Intermediate Accounting Seventeenth Edition Kieso ● Weygandt ● Warfield Chapter 22 Accounting Changes and Error Analysis This slide deck contains animations Please disable animations if they cause issues with your device Learning Objectives After studying this chapter, you should be able to: Discuss types of accounting changes and understand the accounting for changes in accounting principles Describe the accounting for changes in estimates and changes in the reporting entity Describe the accounting for correction of errors Analyze the effect of errors Copyright ©2019 John Wiley & Sons, Inc Preview of Chapter 22 (1 of 2) Accounting Changes and Error Analysis Accounting Changes • Background • Changes in accounting principle • Impracticability Other Changes • Changes in accounting estimates • Changes in reporting entity Copyright ©2019 John Wiley & Sons, Inc Preview of Chapter 22 (2 of 2) Accounting Errors • Example • Summary Error Analysis • Balance sheet errors • Income statement errors • Balance sheet and income statement errors • Comprehensive example • Preparation of statements with error corrections Copyright ©2019 John Wiley & Sons, Inc Learning Objective Discuss the Types of Accounting Changes and the Accounting for Changes in Accounting Principles LO Copyright ©2019 John Wiley & Sons, Inc Accounting Changes Accounting Alternatives: • Diminish the comparability of financial information • Obscure useful historical trend data Types of Accounting Changes: Change in Accounting Principal Change in Accounting Estimate Change in Reporting Entity Errors are not considered an accounting change LO Copyright ©2019 John Wiley & Sons, Inc Changes in Accounting Principle Change from one accepted accounting policy to another Examples include: • Average cost to LIFO • Completed-contract to percentage-of-completion method Adoption of a new principle in recognition of events that have occurred for the first time or that were previously immaterial is not an accounting change LO Copyright ©2019 John Wiley & Sons, Inc Changes in Accounting Principle Approaches Three approaches for reporting changes: 1) Currently 2) Retrospectively 3) Prospectively (in the future) FASB requires use of the retrospective approach Rationale - Users can then better compare results from one period to the next LO Copyright ©2019 John Wiley & Sons, Inc What Do the Numbers Mean?: Quite a Change The cumulative-effect approach results in a loss of comparability Also, reporting the cumulative adjustment in the period of the change can significantly affect net income, resulting in a misleading income for example, at one time Chrysler Corporation changed its inventory accounting from LIFO to FIFO If Chrysler had used the cumulative-effect approach, it would have reported a $53,500,000 adjustment to net income That adjustment would have resulted in net income of $45,900,000, instead of a net loss of $7,600,000 A second case: In the early 1980s, the railroad industry switched from the retirement-replacement method of depreciating railroad equipment to more generally used methods such as straight-line depreciation Using cumulative treatment, railroad companies would have made substantial adjustments to income in the period of change Many in the industry argued that including such large cumulativeeffect adjustments in the current year would distort the information and make it less useful Such situations lend support to retrospective application so that comparability is maintained LO Copyright ©2019 John Wiley & Sons, Inc Changes in Accounting Principle Retrospective Accounting Change Approach Company reporting the change 1) Adjusts its financial statements for each prior period presented to the same basis as the new accounting principle 2) Adjusts the carrying amounts of assets and liabilities as of the beginning of the first year presented, plus the opening balance of retained earnings LO Copyright ©2019 John Wiley & Sons, Inc 10 Appendix 22A: Changing from or to the Equity Method (4 of 7) Dividends in Excess of Earnings Illustration: On January 1, 2019, Investor Company purchased 250,000 shares of Investee Company’s 1,000,000 shares of outstanding stock for $8,500,000 Investor correctly accounted for this investment using the equity method After accounting for dividends received and investee net income, in 2019, Investor reported its investment in Investee Company at $8,780,000 at December 31, 2019 On January 2, 2020, Investee Company sold 1,500,000 additional shares of its own common stock to the public, thereby reducing Investor Company’s ownership from 25 percent to 10 percent LO Copyright ©2019 John Wiley & Sons, Inc 73 Appendix 22A: Changing from or to the Equity Method (5 of 7) Dividends in Excess of Earnings LO Copyright ©2019 John Wiley & Sons, Inc 74 Appendix 22A: Changing from or to the Equity Method (6 of 7) Impact on Investment Carrying Amount 2020 and 2021 Cash 400,000 Dividend Revenue 2022 Cash 210,000 Equity Investments Dividend Revenue LO 400,000 Copyright ©2019 John Wiley & Sons, Inc 60,000 150,000 75 Appendix 22A: Changing from or to the Equity Method (7 of 7) Change to the Equity Method • Companies use prospective approach • Account for the effects of the change in • • • (1) the period of change if the change affects that period only, or (2) the period of change and future periods if the change affects both Companies should also add the cost of acquiring the additional interest in the investee company to the cost basis of their previously held interest (the present stock holding) LO Copyright ©2019 John Wiley & Sons, Inc 76 Learning Objective Compare the Procedures for Accounting Changes and Error Analysis Under GAAP and IFRS LO Copyright ©2019 John Wiley & Sons, Inc 77 IFRS Insights (1 of 9) Relevant Facts Similarities • The accounting for changes in estimates is similar between G AAP and IFRS • Under GAAP and IFRS, if determining the effect of a change in accounting policy is considered impracticable, then a company should report the effect of the change in the period in which it believes it practicable to so, which may be the current period LO Copyright ©2019 John Wiley & Sons, Inc 78 IFRS Insights (2 of 9) Relevant Facts Differences • One area in which GAAP and IFRS differ is the reporting of error corrections in previously issued financial statements While both sets of standards require restatement, G AAP is an absolute standard—that is, there is no exception to this rule • Under IFRS, the impracticality exception applies both to changes in accounting principles and to the correction of errors Under GAAP, this exception applies only to changes in accounting principle • IFRS (IAS 8) does not specifically address the accounting and reporting for indirect effects of changes in accounting principles As indicated in the chapter, G AAP has detailed guidance on the accounting and reporting of indirect effects LO Copyright ©2019 John Wiley & Sons, Inc 79 IFRS Insights (3 of 9) On The Horizon For the most part, IFRS and GAAP are similar in the area of accounting changes and reporting the effects of errors Thus, there is no active project in this area A related development involves the presentation of comparative data Under IFRS, when a company prepares financial statements on a new basis, two years of comparative data are reported GAAP requires comparative information for a three-year period Use of the shorter comparative data period could be an issue when U.S companies adopt IFRS LO Copyright ©2019 John Wiley & Sons, Inc 80 IFRS Insights (4 of 9) IFRS Self-Test Questions Which of the following is false? a GAAP and IFRS have the same absolute standard regarding the reporting of error corrections in previously issued financial statements b The accounting for changes in estimates is similar between G AAP and IFRS c Under IFRS, the impracticality exception applies both to changes in accounting principles and to the correction of errors d GAAP has detailed guidance on the accounting and reporting of indirect effects; I FRS does not LO Copyright ©2019 John Wiley & Sons, Inc 81 IFRS Insights (5 of 9) IFRS Self-Test Questions Which of the following is false? a GAAP and IFRS have the same absolute standard regarding the reporting of error corrections in previously issued financial statements b The accounting for changes in estimates is similar between G AAP and IFRS c Under IFRS, the impracticality exception applies both to changes in accounting principles and to the correction of errors d GAAP has detailed guidance on the accounting and reporting of indirect effects; I FRS does not LO Copyright ©2019 John Wiley & Sons, Inc 82 IFRS Insights (6 of 9) IFRS Self-Test Questions Which of the following is not classified as an accounting change by IFRS? a Change in accounting policy b Change in accounting estimate c Errors in financial statements d None of the above LO Copyright ©2019 John Wiley & Sons, Inc 83 IFRS Insights (7 of 9) IFRS Self-Test Questions Which of the following is not classified as an accounting change by IFRS? a Change in accounting policy b Change in accounting estimate c Errors in financial statements d None of the above LO Copyright ©2019 John Wiley & Sons, Inc 84 IFRS Insights (8 of 9) IFRS Self-Test Questions IFRS requires companies to use which method for reporting changes in accounting policies? a Cumulative effect approach b Retrospective approach c Prospective approach d Averaging approach LO Copyright ©2019 John Wiley & Sons, Inc 85 IFRS Insights (9 of 9) IFRS Self-Test Questions IFRS requires companies to use which method for reporting changes in accounting policies? a Cumulative effect approach b Retrospective approach c Prospective approach d Averaging approach LO Copyright ©2019 John Wiley & Sons, Inc 86 Copyright Copyright © 2019 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein LO Copyright ©2019 John Wiley & Sons, Inc 87 ... of accounting changes and understand the accounting for changes in accounting principles Describe the accounting for changes in estimates and changes in the reporting entity Describe the accounting. .. Objective Discuss the Types of Accounting Changes and the Accounting for Changes in Accounting Principles LO Copyright ©2019 John Wiley & Sons, Inc Accounting Changes Accounting Alternatives: • Diminish... Chapter 22 (1 of 2) Accounting Changes and Error Analysis Accounting Changes • Background • Changes in accounting principle • Impracticability Other Changes • Changes in accounting estimates