The following are various types of accounting changes

The following are various types of accounting changes:

_______ 1. Change in a plant asset’s residual value

_______ 2. Change due to an overstatement of inventory

_______ 3. Change from sum-of-the-years’-digits to straight-line method of depreciation because of a change in the pattern of benefits received

_______ 4. Change in a primary source of GAAP

_______ 5. Change in decision by management from not capitalizing interest during construction to capitalizing it because the change increases the relevance of the resulting information. The company is reporting a self-constructed asset for the first time.

_______ 6. Change in the rate used to calculate warranty costs

_______ 7. Change from an unacceptable accounting principle to an acceptable accounting principle

_______ 8. Change in a patent’s amortization period

_______ 9. Change from the zero-profit method to the percentage-of-completion method on construction contracts because the company now accepts longer commercial contracts rather than shorter residential contracts

_______ 10. Recognition of additional income taxes owing from three years ago as a result of improper calculations by the accountant, who was not familiar with income tax legislation and income tax returns

Instructions

(a) For each change or error, use the following code letters to indicate how it would be accounted for assuming the company follows IFRS:

Accounted for in the current year only (CY)

Accounted for prospectively (P)

Accounted for retrospectively (R)

None of the above, or unable to tell. Explain. (NA)

(b) Identify the type of change for each of the situations in items 1 to 10.

(c) Now assume that the company follows ASPE. Identify the situations in part (a) that would be accounted for differently under ASPE than IFRS.

(d) What are the conditions that must exist for an entity to be allowed to change an accounting policy?

(a) and (b) Accounting treatment under IFRS:

	(a)	(b)
	Accounting treatment	Type of change
1.	P	Change in estimate
2.	R	Accounting error correction
3.	P	Change in estimate
4.	NA*	Change in policy
5.	P	Not an accounting change – selection of policy for first time.
6.	P	Change in estimate
7.	R	Accounting error correction
8.	P	Change in estimate
9.	P	Application of a new accounting policy to transactions that differ in substance from those previously occurring
10.	R	Accounting error correction

* The accounting treatment would be specified in the transitional provisions of the new source of GAAP. If not specified, then apply retrospectively.

The only two approaches that are permitted for reporting changes are retrospective and prospective treatment.  Accounting for the change in the current year only is not permitted under either IFRS or ASPE. When new or revised sources of primary GAAP are adopted, recommendations are usually included that specify how an entity should handle the transition. These are called transitional provisions.

There is a major difference between ASPE and IFRS in accounting for retrospective changes in that IFRS allows partial retrospective treatment and ASPE doesn’t.  In addition, under IFRS, an opening balance sheet must be provided for the earliest comparative period provided when there is a retrospective change.

(c) Accounting treatment under ASPE (if different than part (a) for IFRS):

    There would be no differences to the accounting treatment for the above noted items between IFRS and ASPE, however some items have special considerations worth noting.

    (5) IAS 23 requires that interest be capitalized for qualifying assets, whereas ASPE still permits a choice between capitalization and expensing, provided that the company is consistently applying the policy. Given that the situation is one where this is the first time they have constructed a building for their own purposes then it’s not a change at all, but rather the selection of a policy for the first time.

    (9) Under current IFRS (IAS 11 and IAS 18), the percentage of completion method is the preferred method of accounting for long-term contracts. If the outcome cannot be reliably measured, recoverable revenues equal to costs are recognized under IAS 11 and IAS 18 (sometimes referred to as the zero profit method). No gross profit is recorded until the contract is completed and the gross profit can be reliably measured. IFRS does not provide the choice of the completed contract method. Under accounting standards for private enterprises (ASPE), the percentage of completion method is again the preferred method of accounting for long-term contracts. However, the completed contract method is allowed as a default method for long-term contracts under ASPE where the percentage complete cannot be reliably measured. Under the completed contract method, revenue would only be recorded when the contract is completed.

(d) Under IFRS, one of the following two situations is required for a change in an accounting policy to be acceptable:

1. The change is required by a primary source of GAAP.

2.    A voluntary change results in the financial statements presenting reliable and more relevant information about the effects of the transactions, events, or conditions on the entity’s financial position, financial performance, or cash flows.

    Accounting standards for private enterprises provide for further situations where an accounting policy change may be made without having to meet the “reliable and more relevant” criteria in the second situation above. It allows the following voluntary changes in policy to be made:

3. Between or among alternative private enterprise GAAP methods of accounting and reporting for investments in subsidiary companies, and in companies where the investor has significant influence or joint control; for expenditures during the development phase on internally generated intangible assets; for defined benefit plans; for accounting for income taxes; and for measuring the equity component of a financial instrument that has both a liability and equity component at zero.

  These further situations allowed under private enterprise accounting standards as an acceptable change in accounting policy relate to standards where accounting policy choices have to be made. These changes are treated as voluntary changes, but they do not have to meet the “reliable and more relevant” hurdle required of other voluntary changes. Although not specifically stated in the actual standard, it is assumed that once that choice has been made, the same policy is followed consistently.