Question

In recent years , the Wall Street Journal has indicated that many companies are changing their accounting principles. What are some of the major reasons why companies change their accounting methods? What are some of the effects of errors found on statements? What are some of the effects of changing these errors and how does it affect other accounts and the bottom line for the company?

Answer 1

Reasons for Changing Accounting Policies

Changes in Accounting Policies is not an easy thing to opt for. An entity can go for making changes in accounting policies if and only if:

• there is a requirement of change in the whole organization and its standards.
• it shows the correct statements that contain more reliable and relevant information. They are all related to every transaction ever made in the company so far.

The point to take into consideration here is the changes in accounting policies hold no responsibility for any sort of transaction that has not taken place in the past.

Disclosures Related to Changes in Accounting Policies

The disclosures relating to the coming up changes in accounting policies are as follows:

• the reason behind the change and the interpretation that is responsible for causing it.
• the type of nature and the changes occurring in the policies.
• a detailed description of provisions that will consist of all the necessary options for the changes in the coming time.

The disclosures relating to the coming up voluntary changes in accounting policies are as follows:

• change of nature in the policies.
• the probable reasons behind the relevant information that is easily accessible to gain more reliable details.
• adjustments that were made every time.

US GAAP classifies accounting errors as follows:

• error of commission (a mathematical mistake),
• error of omission (a transaction is not recorded), and
• error of principle (mistakes in the application of US GAAP).

In addition, all errors may be categorized as deliberate and non-deliberate.

Posting incorrect figures or deliberately violating US GAAP is a fraudulent activity. To minimize the risk of fraud a company may consider the fraud triangle (pressure, opportunity, and rationalization). For instance, the rationalization edge can be reduced by promoting a strong sense of ethical behavior amongst employees and creating a positive work environment.

Non-deliberate mistakes take place quite often. No company is assured against them. The way out is to come across the most common mistakes, correct existing discrepancies, and try to avoid making them in the future.

Notably, some errors are material for the company’s financial statements and some are not, which is particularly important for posting adjustments at a year-end or correcting previously issued financial statements. For instance, there may not be a need to correct an immaterial mistake in the previously issued financial statements. However, material errors would need to be corrected in financial statements.

Error Type 4 – Deferred Tax Adjustments

Companies are required to account for both current taxes and the expected future tax consequences related to already recognized events. Deferred taxes arise due to differences between tax rules and accounting rules. Making correct deferred tax calculations and adjustments are crucially important for companies that prepare their financial statements in accordance with local GAAPs and then translate them into US GAAP.

To mitigate the risk of incorrect deferred tax in the financial statements, management should make deferred tax calculations only after all US GAAP transformation adjusting entries are posted.

Error Type 5 – Failing to Apply Other Complex US GAAP Rules

Other complex US GAAP rules include the following:

• Purchase of securities with embedded derivatives;
• Consolidation of subsidiaries and special purpose entities;
• Sale and leaseback contracts;
• Finance lease agreements.

The major reasons why companies change accounting methods are: (1) Desire to show better profit picture. (2) Desire to increase cash flows through reduction in income taxes. (3) Requirement by Financial Accounting Standards Board to change accounting methods. (4) Desire to follow industry practices.