Subtitles section Play video Print subtitles Hi, Else here. And today we'll be talking about accounting changes. In accounting, we have to deal with an uncertain future. There are events that need to be included in our financial statements now, such as accruals for expenses and liabilities. However, we don't know for sure what the amount of the expense will be. Instead, we use an estimate, which is really just an attempt to quantify an uncertain future event. The fact that financial statements include estimates leads to three things. One, a change may be required to reflect changing circumstances. The circumstances that led to our estimate in the past may now be different, so we have to change our estimate to reflect these new circumstances. This is called a change in accounting estimate. Two, a change may occur in the future due to new accounting policies. These new policies are chosen because they reflect current economic circumstances, meaning that the new policy better reflects current reality. These changes may be at the discretion of management, a voluntary change, but they may also be an involuntary change due to a change in accounting standards. This is known as a change in accounting policy. Three, a previous estimate may have been an error. This means that given the information available at the time the estimate was made, management should have known that it was wrong. Regardless of whether the error is an accident or intentional, maybe to bias a financial statements, makes absolutely no difference. This has to be fixed and it is known as an error correction. Let's look at each of these individually and how they are dealt with. First is a change in accounting estimate-- also called a change in estimate. This is where, based on new information, a different estimate is required for the current period compared to the estimate that was used in a prior period. The new estimate may change the carrying value of an asset or a liability or it might change the way we recognize the use of an asset. This is always due to what is true today or what we expect regarding future benefits. What are some examples of changes in estimates? There are many examples of when we make estimates in accounting and any change to these estimates would be considered a change in accounting estimate. A few examples would be a change to the percentage we use to calculate the allowance for doubtful accounts, a change in the value of our investments due to new market conditions, a change in the estimated useful life of long-lived assets or the residual value, the percentage used to calculate warranty provisions may change, and the value of inventory when obsolescence is an issue may also change. There are many other examples of changes in estimates, because estimates are a normal part of accounting, particularly accrual accounting, which is required by both IFRS and ASPE. Because a change in estimate is based on new information, that change does not relate to prior periods after all, when the estimate was made in the prior period, it was the information available then that was important. As long as the estimate in the prior period was made in good faith using the information available at that time, then it is acceptable and should not be changed. That's why a change in estimate does not require any changes to past financial statements. Instead, a change in estimate is treated as a perspective adjustment, meaning the changes implemented for the current and future periods. Past periods are never changed. Sometimes it is very difficult to differentiate between a change in accounting estimate and a change in accounting policy. For instance, if a business changes its depreciation method, say from straight line to declining balance, is that a change in estimate or a change in accounting policy? It may be true that it's a change in estimate, because prior estimates of how the benefits would flow to the business have changed. Or is it a change in accounting policy, which will result in more reliable and relevant information with regards to the company's financial position, performance, or cash flow? This requires professional judgment to determine. Under IFRS, if it is unclear whether a change is one of policy or estimate, the change should be treated as a change in accounting estimate. That's very important to know with regards to a change in estimate. Remember, a change in estimate requires perspective adjustment with no changes to the prior year's financial statements. There are also no disclosure requirements for a change in estimate as they are a normal part of the accounting process. Next is a change in accounting policy. A change in policy can be either voluntary or compulsory. If a new policy would provide more reliable and relevant information to the stakeholders with regards to the company's financial position, performance, or cash flows, then it is a voluntary change in accounting policy and it's at the discretion of management. Note those two words-- reliable, which references faithful representation, and relevant. These are both fundamental qualitative characteristics. These are critical to ensure useful financial information. No wonder they are used to justify a change in accounting policy. The new accounting policy must better reflect the economic circumstances or the nature of the operations moving forward. The burden is on management to explain to stakeholders why the new method is more reliable and relevant than the method used in prior years. An example of a voluntary change in accounting policy would be the movement from a FIFO method of valuing inventory to a weighted average method. If a new policy is due to new or changed accounting standards, then it is considered a compulsory change. For instance, a move from Canadian GAAP to IFRS was a compulsory change of accounting policy. How do we present a change in accounting policy? Retrospective application-- sometimes called retroactive application-- requires that both the current year and all prior years be adjusted to reflect the new policy. After the change, it should look like the company never did anything but the new policy since all prior year's financial statements would be updated for the new policy. This is consistent with the enhancing qualitative characteristic of comparability. Only by changing all the prior year's financial statements can the financial statements remain comparable between periods, allowing for trend analysis. Note that a summary change flowing through equity, more specifically retained earnings, is provided for the earliest prior period presented. What does that mean? Well, if the financial reports included the current year, say 2019, and two prior years, meaning 2018 in 2017, all three years would be updated for the change. This means that individual account balances would be adjusted as if the new accounting policy had always been in place. In addition, in the equity section of 2017, a summary adjustment to retained earnings would show the total impact of the change on all years prior to 2017. What if it's no longer possible to reconstruct all the data for prior years because the details are no longer available? Or it might be true that the data is available, but the cost of obtaining the data would be very high. In this case, where it's impractical to provide retrospective application, partial retrospective application is allowed. In this case, a summary adjustment to retained earnings in the last comparative year where the details can be determined is allowed. If it is no longer possible to determine even the impact on the opening balances of the current year, then a change in accounting policy would be applied prospectively. The same way a change in accounting estimate is. The disclosure requirements for a change in accounting policy