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  • 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