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Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
Chapter 22: Accounting Changes and Error Analysis
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Chapter 22: Accounting Changes and Error Analysis

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    • 1. Chapter 22: Accounting Changes and Error Analysis
    • 2. <ul><li>SFAS No. 154 </li></ul><ul><li>Types of accounting changes </li></ul><ul><li>Changes in Accounting Principle </li></ul><ul><li>Changes in Accounting Estimates </li></ul><ul><li>Changes in Reporting Entity </li></ul><ul><li>Errors in Financial Statements </li></ul>Types of Accounting Changes
    • 3. <ul><li>From one generally accepted principle to another </li></ul><ul><li>Does not result from the adoption of a new accounting principle </li></ul><ul><ul><li>Previously immaterial </li></ul></ul><ul><ul><li>Events for first time </li></ul></ul><ul><li>A change to a generally accepted principle (from an incorrect principle) = correction of an error </li></ul>Changes in Accounting Principle
    • 4. <ul><li>Currently </li></ul><ul><li>Retrospectively </li></ul><ul><li>Prospectively </li></ul>Changes in Accounting Principle
    • 5. <ul><li>Cumulative effect new determined </li></ul><ul><li>Prior period FS recast based on new </li></ul><ul><li>Cumulative effect for periods prior to presentation = adjusted to beginning retained earnings </li></ul><ul><ul><li>Leads to comparable &amp; consistent FS </li></ul></ul>Changes in Accounting Principle Retroactive Reporting
    • 6. <ul><li>Impracticable to retrospectively apply principle change (i.e. FIFO to LIFO) </li></ul><ul><ul><li>Prospective reporting at earliest practicable date </li></ul></ul><ul><ul><ul><li>Effects of retro application not determinable </li></ul></ul></ul><ul><ul><ul><li>Requires assumptions re: management intent in prior periods </li></ul></ul></ul><ul><ul><ul><li>Significant estimates for prior period required AND unable to objectively verify info needed to develop retro adjustment </li></ul></ul></ul>Changes in Accounting Principle Retroactive Reporting
    • 7. <ul><li>Impracticable to retrospectively apply principle change (i.e. FIFO to LIFO) </li></ul><ul><ul><li>Disclose </li></ul></ul><ul><ul><ul><li>Effect of change in operations for change period </li></ul></ul></ul><ul><ul><ul><li>Reasons for omitting computations </li></ul></ul></ul><ul><ul><ul><li>Pro forma amounts for PY should be explained </li></ul></ul></ul><ul><ul><ul><li>Justification for change </li></ul></ul></ul><ul><ul><li>Illustration 22-10 Page 1163 </li></ul></ul>Changes in Accounting Principle Retroactive Reporting
    • 8. <ul><li>FS require estimates re: future conditions &amp; events </li></ul><ul><ul><li>Lack of certainty </li></ul></ul><ul><ul><li>Judgment required </li></ul></ul><ul><li>Examples </li></ul><ul><ul><li>CHANGES IN DEPRECIATION METHOD </li></ul></ul><ul><ul><li>Change in life of depreciable assets </li></ul></ul><ul><ul><li>Salvage values of assets </li></ul></ul><ul><ul><li>Estimates of bad debts </li></ul></ul>Changes in Estimate
    • 9. <ul><li>Prospective basis </li></ul><ul><ul><li>Considered normal recurring corrections &amp; adjustments </li></ul></ul><ul><li>Estimates later determined incorrect </li></ul><ul><ul><li>Change in estimates </li></ul></ul><ul><li>Impossible to determine </li></ul><ul><ul><li>Principle vs. estimate = estimate </li></ul></ul><ul><ul><li>Error vs. estimate = estimate for “careful estimates” </li></ul></ul><ul><ul><ul><li>Judgment required </li></ul></ul></ul>Changes in Estimate
    • 10. <ul><li>Financial statements restated for all prior periods presented </li></ul><ul><li>Examples </li></ul><ul><ul><li>Consolidated statements in lieu of individual FS </li></ul></ul><ul><ul><li>Changes in subsidiaries in a consolidated group </li></ul></ul><ul><ul><li>Change in method for accounting for subsidiaries &amp; investments </li></ul></ul>Reporting a Change in Entity
    • 11. <ul><li>Prior period adjustments </li></ul><ul><ul><li>Adjust beginning RE for earliest period presented </li></ul></ul><ul><li>Examples </li></ul><ul><ul><li>Change from an accounting principle that is not generally accepted to one that is accepted </li></ul></ul><ul><ul><li>Mathematical errors </li></ul></ul><ul><ul><li>Changes in estimates that were not prepared in good faith </li></ul></ul><ul><ul><li>Failure to properly accrue/defer expenses/revenues </li></ul></ul><ul><ul><li>Misapplication or omission of relevant facts </li></ul></ul>Reporting the Correction of an Error
    • 12. <ul><li>New principle preferable to existing accounting principle </li></ul><ul><ul><li>New principle should result in improved financial reporting </li></ul></ul><ul><ul><ul><li>Not solely for income tax effect </li></ul></ul></ul><ul><li>Considered preferable if SFAS: </li></ul><ul><ul><li>Creates new accounting principle, or </li></ul></ul><ul><ul><li>Expresses preference for a new principle, or </li></ul></ul><ul><ul><li>Rejects a specific accounting principle </li></ul></ul>When is a Change in Accounting Principle Appropriate?
    • 13. <ul><li>Self interest </li></ul><ul><ul><li>Managers standards to maximize bonuses </li></ul></ul><ul><li>Political cost </li></ul><ul><ul><li>Less politically visible to avoid regulation </li></ul></ul><ul><li>Capital structure </li></ul><ul><ul><li>High debt/equity </li></ul></ul><ul><li>Smooth earnings </li></ul><ul><ul><li>To avoid notice (regulators, competitors, etc.) </li></ul></ul>Motivations for Change
    • 14. <ul><li>Firms do not correct errors that are insignificant </li></ul><ul><li>Considerations </li></ul><ul><ul><li>What type of error is involved? </li></ul></ul><ul><ul><li>What correcting entries are needed? </li></ul></ul><ul><ul><li>How are financial statements to be restated? </li></ul></ul><ul><li>Reported as PPEs </li></ul>Error Analysis in General
    • 15. <ul><li>Balance sheet </li></ul><ul><ul><li>Classifications </li></ul></ul><ul><li>Income statement </li></ul><ul><ul><li>Classifications </li></ul></ul><ul><li>Balance sheet &amp; income statement </li></ul><ul><li>Types – a MUST KNOW for entry level positions </li></ul><ul><ul><li>Counterbalancing (or self-correcting over two accounting periods) </li></ul></ul><ul><ul><ul><li>Accrued payroll </li></ul></ul></ul><ul><ul><li>Non-counterbalancing (more than two periods needed) </li></ul></ul><ul><ul><ul><li>Expense vs. capitalization </li></ul></ul></ul><ul><ul><ul><li>Examples pages 1177 - 1178 </li></ul></ul></ul>Types of Errors
    • 16. <ul><li>Questions to be considered are: </li></ul><ul><ul><li>Are the books closed ? </li></ul></ul><ul><ul><li>Are comparative statements presented? </li></ul></ul><ul><li>Adjust beginning RE </li></ul><ul><ul><li>Books are closed &amp; error is not counterbalanced, or </li></ul></ul><ul><ul><li>Books are not closed &amp; company is in the second year &amp; error is already counterbalanced </li></ul></ul>Counterbalancing Errors
    • 17. <ul><li>R equires restatement of all prior period FS </li></ul><ul><li>From equity method to FV method must be made when: </li></ul><ul><ul><li>Investor’s level of influence falls below required percentage of ownership </li></ul></ul><ul><li>A change from fair value method to the equity method must be made when: </li></ul><ul><ul><li>Investor’s level of influence rises above required ownership % </li></ul></ul>Changing From and to the Equity Method
    • 18. <ul><li>Retroactive adjustments/reporting </li></ul><ul><ul><li>Carrying value of investment </li></ul></ul><ul><ul><li>Results of current &amp; prior period operations </li></ul></ul><ul><ul><li>Retained earnings of investor </li></ul></ul><ul><ul><li>Any balances in unrealized holding gains &amp; losses are eliminated </li></ul></ul><ul><ul><li>Available-for-sale classification also removed </li></ul></ul>Changing to the Equity Method
    • 19. <ul><li>E22-8 E22-2 </li></ul><ul><li>E22-4 E22-9 </li></ul><ul><li>E22-19 </li></ul>Class Exercises
    • 20. Chapter 24: Full Disclosure in Financial Reporting
    • 21. Types of Financial Information
    • 22. <ul><li>Full disclosure at heart of high quality financial reporting </li></ul><ul><ul><li>MANAGEMENT’S responsibility </li></ul></ul><ul><li>Standards overload </li></ul><ul><ul><li>GAAP hierarchy </li></ul></ul><ul><li>Differential disclosure </li></ul><ul><ul><li>Public vs. nonpublic companies </li></ul></ul><ul><ul><ul><li>AICPA study </li></ul></ul></ul><ul><li>Profession still developing guidelines </li></ul><ul><ul><li>Whether given transaction should be disclosed </li></ul></ul><ul><ul><li>What format disclosure should take </li></ul></ul>Full Disclosure
    • 23. <ul><li>Full disclosure principle </li></ul><ul><ul><li>Financial reporting of significant facts affecting the judgment of an informed reader </li></ul></ul><ul><ul><ul><li>Objective of financial reporting </li></ul></ul></ul><ul><ul><ul><ul><li>Info useful for decision making </li></ul></ul></ul></ul><ul><ul><li>Problems of implementing </li></ul></ul><ul><ul><ul><li>Costs of disclosure </li></ul></ul></ul><ul><ul><ul><li>Information overload </li></ul></ul></ul>The Full Disclosure Principle
    • 24. <ul><li>Reasons for increased reporting requirements </li></ul><ul><ul><li>Complexity of business environment (derivatives, business combinations, pensions) </li></ul></ul><ul><ul><li>Necessity for timely information (interim data, forecasts) </li></ul></ul><ul><ul><li>Accounting used as a control and monitoring device </li></ul></ul>Increase in Reporting Requirements
    • 25. <ul><li>Amplify/explain items presented in FS body </li></ul><ul><li>A statement that identifies the accounting policies of the entity must be disclosed </li></ul><ul><ul><li>GAAP choices = footnote </li></ul></ul><ul><ul><li>Summary of Significant Accounting Policies </li></ul></ul><ul><ul><ul><li>Page 1286 - 1287 </li></ul></ul></ul><ul><li>Common notes </li></ul><ul><ul><li>Inventory </li></ul></ul><ul><ul><li>Deferred taxes </li></ul></ul><ul><ul><li>PPE </li></ul></ul><ul><ul><li>Credit claims </li></ul></ul><ul><ul><li>Contingencies and commitments </li></ul></ul>Notes to the Financial Statements
    • 26. <ul><li>Related party transactions </li></ul><ul><ul><li>Not arm’s-length </li></ul></ul><ul><ul><li>Special audit concerns </li></ul></ul><ul><li>Required disclosures: </li></ul><ul><ul><li>Nature of relationship </li></ul></ul><ul><ul><li>Description of transactions </li></ul></ul><ul><ul><li>Dollar amounts of transactions </li></ul></ul><ul><ul><li>Amounts due from/to related parties at balance sheet date </li></ul></ul><ul><li>Example page 1290 </li></ul>Disclosure of Special Transactions or Special Issues
    • 27. <ul><li>Notes to FS must explain any significant financial events that occurred after the BS date but before issuance of the FS </li></ul>Post-Balance Sheet Events Financial statement period Post-balance sheet events Balance sheet date Issue date
    • 28. <ul><li>Events providing additional evidence about conditions existing at the BS date that require adjustments </li></ul><ul><ul><li>Changes to estimated amounts </li></ul></ul><ul><li>Events arising subsequent to the BS date that do not require adjustments </li></ul><ul><ul><li>Examples page 1292 </li></ul></ul>Types of Subsequent event Transactions to be Disclosed
    • 29. <ul><li>Investors need information </li></ul><ul><ul><li>Regarding IS, BS, &amp; SC </li></ul></ul><ul><ul><li>About segments to assess profitability </li></ul></ul><ul><li>Segmented information may harm reporting firms </li></ul><ul><ul><li>Disclosure of data useful to competitors </li></ul></ul><ul><ul><ul><li>WDW &amp; Universal re: park attendance </li></ul></ul></ul>Reporting by Conglomerates
    • 30. <ul><li>Objectives of reporting segment info – provide info re: </li></ul><ul><ul><li>Different types of business activities </li></ul></ul><ul><ul><li>Different economic environments in which entities operate </li></ul></ul><ul><li>Operating segment = component that: </li></ul><ul><ul><li>Engages in business activities </li></ul></ul><ul><ul><ul><li>Revenues &amp; expenses </li></ul></ul></ul><ul><ul><li>Is reviewed by conglomerate’s chief operating officer </li></ul></ul><ul><ul><ul><li>Assess performance &amp; allocate resources </li></ul></ul></ul><ul><ul><li>Produces discrete financial information from the internal financial reporting system </li></ul></ul>Reporting by Conglomerates
    • 31. <ul><li>May aggregate if have same basic characteristics in: </li></ul><ul><ul><li>Products &amp; services rendered </li></ul></ul><ul><ul><li>Production process </li></ul></ul><ul><ul><li>Type/class of customer </li></ul></ul><ul><ul><li>Methods of product/service distribution </li></ul></ul><ul><ul><li>Regulatory environment </li></ul></ul>Aggregation of Operating Segments
    • 32. <ul><li>Reportable segment if it satisfies one or more of the following criteria </li></ul><ul><ul><li>Revenue criterion </li></ul></ul><ul><ul><li>Profit or loss criterion </li></ul></ul><ul><ul><li>Identifiable assets criterion </li></ul></ul>Reportable Segments
    • 33. <ul><li>Segment revenue </li></ul><ul><li>Segment profit or loss </li></ul><ul><li>Identifiable assets </li></ul><ul><li>Is more than 10% of the combined revenue of all operating segments </li></ul><ul><li>Is 10% or more of the greater of : </li></ul><ul><ul><li>Combined profit of all operating segments not showing a loss OR </li></ul></ul><ul><ul><li>Combined loss of all operating segments reporting a loss </li></ul></ul><ul><li>10% or more of the combined assets of all operating segments </li></ul>Criterion Thresholds Reportable Segments
    • 34. <ul><li>General information about operating segments </li></ul><ul><li>Segment profit &amp; loss &amp; related information </li></ul><ul><li>Segment assets </li></ul><ul><li>Reconciliation of segment revenues, profits &amp; losses, &amp; segment assets </li></ul><ul><li>Information about products &amp; services &amp; geographical areas </li></ul><ul><li>Major customers </li></ul><ul><li>Example page 1297 </li></ul>Required Segmented Information
    • 35. <ul><li>Cover less than one year </li></ul><ul><ul><li>Public = quarterly (10Q) </li></ul></ul><ul><li>Two approaches </li></ul><ul><ul><li>Integral – each interim period integral part of annual report </li></ul></ul><ul><ul><li>Discrete – each interim period stands alone </li></ul></ul><ul><ul><li>Most companies employ both approaches for various transactions </li></ul></ul><ul><li>Reporting requirements: </li></ul><ul><ul><li>Use of same accounting principles </li></ul></ul><ul><ul><ul><li>Some exceptions – page 1299 </li></ul></ul></ul><ul><ul><li>Period costs often charged as incurred </li></ul></ul><ul><ul><li>Not required to publish BS or SCF </li></ul></ul>Interim Reporting Requirements
    • 36. <ul><li>Advertising and similar costs </li></ul><ul><ul><li>Defer if benefit other periods </li></ul></ul><ul><li>Expenses subject to YE adjustments </li></ul><ul><ul><li>Best estimate &amp; allocation </li></ul></ul><ul><li>Income taxes </li></ul><ul><ul><li>Estimated annual effective rate </li></ul></ul><ul><li>Extraordinary items </li></ul><ul><ul><li>Charge in period occurs </li></ul></ul><ul><li>Changes in accounting principles </li></ul><ul><ul><li>Restate first quarter (consider NEW GAAP) </li></ul></ul><ul><li>Earnings per share </li></ul><ul><ul><li>Shares for each period stand alone </li></ul></ul><ul><li>Seasonality </li></ul><ul><ul><li>Examples pages 1301 &amp; 1302 </li></ul></ul>Problems of Interim Reporting
    • 37. <ul><li>Auditor’s reporting standards: </li></ul><ul><li>States whether FS are in conformity with GAAP </li></ul><ul><li>Identifies circumstances in which GAAP have not been consistently applied </li></ul><ul><li>Disclosures in FS are deemed adequate unless otherwise stated </li></ul><ul><li>An opinion on the FS, if possible </li></ul><ul><ul><li>Example page 1304 </li></ul></ul>Auditor’s Reports
    • 38. <ul><li>Types of opinions </li></ul><ul><li>Unqualified opinion </li></ul><ul><ul><li>Additional explanatory paragraphs </li></ul></ul><ul><ul><ul><li>Uncertainties </li></ul></ul></ul><ul><ul><ul><li>Lack of consistency </li></ul></ul></ul><ul><ul><ul><li>Emphasis of a matter </li></ul></ul></ul><ul><li>Qualified opinion </li></ul><ul><ul><li>Scope </li></ul></ul><ul><ul><li>Lack of conformity with GAAP </li></ul></ul><ul><ul><li>Inadequate disclosure </li></ul></ul><ul><ul><li>Example page 1306 </li></ul></ul><ul><li>Adverse opinion </li></ul><ul><ul><li>Circumstances </li></ul></ul><ul><li>Disclaimer </li></ul>Auditor’s Opinion
    • 39. <ul><li>Management’s Discussion and Analysis (MD&amp;A) </li></ul><ul><ul><li>Liquidity </li></ul></ul><ul><ul><li>Capital resources </li></ul></ul><ul><ul><li>Results of operations </li></ul></ul><ul><ul><li>Identifies </li></ul></ul><ul><ul><ul><li>Favorable/unfavorable trends </li></ul></ul></ul><ul><ul><ul><li>Any significant events &amp; uncertainties that affect the three aspects </li></ul></ul></ul><ul><ul><li>Example pages 1306 - 1307 </li></ul></ul><ul><li>Report on Management’s Responsibilities </li></ul><ul><ul><li>Example page 1308 </li></ul></ul>Management’s Report
    • 40. <ul><li>Investing public needs &amp; wants more &amp; better information about corporate expectations </li></ul><ul><li>Forms of disclosures </li></ul><ul><ul><li>Financial forecast of an entity’s expected financial position </li></ul></ul><ul><ul><li>Financial projection based on hypothetical assumptions (what might happen ) </li></ul></ul>Financial Forecasts and Projections
    • 41. <ul><li>Advantages </li></ul><ul><ul><li>Reach more users </li></ul></ul><ul><ul><li>Make traditional reports more useful </li></ul></ul><ul><ul><li>Report more timely information </li></ul></ul><ul><ul><li>Report disaggregated data </li></ul></ul><ul><li>Concern about security </li></ul>Internet Financial Reporting
    • 42. <ul><li>Auditing definition = SAS No. 99 </li></ul><ul><ul><li>Accounting vs. legal fraud </li></ul></ul><ul><li>Intentional/reckless conduct </li></ul><ul><ul><li>Act or omission </li></ul></ul><ul><ul><li>Results in materially misleading FS </li></ul></ul><ul><li>Gross &amp; deliberate distortions </li></ul><ul><li>Misapplication of accounting principles </li></ul><ul><li>Failure to properly disclose material items </li></ul>Fraudulent Financial Reporting
    • 43. <ul><li>Impacted by internal &amp; external environments </li></ul><ul><li>Opportunities increase in certain situations: </li></ul><ul><ul><li>Weak board of directors or audit committee </li></ul></ul><ul><ul><li>Weak internal controls </li></ul></ul><ul><ul><li>Unusual or complex transactions </li></ul></ul><ul><ul><li>Accounting issues requiring significant subjective judgments </li></ul></ul><ul><ul><li>Ineffective internal audit function </li></ul></ul>Fraudulent Financial Reporting: Causes
    • 44. <ul><li>Accounting is greatly influenced by its environment. </li></ul><ul><li>Alternative presentations of certain transactions will continue to exist. </li></ul><ul><li>FASB’s Conceptual Framework will hopefully eliminate unneeded diversity in reporting practices. </li></ul><ul><li>New oversight environment will impact accounting choices. </li></ul>Criteria for Making Accounting and Reporting Choices
    • 45. <ul><li>E24-2 E24-3 </li></ul>Class Exercises

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