Welcome back. To conclude this module,
let's just talk briefly about accounting changes and transitions.
And let's just look at some examples from
recently issued accounting standards updates and how they account for transition.
So, they generally provide
their transition guidance in newly issued accounting standard updates.
Every once in a while, they'll say just
apply the guidance for a change in accounting principle but that's kind of way.
But the default position, again,
is to account for changes as a change in
accounting principle with retrospective application.
But as I noted previously,
retrospective is usually practicable when the standard follows
an amortized cost model and it can be more problematic for fair value measurement.
So, there are many exceptions.
So, let's look at an example of retrospective.
This is a statement of cash flows and update that was issued in
2016 for accounting for restricted cash.
So, they decided that this update could
be applied using a retrospective transition method to each period presented.
Why? Well, cash flow issues usually pertain to classification.
They're not measurement issues per se,
and there's less judgment involved.
So, this one, it was fairly clear cut what
the judgment would be was the cash restricted or not.
You wouldn't know. So, it was practicable to do that.
So, they decided that you would, in fact,
go back and make retrospective application.
Here's an example of a modified retrospective.
This is Update 2016-02 Leases.
So, in transition, lessees and lessors are required to recognize and measure
leases at the beginning of
the earliest period presented using a modified retrospective approach.
Leases are fundamentally an amortized cost model,
even though some judgments are made at inception.
So, what were the modifications?
They did modify it to include
optional practical expedients that entities may elect to apply.
They relate to identification and classification of leases,
judgment required, that commenced before the effective date, initial direct cost,
this was just a nuisance factor I think,
and the ability to use hindsight in evaluating
leases and options to extend or terminate the lease.
Now, this is, again, an example of being able to look back and use hindsight.
It required an exception to be put into the standard to allow you to do that.
So, those were practical expedients.
Now, as we're filming this,
the FASB has just decided to go back and look at whether the match or
modified retrospective approach would in fact be required
for leases and there would be an exposure draft issued sometime in
2018 that may change this.
But this is the modified retrospective approach
that was originally put out when this update was issued.
Prospective application.
Well, here's an example of that.
ASU 2017-04 - Intangibles - Goodwill and Other.
Simplifying the Test for Goodwill Impairment,
probably in response to all those preferably letters they were getting at the SCC.
So, now they're saying here that an entity should
apply the amendments on a prospective basis.
You're required to disclose the nature of and reason for
the change in accounting principles upon transition.
Why is it prospective?I mean,
remember goodwill impairment requires use of fair value measurements.
It's very hard to go back in time and do those kinds of measurements.
So, here's an example of both with
compensation retirement benefits improving the presentation of
net periodic benefit class and that periodic post retirement benefit cost.
So, they should be applied retrospectively.
For the presentation of the service cost component and other components of
net periodic benefit cost in the income statement and prospectively,
for the capitalization of service class components in assets.
So, this is sort of saying we're going to be retrospective for the direct effects and
prospective for the indirect effects because service cost- remember
that one of the components of inventory cost is direct labor.
So, they're saying no, you don't have to go back and look at that and remeasure it,
but you are going to have to go back and remeasure your service cost component.
And again, this is largely presentation.
So, it's not involving remeasurement.
So, it was practicable to do that for the service cost,
but it was decided it would be impracticable to do that for the indirect effect.
They do allow a practical expedient that
you can use the amounts disclosed in your pension
for the prior comparative periods as
the estimation basis for applying the retrospective presentation requirements,
but you would disclose that.
So, you don't have to go back and do a remeasurement.
You're going to use those amounts that were disclosed in the pension.
So, again, you're rarely seeing
a full retrospective approach when it would be difficult to apply.
But it still is the default procedure and it
certainly is a default for voluntary changes.
But as we saw earlier on,
voluntary changes are fairly rare,
given the large number of public companies and
the relatively few finance that you see for that.
A lot of those filings may go away now that they've made
some changes to the accounting for the impairment of goodwill,
the testing for the impairment of goodwill.
Also, I think as the movement from LIFO to FIFO reaches the ultimate conclusion,
you'll see even fewer of those in that point in time.
It's no longer really considered to be
a central feature of
the accounting model that you're making choices between accounting methods.
There really should be most modern standards have a single method that's applied.
You may be able to apply
practical expedients to some of
those methods which are meant to just do a simpler approach,
but in general, you're not going to have these types of
accounting choices that classical accounting from the 1940s and 50s had.
So, although analysts often express
a preference for maximum comparability from period to period,
there are often practical issues with retrospective transitions.
It's especially true of those involving
retrospective application of judgment and that includes for value measurements.
Again, it's still the default transition method,
but it's often overwritten with modifications or prospective applications.
And that concludes our discussion on accounting changes. Thank you for your attention.
John HeppClinical Assistant Professor of Accountancy
