Accounting Changes and Error Corrections - Assignment Example

?SFAS 154 – Accounting Changes and Error Corrections Introduction Companies are required to follow different accounting policies and principles in respect of their financial reporting requirements. Often it happens that certain accounting principles are changed or repealed or replaced with other new standards. It also happens that the company itself brings some changes in its accounting estimates. There is a possibility that company might have occurred some mistakes and errors in the financial statements and now it aims to rectify and make corrections in those errors (Bloom, 2006). At times, it also happens that a change in the accounting policy or principle affects the consolidated financial statements of the group as well. So, SFAS 154 aims to highlight all of the above discussed issues in details and provide appropriate guidance as how to incorporate the effects of all those changes in the financial statements of the reporting entity. This article is structured in such a manner that first section describes the overview of SFAS 154 which includes the objective of its issuance as well as the scope of this standard. Next section focuses on recognition, measurement and disclosure requirements of SAFS 154. Third section highlights the comparison of SFAS 154 of FASB with IAS 8 of IASB i.e. a comparison between US GAAP and IFRS in respect of these two standards. An illustrated example is also provided after the comparison of the standards which is then followed by a conclusion which summarizes the whole article. Overview of SFAS 154 Objective Mainly the objective of FASB to issue this standard is to bring more convergence with IASB towards the preparation, development and furnishing the financial statement as a high quality single set across the world (Deloitte, 2008). As IASB has issued IAS 8 on similar footings, therefore it is the intension of both accounting standard boards to bring more harmonized financial statements in most of the areas of accounting. This standard is developed in by replacing two standards previously issued by FASB which were FASB Statement No.3 “Reporting Accounting Changes in Interim Financial Statements” and APB Opinion 20 “Accounting Changes”. The standard is broadly split into two major areas, which are”Accounting Changes” and “Correction of Error in Previously Issued Financial Statements”. The section “Accounting Changes” is further divided into three areas which are “Changes in Accounting Principle”, “Changes in Accounting Estimates” and lastly, “Changes in the Reporting Entity” (Financial Accounting Standard Board, 2009). Scope The scope of this standard covers three areas which are listed below (Financial Accounting Standard Board, 2009): 1. SFAS 154 is applicable for both profit making business organizations as well as not-for-profit organizations. In this standard both these kinds of organizations are referred to as “entities”. 2. Another application of SFAS 154 can be possible in case of summarized financial information which are primarily based upon the financial statements such that accounting changes are reflected in the accounting period in which those changes have arisen. 3. SFAS 154 also encompasses the other forms of financial statements which are prepared for some special purposes. Measurement, Recognition and Disclosure Changes in Accounting Principles SFAS 154 provides specific guidelines to incorporate a change in the accounting principle. A change in the accounting principle is the change that has been made by FASB by making amendment, addition or deletion in the existing accounting standards issued by FASB (Financial Accounting Standard Board, 2009). FASB requires the entities to bring the effects of the changes in accounting principle retrospectively such that all of the previously issued financial statements need to be modified as a result of change in accounting principles (Deloitte, 2008). SFAS 154 also guides the entities in the situations where it is not practicable for the entities to bring the effects of the changes right from the very beginning therefore SFAS 154 has allowed to bring those changes from the year in which those changes can become practicable. However, SFAS requires entities to bring those changes in the equity portion of the balance sheet rather than incorporating their effects into income statement. Where it is entirely impracticable for the entities to being the effects of those changes in accounting principles on retrospective basis, FASB has allowed to bringing in those changes on prospective basis. Another important factor to be specifically mentioned here is that all the retrospective changes should be made in financial statements only for changes which have direct effects (Financial Accounting Standard Board, 2009). Those changes which have indirect effects are required to be incorporated only in the period in which accounting change has been made. The disclosure requirements relating to changes in accounting principles are as followed (Financial Accounting Standard Board, 2009): 1. Nature, purpose and justification of the accounting change to be made in the financial statements as well as the explanation of new changes that have become in effect. 2. Description regarding the retrospective changes in prior period financial statements 3. The effect of the change in accounting principle in the income statement of the entity 4. The effect of the change in accounting principle in the balance sheet of the entity especially in equity section 5. In case where it is impracticable to bringing in the change on retrospective basis, the reasons and explanation for that matter 6. For the indirect effects, the changes that has been brought in the year in which changes in accounting principles has been incorporate as well as the prior periods. Changes in Accounting Estimates As far as the changes in accounting estimates are concerned, SFAS 154 requires the entities to bring in the effect of those changes in the year in which those estimates have been changed or in the future periods (Financial Accounting Standard Board, 2009). Prospective methodology of changes in accounting estimates has been encouraged by the standard instead of retrospectively making the changes in the prior period financial statements. SFAS 154 has quoted the example of changes in accounting policy in the form changes in the depreciation policy of the entity where the entity is required to make the adjustments in long lived assets only in respect of the existing year as well as the future periods, but there is no need to bring the changes in the prior periods. The disclosure requirements for SFAS 154 requires the entities to disclose the nature and reason of the changes in accounting estimates only in the year in which the change in accounting period has been made. Changes in Reporting Entity In case where a change in accounting principle of the entity results in the change in the financial information provided by the financial statements of the whole group, then SFAS 154 requires both the individual and the group to bring the effect of that change in accounting principles in all the prior periods subject to the practicability of modification on retrospective basis. The only exception provided in this regard is capitalized interest cost under FASB Statement No.3 The disclosure requirement for changes in reporting entity requires the entities to provide the nature and reasons for such a change along with the explanation of such change. The amounts pertaining to that change are required to be incorporated in the income statement of both the individual reporting entity as well as the group as a whole. Correction of an Error in Previously Issued Financial Statements In case, if an accounting error is found the previously issued financial statements that error needs to be corrected by restating the financial statements for all the prior periods. SFAS 154 requires the entities to correct the financial statements in respect of the balances of assets, liabilities and equity portions along with the correction of the errors to be reflected on period-specific effects. As far as the disclosure of the correction of errors is concerned, SFAS 154 requires the entities to disclose the nature, reason and explanation of the correction made as well as the disclosure that previously issued financial statements have been restated. It is also required for the entities to disclose each of the line items of the financial statements as well as the effect of change in the retained earning portion of the balance sheet. Comparison of SFAS 154 and IAS 8 Items GAAP IFRS Change in Accounting Principle Financial Statements need to be amended on retrospective basis (Grant Thornton, 2007) Same as GAAP Changes in Accounting Estimate Financial Statements need to be amended on prospective basis (Grant Thornton, 2007) Same as GAAP Indirect Changes Accounting Treatment is Provided (Grant Thornton, 2007). No Accounting Treatment is provided Exception to Impracticability If retrospective change is impracticable, exception is allowed (Grant Thornton, 2007). Same as GAAP Error Correction Mandatory since the inception (Grant Thornton, 2007). Retrospective Treatment from the prior periods where practicable Illustrated Example The following example is taken from the annual report of CorVel Corporation for the year 2006 such that the excerpt from the notes to the financial statement has been reproduced. Restatement of prior year financial statements The company analyzed the fact that there is a need for restatement for financial statements in respect of some of the previous departures as per SFAS No. 13, "Accounting for Leases," as revised, and Financial Accounting Standards Board Technical Bulletin No. 88-1, "Issues Related to Accounting for Leases" in the year 2006. The other issues that were not in accordance with FASB Technical Bulletin No. 85-3 "Accounting for Operating Leases with Schedule Rent Increases" were pertaining to method of accounting in case of rent as it was accounted for on actual basis instead of straight-line basis. Due to the adoption of above mentioned accounting standards, the company has not determined any material impact of the adoption on its net income. The consolidate balance sheet and statement of shareholder’s equity for the year ended 2003, 04 and 05 are restated under the following tables. Due to the corrections made above, the rents prior to 2004 have been increased and a deferred rent liability also recognized which includes the tax effects as well. The cash flows of the company have not been affected as well as there is no issue arisen regarding the timings of the lease payments. Following is the consolidated balance sheet of the company as on 2005 having the effects of the adjustments made as mentioned above: Balance Sheet as of March 31, 2005:   Reported previously Correction Restated Year ended March 31, 2005   Deferred income tax asset $ 8,252 $ 405 $ 8,657 Total assets 106,293 405 106,698 Accrued liabilities 12,059 1,053 13,112 Retained earnings 140,050 (648) 139,402 Total stockholders' equity 75,241 (648) 74,593 Statements of Shareholders' Equity for the years ended March 31, 2003, 2004, and 2005   Reported previously Correction Restated Retained earnings as of:   2003 $ 103,880 $ (648) $ 103,232 2004 119,893 (648) 119,245 2005 130,050 (648) 129,402   Shareholders' Equity as of:   2003 $ 67,220 $ (648) $ 66,572 2004 77,622 (648) 76,974 2005 75,241 (648) 74,593 Discussion This accounting standard has been set for changes in accounting policies, estimates, correction of errors etc such that the effects of this standard are not presented at the face of income statement or balance sheet (Bloom, 2006). For instance, long-lived assets, leases, inventories, etc all have been discussed in their separate accounting standards but all of them have their presence at the face of either balance sheets or income statement or both. But due to the nature of this accounting standard, the reporting entities are not required to incorporate the effects arising under this standard every year rather this standard has to be applied in the year in which any accounting change comes up. Therefore, the disclosure under this accounting standards are made in the notes to the financial statements. Conclusion This article mainly discussed the changes that affect the financial statements as a result of change in accounting principle, accounting estimates, reporting entity and the correction of errors that are identified in the previously issued financial statements. Accounting treatment in respect of retrospective and prospective adjustments, are required by SFAS 154. As far as the comparison between the GAAP and IFRS is concerned, it is important to mention that both the frameworks have shown quite much similarity in the accounting treatment. References Bloom, R. a. F. J., 2006. SFAS 154: Accounting Changes and Error Corrections. [Online] Available at: http://www.nysscpa.org/cpajournal/2006/306/essentials/p44.htm [Accessed 18 April 2012]. Corvel, 2006. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. [Online] Available at: http://www.corvel.com/ar2006/management.htm[Accessed 19 April 2012]. Deloitte, 2008, IFRSs and US GAAP A pocket comparison, [Online], Available at: http://www.iasplus.com/dttpubs/0809ifrsusgaap.pdf [Accessed on 18 April 2012]. Deloitte, 2012, Summaries of International Financial Reporting Standards, IAS8 Accounting Policies, Changes in Accounting Estimates and Errors , [Online] Available at http://www.iasplus.com/en/standards/standard8 [Accessed on 18 April 2012]. Financial Accounting Series, 2005. Statement of Financial Accounting Standard No. 154. [Online] Available at: http://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175820927509&blobheader=application%2Fpdf [Accessed 18 April 2012]. Financial Accounting Standards Board, 2009, Financial Accounting Series, “Statement of Financial Accounting Standards No. 154 “Accounting Changes and Error Corrections” Norwalk, CT: Financial Accounting Standards Board. Grant Thornton, 2007. Comparison between U.S. GAAP and International Financial Reporting Standards. [Online] Available at:http://www.grantthornton.com/staticfiles/GTCom/files/AboutUs/Assurance_thought_leadership/Grant_Thornton_U%20S%20_GAAP_v_IFRS_Comparison.pdf[Accessed 19 April 2012]. International Accounting Standards Board, 2008, International Financial Reporting Standards (IFRSs®) 2008: Including International Accounting Standards (IASs®) and Interpretations as approved at 1 January 2008, “The consolidated text of International Financial Reporting Standards as approved on 1 January 2008”. London, International Accounting Standards Board. SFAS 154, n.d.. SFAS 154, Accounting Changes and Error Corrections. [Online] Available at: http://www.acsondhi.com/issues/SFAS_154_Accounting_Changes_and_Error_Corrections.pdf [Accessed 18 April 2012]. Read More