12.6 Special Situations

The primary source of guidance on accounting changes and error corrections is ASC 250. ASC 250-10-20 defines a change in accounting estimate as a “change that has the effect of adjusting the carrying amount of an existing asset or liability . . . . Changes in accounting estimates result from new information.” A change in a prior-year tax provision is a change in accounting estimate if it results from new information, a change in facts and circumstances, or later identification of information that was not reasonably knowable or readily accessible as of the prior reporting period. In addition, ASC 740-10-25-14 and ASC 740-10-35-2 state that the subsequent recognition and measurement of a tax position should “be based on management’s best judgment given the facts, circumstances, and information available at the reporting date” and that subsequent changes in management’s judgment should “result from the evaluation of new information and not from a new evaluation or new interpretation by management of information that was available in a previous financial reporting period.”

In contrast, ASC 250-10-20 defines an error in previously issued financial statements (an “error”) as an “error in recognition, measurement, presentation, or disclosure in financial statements resulting from mathematical mistakes, mistakes in the application of [GAAP], or oversight or misuse of facts that existed at the time the financial statements were prepared. A change from an accounting principle that is not generally accepted to one that is generally accepted is a correction of an error.” In determining whether the change is a correction of an error, an entity should consider whether the information was or should have been “reasonably knowable” or “readily accessible” from the entity’s books and records in a prior reporting period and whether the application of information at that time would have resulted in different reporting. The determination of when information was or should have been reasonably knowable or readily accessible will depend on the entity’s particular facts and circumstances.

Distinguishing between a change in accounting estimate and a correction of an error is important because they are accounted for and reported differently. In accordance with ASC 250-10-45-23, an error correction is typically accounted for by restating prior-period financial statements. However, ASC 250-10-45-17 specifies that a change in accounting estimate is accounted for prospectively “in the period of change if the change affects that period only or in the period of change and future periods if the change affects both.” Under ASC 250-10-50-4, if the change in estimate affects several future periods, an entity must disclose the “effect on income from continuing operations, net income (or other appropriate captions of changes in the applicable net assets or performance indicator), and any related per-share amounts of the current period.”

If the change to the prior-period tax provision is determined to be an error, the entity should look to ASC 250 for guidance on how to report the correction of the error. Additional guidance is also provided by SAB Topics 1.M (SAB 99) and 1.N (SAB 108).

An entity must often use judgment in discerning whether a change in a prior-year tax provision results from a correction of an error or a change in estimate.

The following are examples of changes that should be accounted for as changes in accounting estimate:

• A change in judgment (as a result of a change in facts or circumstances or the occurrence of an event) regarding the sustainability of a tax position or the need for a valuation allowance.
• The issuance of a new administrative ruling.
• Obtaining additional information on the basis of the experience of other taxpayers with similar circumstances.
• Adjusting an amount for new information that would not have been readily accessible from the entity’s books and records as of the prior reporting date. For example, to close its books on a timely basis, an entity may estimate certain amounts that are not readily accessible. In this case, as long as the entity had a reasonable basis for its original estimate, the subsequent adjustment is most likely a change in estimate.
• Developing, with the assistance of tax experts, additional technical insight into the application of the tax law with respect to prior tax return positions involving very complex or technical tax issues. Because both tax professionals and the tax authorities are continually changing and improving their understanding of complex tax laws, such circumstances typically constitute a change in estimate rather than an error.
• Making a retroactive tax election that affects positions taken on prior tax returns if the primary factors motivating such a change can be tied to events that occurred after the balance sheet date.
• Deciding to pursue a tax credit or deduction retroactively that was previously considered not to be economical but that becomes prudent because of a change in facts and circumstances. Such a decision is a change in estimate if the entity evaluated the acceptability of the tax position as of the balance sheet date and analyzed whether the tax position was economical but concluded that it was not prudent to pursue this benefit. The decision would not be considered a change in estimate if the entity did not consider or otherwise evaluate the acceptability of the tax position as of the balance sheet date.

The following are examples of changes that should be accounted for as error corrections:

• Intentionally misstating a tax accrual.
• Discovering a mathematical error in a prior-year income tax provision.
• Oversight or misuse of facts or failure to use information that was reasonably knowable and readily accessible as of the balance sheet date.
• Misapplying a rule or requirement or the provisions of U.S. GAAP. One example is a situation in which an entity fails to record a DTA, a DTL, a tax benefit, or a liability for UTBs that should have been recognized in accordance with ASC 740 on the basis of the facts and circumstances that existed as of the reporting date that were reasonably knowable when the financial statements were issued.
• Adjusting an amount for new information that would have been readily accessible from the entity’s books and records as of the prior reporting period. In assessing whether information was or should have been “readily accessible,” an entity should consider the nature, complexity, relevance, and frequency of occurrence of the item.