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Change in estimate? Change in accounting principle? What it means · PwC's accounting podcast

• 0:00
  SPEAKER_02: Welcome to PwC's Accounting Podcast Series.
• 0:04
  SPEAKER_02: I'm Heather Horn.
• 0:05
  SPEAKER_02: Now that many calendar end companies have wrapped up their year in reporting, we're starting to turn our attention to accounting and reporting matters for first quarter.
• 0:14
  SPEAKER_02: One area where I know companies may have questions would be if they're contemplating changes in their accounting, potentially to adopt new guidance, or perhaps to change an accounting principle as their business evolves or to provide better information to their investors.
• 0:29
  SPEAKER_02: We have a lot of questions in this area, and I have popular guests Tom Barbieri and Pat Durbin back with me today to help answer all your questions.
• 0:41
  SPEAKER_02: So, Tom, Pat, thank you so much for joining me today to talk about a topic that I think is always a good thing to revisit at this time of year, which would be potential changes in accounting.
• 0:52
  SPEAKER_02: And I think for many of our listeners, they're either considering adopting new guidance, maybe because it's required, or otherwise changing their accounting principles because their business is evolving.
• 1:04
  SPEAKER_02: And so as we think about this topic, Pat, maybe I'll just kick things off with you and ask the question of give us some background and specifically why do we get so many questions in this area?
• 1:15
  SPEAKER_03: Sure.
• 1:15
  SPEAKER_03: And thanks for having me, Heather.
• 1:17
  SPEAKER_03: Um, accounting changes, and we probably will spend some time level setting on like what we're talking about there.
• 1:23
  SPEAKER_03: But we're starting a new year for, you know, sort of our traditional calendar year reporters.
• 1:28
  SPEAKER_03: And so it's the time when they're thinking about what's their financial plan look like for the year, as you alluded to.
• 1:34
  SPEAKER_03: Has my business evolved?
• 1:36
  SPEAKER_03: And should I be thinking about how to best reflect that in the financial statement?
• 1:39
  SPEAKER_03: So this is a time when we tend to get questions on thinking about changes in accounting, and there's some specific guidance we have to think through, but that's sort of the why now piece of it.
• 1:50
  SPEAKER_02: And then in terms of the different types of changes, can you kind of walk us through what we tend to see?
• 1:56
  SPEAKER_03: Just a level set on what we mean when we say a change in accounting.
• 2:00
  SPEAKER_03: There is a specific standard that talks about changes in accounting.
• 2:03
  SPEAKER_03: It's in the FASBE's codification uh section 250 or what we refer to as ASC 250.
• 2:10
  SPEAKER_03: It talks about three types of changes.
• 2:13
  SPEAKER_03: There's a change in accounting principle, which is essentially when you're choosing between two acceptable methods of presenting the same transaction under gap.
• 2:23
  SPEAKER_03: There's a change in accounting estimate, which is a different type of change and one that has more of a kind of an evolutionary feel to it.
• 2:32
  SPEAKER_03: You know, new information happens, so you have to change an estimate in response to that.
• 2:37
  SPEAKER_03: And then you might also have not usually a very happy topic to think about, but a correction of an error, which is also technically a change in accounting.
• 2:46
  SPEAKER_02: And Tom, could you give us some examples of the theories Pat just described?
• 2:51
  SPEAKER_01: So if you think about what a change in accounting policy might be, the one that everyone always talks about is changing your method of inventory costing from LIFO to FIFO, or another example would be changing the date in which you want to do your annual goodwill impairment test, right?
• 3:05
  SPEAKER_01: So those are sort of examples of changes in accounting principles.
• 3:08
  SPEAKER_01: You sort of contrast that to an estimate, right?
• 3:10
  SPEAKER_01: As you had mentioned before, it's when you're really incorporating new information into the measurement of an existing asset or liability.
• 3:16
  SPEAKER_01: And so that might be a contingent liability that you may have for litigation and there's new information, something's evolved in the case.
• 3:23
  SPEAKER_01: And so that would result in you actually recording that change, or you're refining a model for a fair value estimate because you believe that the way a market participant would look at it would be different.
• 3:33
  SPEAKER_01: So those are those examples.
• 3:34
  SPEAKER_01: And then you mentioned the maybe the depressing side of things, which is when we get to errors.
• 3:39
  SPEAKER_01: And so, you know, examples of that is when you've got information that was available that you either misapplied or you misinterpreted, or you just didn't include it.
• 3:48
  SPEAKER_01: And that could be a mathematical mistake, or you just didn't appropriately incorporate it into your estimate.
• 3:53
  SPEAKER_01: And so I think those are you know some of the examples of what I think Pat was talking to.
• 3:57
  SPEAKER_02: And then I think key point here, we'll come back a little bit more to talk about error, but Pat, you touched very briefly, but I just want to highlight is that we also have where you're changing accounting principles because you're adopting a new standard.
• 4:09
  SPEAKER_02: And again, it's very typical of this time of year.
• 4:12
  SPEAKER_02: But given the fact that the ASUs typically tell us how we're supposed to do that and what the transition provisions, et cetera, look like, I think we won't focus on that further today, but just wanted to mention that is another one.
• 4:26
  SPEAKER_02: But focusing on the two that you guys highlighted, the change in accounting estimate and change accounting principle.
• 4:32
  SPEAKER_02: Pat, maybe starting with the change in accounting principle, what does that assessment look like?
• 4:37
  SPEAKER_03: When we talk about a change in accounting principle, as I mentioned, it's a situation where there is more than one acceptable way to account for the same transaction in GAAP.
• 4:47
  SPEAKER_03: And there's a specific provision in GAAP that says you are allowed to change from one acceptable principle to another, as long as you can justify that that change is preferable.
• 4:58
  SPEAKER_03: And that's an important concept, and we'll talk about what that means.
• 5:02
  SPEAKER_03: But assuming that you can then justify that change as preferable, you can change the manner in which you report that same transaction.
• 5:11
  SPEAKER_03: So, one I deal with all the time, one of the examples that Tom gave is changing your method of inventory costing.
• 5:17
  SPEAKER_03: One of the types of change we see pretty frequently is a lot of companies historically applied LIFO or the last in, first out method of inventory costing.
• 5:26
  SPEAKER_03: That's a complicated way to do inventory accounting, sort of counterintuitive, requires a lot of record keeping.
• 5:32
  SPEAKER_03: And in a period where costs in many cases are going down andor relatively flat, there's not a lot of advantages to applying LIFO.
• 5:42
  SPEAKER_03: So there's a really good like rationale for why you might want to change from LIFO to some other method.
• 5:48
  SPEAKER_03: So we deal with that all the time.
• 5:49
  SPEAKER_03: And so we have to think through okay, well, why is that preferable?
• 5:53
  SPEAKER_03: Now you'd say, well, if they're both acceptable, like why is any one accounting principle preferable?
• 5:59
  SPEAKER_03: There are some specific considerations that actually the SEC and one of their staff accounting bulletins has sort of talked about what constitutes a preferable method of accounting.
• 6:10
  SPEAKER_03: A lot of it comes down to ultimately what provides better information to the users of the financial statements.
• 6:17
  SPEAKER_03: That's sort of the threshold question when you're thinking about preferability.
• 6:20
  SPEAKER_03: It's not what's easier for me or what makes it seem more straightforward to do the accounting.
• 6:28
  SPEAKER_03: It's really thinking about what's better for the user.
• 6:32
  SPEAKER_02: So I think, Pat, that's a really good point because a lot of times, because the guidance comes from, as you said, this SEC guidance, I think there's a conception or misconception that private companies don't have to consider preferability and are able to just make a change.
• 6:49
  SPEAKER_02: And so how do we think about that in terms of whether I'm a public or a private company, this is an important consideration.
• 6:57
  SPEAKER_03: Yeah, actually, I'm glad you brought that up, Heather.
• 6:58
  SPEAKER_03: That's a great point because a lot of people think about the SEC's rules, which actually, if you're an SEC registrant and you make a change, you're actually required to obtain a preferability letter from your auditor.
• 7:10
  SPEAKER_03: And so sometimes people think, well, that's the only time the preferability is relevant.
• 7:15
  SPEAKER_03: In fact, as you alluded to, it's in the accounting standard, the ASC 250 that we talked about, which applies to public and private companies, that the entity has an obligation to justify that the accounting is preferable, notwithstanding the need for this separate letter from the auditor.
• 7:32
  SPEAKER_03: So it is important to think about regardless of whether you're a public company or a private company.
• 7:37
  SPEAKER_02: Okay, so Pat, I think it's helpful, but I know we hit at a high level what we should think about for preferability and preferability letters, but I know there's a lot more detail that we go into.
• 7:48
  SPEAKER_02: So what are some of those key considerations that the company should think about when it's making its assessment?
• 7:54
  SPEAKER_03: Yeah, so again, I think I would preface it with this overriding concept that you should be thinking about it through the lens of the reader of the financial statement or the user, right?
• 8:03
  SPEAKER_03: That's really got to be central to this discussion.
• 8:06
  SPEAKER_03: The only place where there's really an articulation of specific things that you might consider for preferability, as I mentioned in the SEC staff accounting bulletins, it's actually uh Sab Topic 6G, is where there is some specific consideration of things to consider.
• 8:25
  SPEAKER_03: It's specific to the context that we're talking about where the authoritative literature has not expressed a preference.
• 8:31
  SPEAKER_03: And while there are a very small number of cases, there are a couple of cases where the authoritative literature actually expresses a preference.
• 8:40
  SPEAKER_03: So we're not talking about those.
• 8:41
  SPEAKER_03: This is when we really have nothing to work with other than knowing that both things or more than one thing is potentially acceptable.
• 8:49
  SPEAKER_03: And so you should be really thinking about what the impact of the accounting is in relation to sort of the general economic conditions that the company is facing.
• 9:00
  SPEAKER_03: So I mentioned in the context of the inventory costing, one thing you might think about is in an inflationary environment, there's a material difference between using the last in first out method for inventory versus the first in first out method.
• 9:14
  SPEAKER_03: So in a period of relatively stable prices, you might say less of an impact.
• 9:18
  SPEAKER_03: In a situation where maybe there's more emphasis on a company's balance sheet because they're perhaps not a very liquid company or there's a potential risk of bankruptcy, you might think, well, having more current values on the balance sheet, all other things being equal, would be more preferable than having old balances.
• 9:39
  SPEAKER_03: So like that would be a good argument for why moving off of LIFO to FIFO might make a lot more sense.
• 9:45
  SPEAKER_02: So, Pat, I think what you're saying there then is that sometimes timing can matter because potentially, depending on the external circumstances, there could be periods where we'd say, yes, it could be preferable at this point to make this change versus in other circumstances the same change wouldn't necessarily qualify as preferable.
• 10:07
  SPEAKER_02: Is that a fair summary of what you just said?
• 10:09
  SPEAKER_03: I think that is fair.
• 10:10
  SPEAKER_03: The one thing I would just highlight is this is a sort of a long-term proposition, right?
• 10:16
  SPEAKER_03: The general premise is financial reporting is better when it's done on a consistent basis over time, period to period, so there's good comparability.
• 10:25
  SPEAKER_03: So this is not something that you should be thinking about.
• 10:27
  SPEAKER_03: Well, this year I'm gonna pick this accounting policy, next year I'm gonna pick another one.
• 10:32
  SPEAKER_03: So we're talking about sort of a long-term horizon when we think about these things, that we should really be thinking about has there been sort of a shift such that my expectation about the long-term outlook for this business has changed, not just a very current, what does the next six to 12 to 18 months look like?
• 10:52
  SPEAKER_02: Okay, so then Pat, I think that's an important consideration.
• 10:55
  SPEAKER_02: But one question is that I know often when we're thinking about preferability, a key point in that is the business judgment and perhaps how the company is thinking about its business.
• 11:06
  SPEAKER_02: And so, how do you consider that if you're assessing preferability?
• 11:10
  SPEAKER_03: That's an interesting one.
• 11:11
  SPEAKER_03: And in some ways, it's sort of the catch-all, meaning, like there's not a clear indication from maybe the pure user perspective of what's more preferable.
• 11:22
  SPEAKER_03: But when I think about how I'm running my business, when I think about how I want to translate my results again within the confines of GAP, that's really where this notion of business judgment and planning come in.
• 11:34
  SPEAKER_03: And I think does give some degree of latitude to the registrant or to the company to say this is, in my judgment, a better reflection of the economics of my business.
• 11:45
  SPEAKER_03: Again, you have to keep a little bit of that external lens on it, but I think it's a fairly broad consideration that does give some degree of latitude to the registrant.
• 11:56
  SPEAKER_02: But then, Pat, it all that almost makes it sound like if I think it's a better reflection, I can make a change.
• 12:05
  SPEAKER_02: And I know that is not the case.
• 12:06
  SPEAKER_02: So, how do we think about that?
• 12:08
  SPEAKER_03: Yeah, I think you still have to calibrate that back to some of the things that are important in financial reporting.
• 12:15
  SPEAKER_03: So, what are users focused on?
• 12:16
  SPEAKER_03: Are they focused on having more current values on the balance sheet?
• 12:21
  SPEAKER_03: What are your peers doing?
• 12:22
  SPEAKER_03: That's a very relevant consideration.
• 12:25
  SPEAKER_03: So, who do you identify as your peers for competing for capital?
• 12:30
  SPEAKER_03: And how are they reporting similar transactions?
• 12:33
  SPEAKER_03: I think those are probably two key things that you want to think about.
• 12:36
  SPEAKER_02: So it sounds like it's it fair to say that if I'm, you know, again, I have an accounting principle that there are two acceptable methods and I would like to change, you cannot do that sort of willy-nilly, like, oh, this year I want to make this change, it's easier, you know, sort of those types of superficial reasons.
• 12:56
  SPEAKER_02: But as a company, if I can really conclude that perhaps it's more prevalent in my industry, it's a better reflection of my business, and there's true substance, that's a point in time that it may make sense to make this type of change.
• 13:10
  SPEAKER_03: Yeah, and importantly, just as you were describing that, these are voluntary.
• 13:15
  SPEAKER_03: Like the presumption is you will continue to apply the same accounting policies indefinitely.
• 13:20
  SPEAKER_03: So there's never an obligation absent a change in gap to change these policies.
• 13:25
  SPEAKER_03: It's only if you believe, one, you want to, and two, you can justify the change is preferable.
• 13:31
  SPEAKER_03: So it's just as you reflect on the evolution of the business, what your peers are doing, those sorts of things that might be a reason for thinking about a change.
• 13:41
  SPEAKER_01: Yeah, and I would agree with that, Pat.
• 13:42
  SPEAKER_01: My observation would be if someone was really going to change their fundamental business, you could look at what their future peers are going to be and do an analysis around what's important for the users of those peers.
• 13:51
  SPEAKER_02: And then I guess this point we can't really emphasize enough that this is not a case that the company should be going to their external auditor and saying, you know, hey, can I make this change?
• 14:03
  SPEAKER_02: You know, do you think it's preferable?
• 14:05
  SPEAKER_02: Because this really does start with does the company think it's preferable?
• 14:09
  SPEAKER_02: Can they make their case?
• 14:10
  SPEAKER_02: And then, you know, that conversation with the independent accountant would happen after the company's made its assessment.
• 14:17
  SPEAKER_03: Yeah, I would say that's actually a common misconception because there is this SEC requirement that the independent auditor provide a preferability letter.
• 14:25
  SPEAKER_03: And in fact, it's really the company's obligation, like everything with the SEC, for them to file their financial statements.
• 14:31
  SPEAKER_03: And if they report a change, one of their obligations is to obtain from their auditor a preferability letter, which they file as an exhibit to their financial statements or their 10Q or 10K, whatever the sort of relevant filing is.
• 14:46
  SPEAKER_03: It's not, as you know, the auditor's primary responsibility to decide whether it's preferable.
• 14:52
  SPEAKER_03: They're just simply affirming that.
• 14:54
  SPEAKER_02: So, Tom, let me go to you with a question because we've talked about changes in your financial statements, and it almost makes it seem like anytime there's a change in your financial statements, you have to go through this preferability assessment.
• 15:07
  SPEAKER_02: But are there cases we see changes that wouldn't be called a change in accounting principle?
• 15:13
  SPEAKER_01: Sure, Heather.
• 15:13
  SPEAKER_01: I think there's a few.
• 15:14
  SPEAKER_01: Probably the most obvious is when you initially select an accounting policy.
• 15:18
  SPEAKER_01: So an event or a transaction's occurred in which you're for the first time electing an accounting policy.
• 15:24
  SPEAKER_01: An example of that would be you're selecting for the first time when your goodwill impairment date will be because you just executed a transaction, you're recording goodwill for the first time.
• 15:33
  SPEAKER_01: Another one is when you do an acquisition and you're actually having the acquireree conform their accounting policies to you as purchaser of the acquirer's books, right?
• 15:43
  SPEAKER_01: So oftentimes we see that people go through that process, you don't need to really worry about preferability there.
• 15:48
  SPEAKER_01: However, if it's the flip side in which the acquirer wants to conform to the acquiree's accounting policy because they realize that that's for whatever reason, more preferable and a better reporting for them, you would have to go through that preferability assessment, sort of contrast both sides of that.
• 16:03
  SPEAKER_01: And then probably the third is you've adopted a new accounting policy or amended your accounting principle, if you will, as a result of changes in the transactions or events that are different in substance from what you've done previously.
• 16:16
  SPEAKER_01: For example, you've changed contractual relationships and terms and conditions that you have relative to some of the revenue transactions you have.
• 16:23
  SPEAKER_01: And as a result, going forward, you need to report those on a net basis where previously you reported them on a gross basis.
• 16:29
  SPEAKER_01: So that would be another example, things evolving over time.
• 16:32
  SPEAKER_01: So I think those are probably the most common ones.
• 16:34
  SPEAKER_03: So maybe if I could just jump in there, Tom, you mentioned the acquisition scenario, and I think that's an important one because we we do see that quite frequently.
• 16:42
  SPEAKER_03: And just to remind people, the expectation is that the acquiring company will conform the policies of the acquired company to their accounting for the similar transactions.
• 16:54
  SPEAKER_03: And it is important to focus on that in the period of the acquisition because if you wait and leave the acquired company's policies intact and they're different than the acquiring company's, you're gonna need to answer the question: well, are those transactions of the acquired company sufficiently different that I can justify a different accounting policy?
• 17:16
  SPEAKER_03: Or did I potentially miss the need to conform those policies and now I'm gonna have to deal with an error, which is never a happy topic.
• 17:25
  SPEAKER_03: Similarly, once they sort of pass that window, assuming that it wasn't an error, then anything they want to do with the acquired company's policies prospectively is going to be subject to this preferability discussion.
• 17:37
  SPEAKER_03: So it there is a timing or a timeliness aspect that needs to be considered.
• 17:42
  SPEAKER_02: Yeah, Pat, I think that's a great point and one that often gets sort of lost in the, you know, there's so much else to do with purchase accounting.
• 17:51
  SPEAKER_02: So I think that's a a great reminder and something for companies to think about because I know from personal experience that you don't want to leave that, you know, too late in the process.
• 18:01
  SPEAKER_02: So with this sort of framework then, or those overall thoughts on preferability, let's assume I've gotten over my hurdle that I'm making a change, it's a change in accounting principle and it is preferable.
• 18:16
  SPEAKER_02: Then, Tom, how do I think about the accounting?
• 18:19
  SPEAKER_01: So generally, whenever you have a change in accounting principle, you would apply it on a retrospective basis, right?
• 18:24
  SPEAKER_01: And I'll get to a couple of examples where you're not required to do that, if it's impractical or it's immaterial.
• 18:29
  SPEAKER_01: But what does retrospective mean?
• 18:30
  SPEAKER_01: Well, that effectively means you go back in time and basically fix all the accounts to what they would have been had you always followed that accounting policy.
• 18:38
  SPEAKER_01: And that generally involves like a two-step process.
• 18:41
  SPEAKER_01: So think about a case in which you're a public company.
• 18:43
  SPEAKER_01: What you're really gonna go do is you're going to go back to the earliest period presented and sort of true up your balance sheet and equity amounts for what they would have been had you always followed the accounting policy.
• 18:54
  SPEAKER_01: And that's going to result in an offsetting entry to retained earnings.
• 18:57
  SPEAKER_01: So not the PL, but to retained earnings.
• 18:59
  SPEAKER_01: And then going forward each period, you'll present the financials following that accounting policy.
• 19:04
  SPEAKER_01: Okay.
• 19:04
  SPEAKER_01: So it's pretty straightforward.
• 19:06
  SPEAKER_01: Now, the hard part about it is making sure that you take into account all the knock-on or direct effects from adopting that accounting policy.
• 19:13
  SPEAKER_01: So what does it do to your income tax balances, right?
• 19:17
  SPEAKER_01: What does it do to other accounts that might be affected as a result of that change in accounting policy?
• 19:22
  SPEAKER_01: For example, let's say you're you've altered your accounting policy and it's going to result in a change to the actual carrying amount of long-lived assets that you have.
• 19:30
  SPEAKER_01: If those assets were previously impaired, the amount of the impairment might change now as a result, right?
• 19:35
  SPEAKER_01: So it's those knock-on effects you really need to think about.
• 19:38
  SPEAKER_01: Now, the standard does uh talk about indirect effects, which you don't have to account for.
• 19:44
  SPEAKER_01: And the classic example is if you true up your prior year's net income as a result of adopting the accounting policy, and it results in an additional bonus that has to get paid to your employees, that would be an indirect effect, which you don't record on a retrospective basis, but rather you record it into the current period.
• 20:01
  SPEAKER_01: It's a nuance, right?
• 20:02
  SPEAKER_01: And the way I like to think about that nuance is if as a result of changing my accounting policy, I'm gonna have to write a check, right?
• 20:10
  SPEAKER_01: Or render over an asset or what have you, that's gonna be an indirect effect that you'd actually record to the current period.
• 20:17
  SPEAKER_01: So it's an important nuance to take into account there.
• 20:20
  SPEAKER_03: Yeah, and I think I I just maybe highlight that, Tom, that like it's not an option, right?
• 20:24
  SPEAKER_03: I mean, it's their indirect effects, but they're they're current period transactions, as you know it.
• 20:28
  SPEAKER_03: And maybe just I know you mentioned one of the classic direct effects is the income tax consequences.
• 20:35
  SPEAKER_03: Certainly as it relates to the pure impact on current deferred taxes for that period.
• 20:41
  SPEAKER_03: Presumably it's mostly deferred taxes because we're likely changing the measure of an asset or liability.
• 20:47
  SPEAKER_03: That's a direct effect.
• 20:48
  SPEAKER_03: If you said, well, gee, my results don't look as good.
• 20:52
  SPEAKER_03: Maybe I'd had a different view of my valuation allowance.
• 20:55
  SPEAKER_03: That's one of these indirect effects that we would say, well, that's, you know, we're not rewriting history here, right?
• 21:00
  SPEAKER_03: We had a judgment about that asset at that point in time.
• 21:04
  SPEAKER_03: We're not going to go change that.
• 21:05
  SPEAKER_03: We're going to change the direct measure of the deferred tax asset or liability.
• 21:09
  SPEAKER_03: We're not going to reassess our judgment about the valuation allowance, for example.
• 21:15
  SPEAKER_01: Yeah.
• 21:15
  SPEAKER_01: So you could see that going back on a retrospective basis requires a lot of work, right?
• 21:19
  SPEAKER_01: Now, there are two exceptions.
• 21:21
  SPEAKER_01: The first is what's referred to as the impractability exception.
• 21:24
  SPEAKER_01: It's a tough exception to apply, okay?
• 21:27
  SPEAKER_01: And and if so, if you apply this exception, you don't have to go back.
• 21:31
  SPEAKER_01: And I'll come back to how what you would do in a second.
• 21:34
  SPEAKER_01: But to invoke it, you really need to meet one of the three criteria.
• 21:38
  SPEAKER_01: The first is you're just unable to apply it after making every reasonable effort to do so.
• 21:44
  SPEAKER_01: This is what I would call the information out.
• 21:46
  SPEAKER_01: Like I just don't have the information to go back in time.
• 21:49
  SPEAKER_01: I think it's really hard to squeeze into that one.
• 21:51
  SPEAKER_01: At least that we we found in practice it's really hard.
• 21:54
  SPEAKER_01: The second two, really focus on um assumptions.
• 21:59
  SPEAKER_01: And the first is around.
• 22:00
  SPEAKER_01: Around management's intent.
• 22:02
  SPEAKER_01: So you're trying to go back in time and assess management's intent.
• 22:09
  SPEAKER_01: And in cases in which you can't independently substantiate intent, right?
• 22:15
  SPEAKER_01: You can't audit it.
• 22:16
  SPEAKER_01: That would be a case where you can invoke it.
• 22:18
  SPEAKER_01: And then lastly, it revolves around significant estimates of amount.
• 22:22
  SPEAKER_01: And it's impossible to objectively provide evidence of circumstances that existed or were available at that date.
• 22:28
  SPEAKER_01: So you just can't go back in time and actually come up with a an accurate estimate.
• 22:33
  SPEAKER_01: Again, in practice, we see it's rarely invoked, rarely applied.
• 22:37
  SPEAKER_01: I think there's an explicit notion and gap that you could do it when you go from FIFO to LIFO because you you won't have all the requisite records to go back and do it.
• 22:46
  SPEAKER_01: But if you're thinking about it, which basically no one ever does.
• 22:49
  SPEAKER_01: Right.
• 22:49
  SPEAKER_01: No one, that's exactly right.
• 22:50
  SPEAKER_01: No one really does.
• 22:51
  SPEAKER_01: The the other thing I would say is even if you are able to argue one of these three, the standard does require you to go back to the earliest period in which it is practical.
• 23:01
  SPEAKER_01: So you might not be able to go all the way back, but maybe you can go back five years.
• 23:05
  SPEAKER_01: And so it's not really getting you that much at the end of the day, and there's still a lot of work to do.
• 23:09
  SPEAKER_01: I think the one that we see more frequently is just materiality, right?
• 23:12
  SPEAKER_01: That you can argue it's immaterial.
• 23:14
  SPEAKER_01: Now, when you think about immaterial, you need to think about the effect on previously issued financial statements and to argue that that's immaterial to all the previous issued financial statements, right?
• 23:24
  SPEAKER_01: That's that's the first part of the step.
• 23:26
  SPEAKER_01: The second part is you still need to record the effect into the current period.
• 23:30
  SPEAKER_01: You need to make sure that uh recognition of that effect in the current period doesn't create a distortion into the current period, thereby basically rendering it material to the current period, which would still force you to go back and restate.
• 23:44
  SPEAKER_01: So that's kind of the considerations for that second hour.
• 23:46
  SPEAKER_01: We do see that invoked a lot.
• 23:48
  SPEAKER_02: Well, I guess, Tom, for that um latter point you made, that is probably a good example of a time a company might think about wanting to change principles that maybe historically a type of transaction's been immaterial, it hasn't been a big focus, now it's becoming more material.
• 24:03
  SPEAKER_02: And at that point, as you're making this reassessment and saying, oh, actually this other method is preferable back to the conversation we were having earlier.
• 24:13
  SPEAKER_01: Exactly.
• 24:13
  SPEAKER_01: And some companies want to get ahead of it before it gets material, right?
• 24:16
  SPEAKER_01: So they sort of see that these transactions are going to become more significant for the entity.
• 24:20
  SPEAKER_01: They want to adopt accounting policy, get it behind them, they could absorb it into the current period based upon the immaterial exception and is move forward.
• 24:26
  SPEAKER_01: I would agree with that.
• 24:27
  SPEAKER_03: Yeah, so I just was gonna jump in, Tom, maybe on that point you made on uh materiality, and just as a point of emphasis, gap for reporting a change in accounting is to retrospectively adjust the financial statement.
• 24:41
  SPEAKER_03: So that is always an option.
• 24:43
  SPEAKER_03: The option, if you will, is that in the case where it isn't material, as you alluded to, you have this ability to avoid retrospective application.
• 24:52
  SPEAKER_03: But you can theoretically retrospectively adjust it even if you happen to judge it immaterial.
• 24:58
  SPEAKER_03: That's still an option.
• 24:59
  SPEAKER_03: Because a lot of times the reasons why people want to report a change in accounting is they feel like it's a better reflection of the business.
• 25:06
  SPEAKER_03: They want that consistent track record, they want to be able to talk about the trends on a consistent basis.
• 25:12
  SPEAKER_03: So, yeah, while it somehow simplifies the retrospective application, it could complicate your ability to communicate the trends in the business because you've got this sort of out-of-period item coming through.
• 25:24
  SPEAKER_01: Yeah, I'd agree, Pat.
• 25:25
  SPEAKER_01: We've definitely seen cases where people have gone ahead and chosen to do that because they want to sort of establish good comparability going forward as well.
• 25:31
  SPEAKER_01: So yeah, I would agree that is a good option.
• 25:33
  SPEAKER_02: And if I think about all the work involved and what the two of you just talked about, I think it's a good reason to highlight why we see this more frequently happening in Q1, if possible, just given that it's hard enough to do retrospective application at the beginning of the year.
• 25:48
  SPEAKER_02: And then, you know, for if you get into the middle of the year, obviously that's even further complicated.
• 25:53
  SPEAKER_02: So just something to think about, because definitely a lot of work here.
• 25:56
  SPEAKER_03: It's interesting you raise that, Heather, because we we didn't cover it really, but there is actually a concept, or it's it's actually mentioned in ASC 250 that ordinarily you would report these changes in accounting, these voluntary changes during the first interim period.
• 26:13
  SPEAKER_03: It's not a prohibition to doing it later in the year, but there's sort of this notion that you don't want to end up in a situation where you're reporting your first, second, maybe even your third quarter on one method of accounting, and then all of a sudden in the fourth quarter saying, Oh, you know what, I want to change the way I'm reporting things.
• 26:31
  SPEAKER_03: Now you've got to go back and redo those quarters.
• 26:34
  SPEAKER_03: You start to raise the question of, well, what confidence do I have in those quarters?
• 26:39
  SPEAKER_03: You know, even if they were gap, why the change late in the year?
• 26:43
  SPEAKER_03: There is also another dynamic that depending on where you are in thinking about going to the capital markets to raise capital, you have to think about the implications on your historical financial statements that are available, say, for example, in a shelf registration, those need to be current.
• 27:00
  SPEAKER_03: And if you change your accounting that would require retrospective application, but you haven't yet produced those retrospectively adjusted financial statements, you could end up in a situation where your financial statements included in your securities offering need to be updated so it could have an impact on the timing of when you can go to the market.
• 27:21
  SPEAKER_02: Wow.
• 27:22
  SPEAKER_02: So definitely a lot to think about there.
• 27:23
  SPEAKER_02: I think that's a good reminder, Pat.
• 27:25
  SPEAKER_02: So then, Tom, I'm thinking about all of these changes you just talked about and retrospective application, et cetera.
• 27:33
  SPEAKER_02: So I think it goes without saying disclosure will be important if you decide uh to make one of these changes.
• 27:39
  SPEAKER_01: Yeah, absolutely.
• 27:40
  SPEAKER_01: There's there are specific disclosure requirements that are included in the standard, things like the nature and the reason for the change, why the company believes it's preferable, right?
• 27:49
  SPEAKER_01: So actually putting in the reason as to why you believe it's preferable.
• 27:52
  SPEAKER_01: The method of applying the change, which as we discussed, is generally retrospective, right?
• 27:56
  SPEAKER_01: As well as showing the effects on the prior period uh financial statement line items.
• 28:00
  SPEAKER_01: And so generally people will actually include a table, which actually has all the old numbers and shows how they've been adjusted as a result of adopting the accounting policy.
• 28:10
  SPEAKER_01: Generally speaking, disclosures don't need to be repeated in subsequent period financial statements.
• 28:14
  SPEAKER_01: However, if prior periods are not retrospectively adjusted as a result of the impracticability exception, for example, the disclosure should be included in subsequent periods until all the periods uh presented are prepared using the same principle.
• 28:28
  SPEAKER_01: And then even when financial statements are retrospectively adjusted, there's a requirement to disclose the effects of the change on the current period.
• 28:36
  SPEAKER_01: So what the effective financial statements amounts would have been if the old policy had been continued.
• 28:41
  SPEAKER_01: And again, this is a a bit of a sleeper and it has some systems and control considerations as you as you make that adoption.
• 28:47
  SPEAKER_02: So definitely not something to leave till the very end of your process to start all this.
• 28:52
  SPEAKER_01: No, I mean, I I think overall, right, you really got to get ahead of these accounting changes.
• 28:56
  SPEAKER_01: They do require a lot of work, right?
• 28:58
  SPEAKER_01: So, you know, you need to talk to your auditor around your preferability assessment, right, to make sure that they're on board.
• 29:04
  SPEAKER_01: Uh, think about whether or not you're actually going to have to file a preferability letter.
• 29:08
  SPEAKER_01: Again, you got to get ahead of the disclosures.
• 29:10
  SPEAKER_01: If you're going to make a materiality call, you need to get in front of materiality and how you're doing your assessment of materiality, make sure it's appropriate.
• 29:18
  SPEAKER_01: Thinking about the knock-on effects of adoption, like we had talked about before, right?
• 29:22
  SPEAKER_01: What other accounts could be impacted as a result of the accounting policy is not easy.
• 29:25
  SPEAKER_01: Getting all the disclosures.
• 29:27
  SPEAKER_01: And then probably the worst part actually is thinking about how you're going to change your mDNA if you're a public company or your uh financial supplement and making sure that you're reflecting all the changes in your financial supplement.
• 29:38
  SPEAKER_01: And obviously, analysts want to see that information and they want to get it as early as possible so that they can incorporate that into their models.
• 29:44
  SPEAKER_01: And so if you're reflecting in the first quarter, for example, that might be good, but they want to see the prior year's financials revised and get those out in a supplement as well.
• 29:54
  SPEAKER_01: So you really need to coordinate with your investor relations group and make sure that everyone's on board with what's going to be the result of the change and all the steps that need to be undertaken.
• 30:02
  SPEAKER_01: So it's it is a lot of work.
• 30:04
  SPEAKER_02: Yeah, almost sounds like we're discouraging it, but I think what we're saying is you just need to be thoughtful, make sure you really have a reason to do this, you have a good reason to do it, and then to make sure you have the right process in place if you are contemplating one of these.
• 30:19
  SPEAKER_01: Absolutely.
• 30:20
  SPEAKER_02: All right.
• 30:20
  SPEAKER_02: So then let me go back to something we talked about at the very beginning, which we talked about changes in accounting principle, but we also talked about cases where an entity may conclude that they only have a change in estimate.
• 30:32
  SPEAKER_02: So, first of all, what do we mean when we say change in estimate?
• 30:36
  SPEAKER_02: And then how do we think about that?
• 30:37
  SPEAKER_02: And Pat, I'll go back to you for that question.
• 30:40
  SPEAKER_03: Yeah, sure.
• 30:40
  SPEAKER_03: And I think Tom kind of teed it up when we were going through the different types of changes, but as we probably all appreciate, preparing financial statements includes lots of estimates about things that haven't actually happened.
• 30:56
  SPEAKER_03: We're trying to estimate the outcome of a particular uncertain condition.
• 31:01
  SPEAKER_03: It could be something we're actually estimating fair value for, so that's a could be a financial asset of some sort, could be some sort of an intangible, that's an estimate.
• 31:11
  SPEAKER_03: Contingent liabilities, very classic example of an accounting estimate.
• 31:16
  SPEAKER_03: And by definition, we know that facts will change, information will change, new information will become available, economic events will change, all of those things can affect that accounting estimate.
• 31:30
  SPEAKER_03: And so the notion is well, as long as you properly considered all the facts and information that was available to you at a particular balance sheet date, at a later balance sheet date, when all that new information is now available, you're going to revise that estimate.
• 31:45
  SPEAKER_03: So you change that estimate.
• 31:47
  SPEAKER_03: That is a current period change in accounting.
• 31:50
  SPEAKER_03: It's a change in accounting estimate reflected in the current period.
• 31:53
  SPEAKER_03: So there's no, oh, I'm going to go back and pretend that that should have been my estimate and retrospectively adjust it.
• 31:59
  SPEAKER_03: I'm going to account for that prospectively.
• 32:01
  SPEAKER_03: So that's really the key distinction between the change in accounting principle where you're essentially saying, I don't have any new information.
• 32:09
  SPEAKER_03: I've just decided there's a different way to account for this thing.
• 32:12
  SPEAKER_03: So I'm going to present that different way all along versus in a change in estimate scenario, it's the same thing.
• 32:20
  SPEAKER_03: It's just I have new information, better information now to reflect that estimate.
• 32:26
  SPEAKER_01: Yeah.
• 32:26
  SPEAKER_01: And probably the bigger challenge is distinguishing a change in estimate from an error, which we mentioned before.
• 32:31
  SPEAKER_01: And I think where I run into this a lot is in cases in which the measurement model that you're applying to an asset or liability, you're using a model.
• 32:40
  SPEAKER_01: And along the way, the model might become more sophisticated, right?
• 32:44
  SPEAKER_01: And you might include other elements to your models.
• 32:47
  SPEAKER_01: And it begs the question, like why and why now?
• 32:51
  SPEAKER_01: The question was, were you aware of that model limitation in prior periods and thought it was immaterial?
• 32:57
  SPEAKER_01: And did you have a basis for that?
• 32:58
  SPEAKER_01: Or is it something you didn't contemplate?
• 33:01
  SPEAKER_01: It's those types of questions I think you really need to answer and be able to defend why you believe it's a change in estimate rather than error.
• 33:07
  SPEAKER_01: And that's sort of the real difficult analysis.
• 33:10
  SPEAKER_02: And but I think to that point, Tom, and I know we've all been involved in working with clients on this, you don't want to say, okay, but don't make the change because you're going to have to answer those questions.
• 33:22
  SPEAKER_02: Like if you do get more information and you can make your models better, then yes, please do that.
• 33:27
  SPEAKER_02: But it's just you need to be thoughtful once again.
• 33:30
  SPEAKER_01: I agree with that, Heather.
• 33:31
  SPEAKER_01: The other observation I would have is if you're using a model now and you've got known deficiencies in the model, like it doesn't contemplate for X, Y, and Z, and you believe the effects of that are immaterial.
• 33:40
  SPEAKER_01: Make sure you document that contemporaneously when you're doing that assessment now and defending why you believe that's the case.
• 33:46
  SPEAKER_01: I think that helps with your story around why and why now down the road when you're actually employing those changes to your models.
• 33:53
  SPEAKER_03: Yeah, maybe the other thing, and it's always a little tricky, you don't want to double down on this topic that's not very fun to talk about.
• 34:01
  SPEAKER_03: But I think it is important to really focus when you're making an estimate that a lot of times there's a lot of information you might need.
• 34:09
  SPEAKER_03: It might be hard to get at some of that information, but that doesn't mean you can just wait until you get it, right?
• 34:16
  SPEAKER_03: You have an obligation to gather all the good information you have available to you to inform that estimate.
• 34:23
  SPEAKER_03: And if you find out later that there was information available to you that you didn't properly consider, that's not a change in estimate.
• 34:32
  SPEAKER_03: That means you really should have had that information included in the estimate you made at an earlier date, and that might be indicative that you have have an error.
• 34:41
  SPEAKER_03: Agreed.
• 34:42
  SPEAKER_02: And I think that's a perfect lead-in, then for all of this, a huge focus should be controls.
• 34:48
  SPEAKER_02: So, I mean, we we always know the controls are important, but I think even more so when you start dealing with questions like estimates, change in accounting principle, errors.
• 34:58
  SPEAKER_02: If you had the right controls in place, and Tom, to the point you made, if you had good contemporaneous documentation, that often can make these future discussions a lot easier.
• 35:08
  SPEAKER_02: So just even, you know, if nothing else for our listeners, I think Q1 is always a good time to shore up documentation, rethink things.
• 35:16
  SPEAKER_02: So I just make that pitch right now as companies are thinking about Q1.
• 35:21
  SPEAKER_03: Yeah, and in theory, you have the most runway ahead of you, right?
• 35:24
  SPEAKER_03: You've got uh another good uh 12 months until you have to issue an audited set of financial statements anyway.
• 35:30
  SPEAKER_02: Yes, excellent point, Pat.
• 35:31
  SPEAKER_02: So then with that, why don't we wrap up with some final reminders?
• 35:35
  SPEAKER_02: So any final thoughts for our audience?
• 35:37
  SPEAKER_01: I guess the first would be is look, this is all about a judgment.
• 35:40
  SPEAKER_01: So really understanding what your facts are and laying against the model around is it a policy change or is it a change in estimate is really going to come down to the judgments and making sure you're doing a thorough assessment.
• 35:51
  SPEAKER_01: And to your point, if you're gonna make a change, get ahead of it.
• 35:54
  SPEAKER_01: There's a lot of work to be done, and it a lot of these knock-on effects take more time than people realize when they're originally contemplating a change in accounting policy.
• 36:01
  SPEAKER_01: Those would be my observations.
• 36:03
  SPEAKER_03: Yeah, and I think the point you made earlier, Tom, about the engagement with the investor relations team is is critical, right?
• 36:10
  SPEAKER_03: Because a lot of this, especially if we're talking about the voluntary changes, it really does come down to how are you rendering your business in the eyes of the user.
• 36:19
  SPEAKER_03: So getting that input and sort of making sure that all those downstream implications of what it does to your mDNA, all the other trend commentary is really a critical part of the, I think, decision process, honestly, on whether you think a voluntary change makes sense.
• 36:36
  SPEAKER_02: All right, very helpful both.
• 36:38
  SPEAKER_02: Just to wrap things up today, shift gears to a lighter note.
• 36:41
  SPEAKER_02: And as we're doing this for Q1, what is top of mind for me is that it's almost spring, which I personally am very much looking forward to.
• 36:49
  SPEAKER_02: But just curious what you guys are looking forward to as you look ahead into the spring and maybe even summer.
• 36:55
  SPEAKER_02: So, Pat, I'll start with you.
• 36:56
  SPEAKER_03: I thought you lived in Southern California, Heather, where it's spring like all the time or summer all the time.
• 37:02
  SPEAKER_02: You're still allowed to look forward to longer days, more sunshine, etc., flowers in the garden.
• 37:09
  SPEAKER_03: Well, so I I guess I'm a I'm a four seasons type.
• 37:11
  SPEAKER_03: I enjoy the change of seasons, but I do look forward to the warm weather and being able to golf.
• 37:17
  SPEAKER_03: That's a big uh outdoor, warmer weather passion for me.
• 37:21
  SPEAKER_03: And we have a relatively short season here in the Northeast.
• 37:24
  SPEAKER_03: So that's my sort of look forward to thing in spring.
• 37:26
  SPEAKER_02: All right.
• 37:27
  SPEAKER_02: And how about you, Tom?
• 37:28
  SPEAKER_01: Uh yeah, a couple things.
• 37:29
  SPEAKER_01: One is college basketball, right?
• 37:31
  SPEAKER_01: We're coming up to March Madness here.
• 37:33
  SPEAKER_01: So uh definitely that.
• 37:35
  SPEAKER_01: And then like Pat, I like to enjoy golf, although I'm not very good right now.
• 37:40
  SPEAKER_01: So I need a golf lesson because I'm actually worse than I was a couple of years ago.
• 37:43
  SPEAKER_01: So uh, but I agree with Pat, spending more time outdoors and with a little sun will be great.
• 37:48
  SPEAKER_02: Yes, and and to Pat's point, even in SoCal, it's nice when the days get longer.
• 37:52
  SPEAKER_02: So um, anyway, as always, gentlemen, appreciate it.
• 37:56
  SPEAKER_02: I shouldn't wrap up today without reminding our listeners that chapter 30 of the financial statement presentation guide is a great place to go for more information.
• 38:05
  SPEAKER_02: We covered a lot of ground here, and that will should cement it if you have specific questions.
• 38:10
  SPEAKER_02: So, once again, thanks for joining me.
• 38:12
  SPEAKER_01: Great.
• 38:12
  SPEAKER_01: Thanks, Eather.
• 38:13
  SPEAKER_01: Thank you.
• 38:16
  SPEAKER_02: Join me back here every Tuesday for new episodes on all things accounting and reporting.
• 38:21
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• 38:31
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• 38:35
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• 38:53
  SPEAKER_02: For PWC, I'm Heather Horn.
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