3.2.1. Accounting Year-end
Choosing the fiscal year-end date is a strategic activity that requires careful consideration because the decision made can result in operational and tax advantages. The year-end will likely be influenced most by the company’s business cycle. For example, a retailer will likely choose a year-end at the end of its busiest season, when inventory is at its lowest levels. This makes the physical count easier and less costly, because there will be more staff available and fewer adjustments to make before the books are closed. Planning a fiscal year-end based on advantageous tax consequences can be tricky, but essentially it means choosing a year-end that results in some temporary differences between certain transactions accounted for in one fiscal year but not taxed until a subsequent fiscal year. Alternatively, businesses that are not incorporated (e.g., proprietorships and partnerships) may choose the calendar year-end to coincide with Canada Revenue Agency, for simplicity from a tax perspective. Whatever fiscal year-end is chosen, accounting standards require that the financial statements be accrual based. This relates back to the accounting principles of revenue recognition, in terms of when to record revenue, and the matching principle, to ensure that all expenses related to that revenue recorded are included. The statements are also the results of operations for a specified period of time (the periodicity principle), called the reporting period. This raises the issues of what, when, and how much detail to record for any transactions that occur near, at, or subsequent to the reporting period year-end date.
Financial statements are often done on an interim basis each year. Interim reports can be monthly, quarterly, or some other reporting period. For example, public companies in Canada are required to produce quarterly financial statements. The accounting cycle has not yet been completed, so the temporary revenue, expense, gains, and loss accounts are not closed, and several end-of-period adjusting entries are recorded in order to ensure that the accounting records are as complete as possible for the interim period being reported. The annual published financial statements usually cover a fiscal or calendar year (on rare occasions, an operating cycle, if longer than one year). After the release of the year-end financial statement, the temporary accounts are closed to retained earnings, and an updated post-closing trial balance for all the (permanent) balance sheet accounts is completed to commence the new fiscal year.
There is also a period of time after the year-end date when certain events or transactions detected in the new fiscal year may need to either be recorded and reported in the financial statements or disclosed in the notes to the financial statements. For this reason, the accounting records from the previous fiscal year are kept open to accrue any significant entries and adjustments found in the new year that pertain to the fiscal year just ended. This time period may be anywhere from a few days to several weeks or months, depending on the size of the company. The end of this time marks the point at which the temporary accounts for the old fiscal year are closed and the financial statements are completed and officially published.
The following are examples of these types of transactions.
- Inventory – the physical inventory count that takes place as soon after the year-end date as possible. The total amount from the physical count is compared to the ending balance in the inventory subledgers, and an adjusting entry recorded for the difference. Since the accounting standards state that inventory is to be valuated each reporting date at the lower of cost and net realizable value (LCNRV), a write-down of inventory due to shrinkage may be required.
- Invoices Received after Year-end – this relates to goods and services received from suppliers before the year-end date, but not yet recorded. For example, companies purchasing goods from a supplier close to the year-end date usually receive the goods with a packing slip that details the types and quantities of goods received as well as the total cost. Once the goods are received and verified, the entry to record the goods and recognize the accounts payable will occur with the packing slip and the company’s own purchase order being the source documents for the accounting entry. Recording entries relating to purchasing services, on the other hand, can be tricky since there is no packing slip involved when purchasing services. If the supplier providing the services does not leave an invoice with the purchaser as soon as the services have been completed, it will be sent at some later date, usually sometime during the following month of the new fiscal year. Keeping the books open for a time after the year-end date allows the company extra time to catch and record any significant transactions that are discovered during the next fiscal year that might otherwise be missed.
Any significant subsequent event that occurs after the fiscal year-end should be disclosed in the notes to the financial statements for the year just ended. An example might be where early in 2021 vandals damage some buildings and equipment. If the repair or replacement costs are material, these costs, though correctly paid and recorded in 2021, should be disclosed in the financial statements of 2020 if not yet published. This will ensure that the company stakeholders have access to all the relevant information.
3.2.2. Changes in Accounting Estimates, Changes in Accounting Policy, and Correction of Errors
Financial statements can be impacted by changes in accounting policies, changes in estimates, and correction of errors. These were first introduced in the introductory accounting course and will also be discussed in detail in the next intermediate accounting course. However, it is worth including a review at this time because they can significantly affect the financial statements.
Changes in Accounting Estimates
Accounting is full of estimates that are based on the best information available at the time. As new information becomes available, estimates may need to be changed. Examples of changing estimates would be changing the useful life, residual value, or the depreciation method used to match use of the assets with revenues earned. Other estimates involve uncollectible receivables, revenue recognition for long-term contracts, asset impairment losses, and pension expense assumptions. Changes in accounting estimates are applied prospectively, meaning they are applied to the current fiscal year if the accounting records have not yet been closed and for all future years going forward.
Changes in Accounting Policy
The accounting treatment for a change in accounting policy is retrospective adjustment with restatement. Retrospective application means that the company deals with the error or omission as though it had always been corrected.
Examples of changes in accounting policies are:
- Changes in valuation methods for inventory such as changing from FIFO to weighted average cost.
- Changes in classification, presentation, and measurement of financial assets and liabilities under categories specified in the accounting standards such as investments classified as fair value reported through net income (FVNI), amortized cost (AC), or fair value reported through OCI (FVOCI) (IFRS only). Details of these are discussed in the chapter on intercorporate investments, later in this text.
- Changes in the basis of measurement of non-current assets such as historical cost and revaluation basis.
- Changes in the basis used for accruals in the preparation of financial statements.
Management must consistently review its accounting policies to ensure they comply with the latest pronouncements by IFRS or ASPE and to ensure the most relevant and reliable financial information for the stakeholders. Accounting policies must also be applied consistently to promote comparability between financial statements for different accounting periods. For this reason, a change in accounting policy is only allowed under two conditions:
- due to changes in a primary source of GAAP
- applied voluntarily by management to enhance the relevance and reliability of information contained in the financial statements for IFRS. ASPE has some exceptions to this “relevance and reliability” rule to provide flexibility for changes from one existing accounting standard to another.
As a rule, changes in accounting policies must be applied retrospectively with restatement to the financial statements. Retrospective application means that the company implements the change in accounting policy as though it had always been applied. Consequently, the company will adjust all comparative amounts presented in the financial statements affected by the change in accounting policy for each prior period reported. Retrospective application reduces the risk of changing policies to manage earnings aggressively because the restatement is made to all prior years as well as to the current year. If this were not the case, the change made to a single year could materially affect the statement of income for the current fiscal year. A cumulative amount for the restatement is estimated and adjusted to the opening retained earnings balance of the current year, net of taxes, in the statement of changes in equity (IFRS) or the statement of retained earnings (ASPE). This will be discussed and illustrated later in this chapter.
Retrospective application of a change in accounting policy may be exempted in the following circ*mstances.
- A transitional provision of the changed standard allows the prospective application of a new accounting policy. Specific transitional guidance of IFRS or ASPE must be followed in such circ*mstances.
- The application of a new accounting policy regarding events, transactions, and circ*mstances that are substantially different from those that occurred in the past.
- The effect of the retrospective application of a change in accounting policy is immaterial.
- The retrospective application of a change in accounting policy is impracticable. This may be the case where a company has not collected sufficient data to enable an objective assessment of the effect of a change in accounting estimates and it would be unfeasible or impractical to reconstruct the data. Where impracticability impairs a company’s ability to apply a change in accounting policy retrospectively from the earliest prior period presented, the new accounting policy must be applied prospectively from the beginning of the earliest period feasible, which may be the current period.
The following are the required disclosures in the notes to the financial statements when a change in accounting policy is implemented:
- Title of IFRS or ASPE standard
- Nature of change in accounting policy
- Reasons for change in accounting policy
- Amount of adjustments in current and prior periods presented
- Where retrospective application is impracticable, the conditions that caused the impracticality (CPA Canada, 2011).
Changes Due to Accounting Errors or Omissions
The accounting treatment for an error or omission is a retrospective adjustment with restatement. For example, an accounting error in inventory originating in the current fiscal year is detected within the current fiscal year while the accounting records are still open. The inventory error correction is recorded as soon as possible to the applicable accounts. However, if the accounting records are already closed when the inventory error is discovered, the error is treated retrospectively. This means that the cumulative amount due to the inventory error would be calculated and recorded, net of taxes, to the current year’s opening retained earnings balance. If the financial statements are comparative and include previous year’s data, this data is also restated to include the error correction. This will be discussed and illustrated later in this chapter.
