nature of the change in estimate
2. The amount of the change in estimate
affecting the current period
IFRS also requires disclosure of the

nature and amount of any change
expected to impact future periods
. If it is not practicable to estimate effect, this fact is
disclosed

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Accounting Changes
and Error Analysis
and Errors
Types of accounting
changes
methods
policy
Retrospective
of error
Analysis
Motivations for
change
Interpreting
accounting
changes

Ltd.
IFRS/ASPE
Comparison
Comparison of IFRS
and ASPE
Looking ahead
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Motivations for Change

1. Political costs larger firms, larger profits, may
become political targets; select policies to
reduce profits
2. Capital structure debt/equity structure will
impact accounting policies due to debt
covenants
3. Bonus payments when bonuses attached to
income, managers may select methods that
maximize income
4. Smooth earnings gradual increase (decrease)
in income to shift attention
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Interpreting Accounting
Changes
Accounting changes often make it difficult
to develop trend data
Users of the financial statements should look
at accounting changes closely when they
occur and adjust trend data as appropriate

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38
Accounting Changes
and Error Analysis
and Errors
Types of accounting
changes
methods
policy
Retrospective
of error
Analysis
Motivations for
change
Interpreting
accounting
changes

Ltd.
IFRS/ASPE
Comparison
Comparison of IFRS
and ASPE
Looking ahead
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Looking Ahead
No significant changes are expected in the
immediate future

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COPYRIGHT
Copyright 2013 John Wiley & Sons Canada, Ltd. All
rights reserved. Reproduction or translation of this
work beyond that permitted by Access Copyright (The
Canadian Copyright Licensing Agency) is unlawful.
Requests for further information should be addressed
to the Permissions Department, John Wiley & Sons
Canada, Ltd. The purchaser may make back-up copies
for his or her own use only and not for distribution or
resale. The author and the publisher assume no
responsibility for errors, omissions, or damages
caused by the use of these programs or from the use
of the information contained herein.

Ltd.
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INTERMEDIATE

Lisa Harvey, CPA, CA

Copyright John Wiley & Sons Canada,

2. Change in Accounting Estimate

Types of Accounting Changes

Copyright John Wiley & Sons Canada,

Copyright John Wiley & Sons Canada,

Investments in subsidiaries, and investments with

Development phase expenditures on internally

Defined benefit plans

Measuring equity component of certain financial

Copyright John Wiley & Sons Canada,

Copyright John Wiley & Sons Canada,

Where it is not clear, treat the change as a change in

Copyright John Wiley & Sons Canada,

Correction of a Prior Period

Correction of a Prior Period

Copyright John Wiley & Sons Canada,

Accounting Method Applied

Change in Accounting Policy

Apply method approved in

Change in Accounting Policy

Change in accounting estimate

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Cumulative effects at January 1, 2014:

Copyright John Wiley & Sons Canada,

Copyright John Wiley & Sons Canada,

Copyright John Wiley & Sons Canada,

Copyright John Wiley & Sons Canada,

Retrospective with Partial

Retrospective with Partial

Retrospective with Partial

For changes in policy resulting from initial application of a primary

Under ASPE, full retrospective

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Copyright John Wiley & Sons Canada,

Effect of a change in estimate is accounted for by

Copyright John Wiley & Sons Canada,

IFRS also requires disclosure of the

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Copyright John Wiley & Sons Canada,

Motivations for Change

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Copyright John Wiley & Sons Canada,

Copyright John Wiley & Sons Canada,

Copyright John Wiley & Sons Canada,

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