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






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

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