Workbook on IAS 8 Accounting policies, changes in accounting estimates and errors
Scope
IAS 8 covers:
- Selecting or changing accounting policies;
- Changes in accounting estimates;
- Correction of prior-period errors.
Tax related errors / adjustments are dealt with under IAS 12 Income Taxes.
PRINCIPLES are guiding concepts.
STANDARDS are written guidelines for the treatment of various types of functions and activities. They apply to all commercial banks. Standards include acceptable alternatives for appropriate accounting under international financial reporting standards.
POLICIES discuss specific accounting for certain types of assets and activities. They apply to all commercial banks. Policies indicate, where applicable, which method of accounting is required when alternatives exist.
PROCEDURES give detailed instruction on the handling of specific transactions arising from activities, or in accounting for assets or liabilities. They are written by individual banks for internal use. A number of separate procedures are typically necessary to cover all the various activities associated with accounting for one type of function.
Definitions
Accounting policies are rules and practices applied in presenting financial statements.
A change in accounting estimate is an adjustment of the carrying amount of an asset or a liability or the consumption of an asset.
Changes in estimates result from new information or new developments and are not corrections of errors.
Impracticable. Error correction may be impracticable if:
- the impact cannot be determined;
- assumptions on management’s intent must be made;
- restatement requires evidence that is not available.
Material is defined in IAS 1 and is used in IAS 8 with the same meaning.
Materiality depends on the size and nature of the omission or misstatement, judged in the surrounding circumstances.
Prior-period errors are omissions, or misstatements in the financial statements of prior-periods.
Information that was available and should have been taken into account is classified as an error.
Errors include:
- calculation error;
- incorrect application of accounting policies;
- oversights or misinterpretations;
- fraud.
Prospective application is applying a change in current and future periods
Retrospective application is applying a new policy as if that policy had always been applied.
Retrospective restatement is restating financial statements as if a prior-period error had never occurred.
Accounting Policies
Selection and Application of Accounting Policies
Apply the relevant Standard when determining Accounting Policies.
EXAMPLE – application of a Standard
You have leased an asset for your use. You refer to IFRS 16 Leasing to determine the accounting treatment.
Guidance is available from specific IFRS Standards, the Framework and interpretations. Other standard-setting bodies may also be a source of reference where the issue is not covered by IFRS.
| EXAMPLE – Deviation of accounting policy from general Framework definitions Issue Management must use its judgment in developing an accounting policy in the absence of a specific IFRS or Interpretations. The factors to consider in making this judgement include the definitions, recognition and measurement criteria for assets, liabilities, income and expenses set out in the Framework. How should redundancy costs incurred as part of a restructuring to reduce costs be treated? Background The management of Bank K, based in Europe, is facing severe competition. Management therefore decides to reduce costs by moving all of Bank K’s call centres to Asia. The costs incurred in relocating will significantly reduce cash outflows from operations. Part of the costs of relocation will be the redundancy costs of the staff working in the factory in Europe. Management proposes that the costs of relocation, including redundancy costs, be capitalised because they lead to a substantial reduction in future operating costs. Solution The redundancy payments should not be recognised as an asset. The redundancy payment has not given the bank control over a resource even though it results in the bank reducing its future cash outflows. An asset should only be recognised if the bank controls certain resources. The redundancy payments should therefore be expensed. |
Consistency of Accounting Policies
An undertaking shall apply its policies consistently for similar transactions or categories.
EXAMPLE-categorisation of items
You have a portfolio of properties. These include both investment and owner-occupied properties. IAS 16+ IAS 40 require these categories to be accounted for separately, so each requires an accounting policy.
Policies should be consistent from period to period to allow comparisons to be made.
| EXAMPLE- consistency Your financial instruments are now being accounted for using FIFO. This must be used in each period to allow users to compare one period with another. |
Changes in Accounting Policies
A change in presentation and classification of items from one period to the next is permitted only when it is a result of;
- a significant change in the nature of the bank's operations;
- identification of a more appropriate presentation; or
- the requirements of a new IFRS or interpretation.
A change in accounting policy should be accounted for retrospectively. Any adjustment should be reported as an adjustment to the opening balance of each affected component of equity for the earliest period presented.
Where such changes are made, the corresponding figures for prior periods should also conform to the new presentation. The nature, amounts and reasons for the amendments should also be disclosed.
Other comparative amounts disclosed shall be presented as if the new accounting policy had always been applied, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change.
An undertaking should disclose the reason for not reclassifying comparative information if it is impossible, or economically unreasonable, to determine comparable amounts for previous periods. The nature of changes that would have been made if the amendments had been practicable should also be given.
Changes on the basis of a more appropriate presentation should only be made where the benefit of the alternative presentation is clear. Such changes will therefore be infrequent.
When an undertaking presents summary financial information (such as five and ten year summaries), the presentation should be consistent with the most recent presentation adopted in the financial statements. Management should disclose the fact where a consistent presentation is not feasible.
The adoption of an accounting policy for events or transactions that differ in substance from previously occurring events or transactions is not a change in accounting policies.
| EXAMPLE- new accounting policy in respect of an existing asset How should management recognise the adoption of a new accounting policy in respect of an existing asset? Background H owns an office building which it uses for its own administrative purposes. Accordingly, the building is classified as property, plant and equipment and is carried at depreciated historical cost. During the current year, management moved the workforce to a new building and leased the old building to a third party. Accordingly, the old building was reclassified as investment property and carried at fair value. H had not previously earned rental income on any of its properties. Management has questioned whether the comparative amounts for the old building should be restated to fair value to aid comparability with the prior period. Solution Management should recognise the effects prospectively, since it is not a change in accounting policy but there is a change in use of the property. No restatement of the comparative amounts should be made. The different accounting treatment applied to the same property in the current and prior years is appropriate, because the building was used for different purposes in the two years. Depending on the materiality of the rental revenue in relation to the bank’s revenue as a whole, management should consider whether a new reportable operating segment now exists. This is not the same as a situation where an existing operating segment becomes reportable. Management should not restate operating segment reporting information. |
Accounting policies are changed as required by IFRS, or where better information results.
EXAMPLE-change in policy
Your financial instruments had been accounted for using LIFO. IAS 2 Inventories has now removed LIFO as an option. You change your policy for financial instruments to FIFO in accordance with IFRS.
The effects of any changes must be clearly stated.
EXAMPLE- new transaction types
You are hedging financial instruments for the first time and apply the relevant sections of IFRS 9 Financial Instruments. This is not a change of policy.
EXAMPLE- application of a new policy for transactions that were previously immaterial
Property was previously rented to your business and the rental was expensed. A small amount of the property was sublet.
You buy a group that has an investment property portfolio and account for the property according to IAS 40. This is not a change of policy.
Applying Changes in Accounting Policies
Transitional provisions may apply when first applying a Standard.
EXAMPLE- transition provisions
You have just purchased a bank that has some intangible assets. These were accounted for under a non-IFRS regime. You wish to account for them under IFRS. You use the IAS 38 Intangible Assets transition provisions.
The initial application of a policy to revalue assets in accordance with IAS 16 Property, Plant and Equipment, or IAS 38 Intangible Assets, is a change in an accounting policy to be dealt with as a revaluation in accordance with IAS 16 or IAS 38, rather than in accordance with IAS 8.
For a voluntary change of policy, comparative figures must also be changed if the standard has no transitional provisions.
Early application of a standard or interpretation is not a voluntary change in accounting policy.
EXAMPLE new Standard not yet in force
A new Standard has been issued which will come into force in 2XX8. You introduce its provisions into your 2XX7 financial statements which is permitted but not compulsory. This is not a voluntary change in policy so no change of comparative figures is necessary.
| EXAMPLE new Standard – interim financial statements The accounting policies applied in the interim financial report should be the same as those applied in the annual financial statements. Should an undertaking apply the requirements of a new standard effective for the current year in its interim financial reports? Background Bank A operates in the financial services industry. It is publicly traded and publishes quarterly financial information in accordance with IAS 34. Bank A is preparing its quarterly financial information for the period ending 31 March 2007. Management is aware that IFRS 7 is effective for annual financial statements covering periods beginning on or after 1 January 2007, but is unclear whether it should first adopt IFRS 7 in the interim financial report or in its 2007 annual financial statements. Solution Bank A must adopt IFRS 7 in its first quarter financial report at 31 March 2007. Management should apply IFRS 7 in preparation of the first quarter financial information in the same way in which it will apply the standard in the annual financial statements. IFRS 7 does not establish any specific transitional provisions. To reflect the change in accounting policy, Bank A will apply IFRS 7 retrospectively unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. |
Retrospective application
Accounting policy applied retrospectively requires adjustment of the prior opening balance of each component of equity. Also affected may be historical summaries.
The effect is as if the new accounting policy had always been applied.
EXAMPLE- retrospective application
Your jointly-controlled bank has been accounted for at equity method. You change your policy to the proportionate consolidation for the benefit of users. This is a voluntary change of policy. The change must be made retrospectively. This requires you to change the figures for all periods that feature in your financial statements.
Limitations on retrospective application
A change in accounting policy shall be applied retrospectively from when it is practicable.
EXAMPLE- limitations on retrospective application
Your financial instruments have been accounted for using FIFO. You change your policy to weighted-average cost for the benefit of users. The change must be made retrospectively. This requires you to change the figures for all periods that feature in your financial statements.
Your financial instruments records are only available for the last three years though your financial statements are presented with comparatives for the last five years.
Adjustments are limited to the last three years due to the impracticality of securing the information for the other two years.
Retrospective application is not practicable, unless cumulative impact in both the opening and closing balance sheets, in the period, can be determined.
EXAMPLE – Adjustments: no opening balance sheet
You have previously expensed borrowing costs, but now have to capitalise them under IAS 23, due to the revisions to IAS 23.
Your records are only available for the last 3 years but you have no adequate analysis for the earliest period.
Adjustments have to be limited to the last 2 years due to the impracticality of not having a detailed opening balance sheet for the earliest period.
Disclosure
Disclosure is required in respect of a change in accounting policy:
- nature and reasons for the change;
- amount of the adjustment for the current period and for each period presented;
- the amount of the adjustment relating to periods prior to those presented; and (if appropriate);
- the fact that the retrospective application is impracticable, and the reasons why.
When initial application of a Standard has an impact on the current, past or future period disclose the:
- title of the Standard ;
- that the changes in accounting policy are made in accordance with transitional provisions (if applicable) and description of them;
- the nature of the change in accounting policy;
- present and future impact;
Financial statements of subsequent periods need not repeat these disclosures.
When a voluntary change in accounting policy has an impact on the current period or any prior or future period, but it is impracticable to determine the amount of the adjustment a bank shall disclose:
1. the nature of the change in accounting policy;
2. the reasons why applying the new accounting policy provides reliable and more relevant information;
3. for the current period and each prior period presented, to the extent practicable, the amount of the adjustment:
- for each financial statement line item affected; and
- If IAS 33 applies to the bank, for basic and diluted earnings per share;
4. the amount of the adjustment relating to periods before those presented, to the extent practicable; and
5. if retrospective application is impracticable for a particular prior period, or for periods before those presented, the circumstances that led to the existence of that condition and a description of how and from when the change in accounting policy has been applied.
If a new standard or interpretation has been issued but is not yet effective, disclose the likely impact in the period of initial application.
EXAMPLE – Standard not yet effective - 1
A new Standard has been issued which will come into force in 2XX8. You decide not to apply it to your 2XX7 financial statements. However, in your 2XX7 financial statements, you will need to disclose the likely impact on future application in 2XX8.
Optional disclose:
- nature of the impending changes in accounting policy;
- effective date for application of the standard or interpretation and mandatory date;
- discussion of the impact of the standard or interpretation or a statement that the impact is not known.
| EXAMPLE – Standard not yet effective - 2 An accounting policy shall be changed only if: i) a standard or interpretation requires it; or ii) it results in the financial statements providing reliable and more relevant information about the effects of transactions, other events or conditions on the undertaking’s financial position, financial performance or cash flows. The IASB issued revised standards in December 20X3 which must be applied for annual periods beginning or after 1 January 20X5. Early adoption is encouraged. Can some, but not all, of the revised standards be adopted early? Background Bank X’s management plans to adopt some, but not all, of the revised standards for the 20X3 financial statements. The financial statements of Bank X will be issued in July 20X4. Solution Yes. There is no requirement for the improvements to be adopted as a single package. Bank X’s management may choose which standards it early adopts. However, all changes of each individual standard must be implemented at the same time. Selective application of different elements within an individual standard is not permitted. Selective adoption of certain standards might not reflect well on the credibility of management and the organisation as a whole. Each standard should be considered separately. Changes in accounting policies should be treated in accordance with IAS 8. IAS 8 requires banks that have not adopted a new standard, or interpretation, to disclose this fact and the known, or reliably estimable, information relevant to assessing the possible impact that the new standard, or interpretation, will have on the undertaking's financial statements in the period of initial application. |
Changes in Accounting Estimates
Some financial statement items can only be estimated, rather than measured precisely. These are forecasts of the future.
Estimation involves judgments based on the latest available information. For example estimates may be required of loan loss provisions, inventory obsolescence, fair values, useful lives and warranty obligations.
An estimate may need revision if changes occur as a result of new information or experience.
The revision of an estimate does not relate to prior periods and is not the correction of an error. Financial information presented for prior periods should not be restated.
IFRS consider prior-period financial statements to have been properly prepared, even though estimates are revised in a subsequent period.
The effect of revisions to estimates should be included in income in the period of the change, and future periods where relevant.
EXAMPLE- revision of estimates-useful lives - 1
Your bank has an interest in a corporate aircraft fleet. New legislation will ban them for use on international flights, reducing their useful lives. You will need to accelerate depreciation and review their residual values. This is a revision of estimates and will have no impact on prior periods, but will increase depreciation in the current and later periods.
EXAMPLE- revision of estimates-useful lives - 2
| Should management adjust the carrying amount of an undertaking’s asset to recognise a change in the asset’s estimated useful life? Background Management purchased a money-counting machine on 1 January 20X1 for 1,000. The asset’s useful life was originally estimated to be ten years. Management reviewed the useful life in January 20X3 and concluded that the asset had a remaining useful life at that date of ten years (twelve years in total). Solution No, management should not adjust the asset’s carrying amount but instead adjust the depreciation charges prospectively. The asset’s net carrying amount at January 20X3 was 800. Management should not restate the results for 20X1 or 20X2. Management should instead reduce the annual depreciation charge from 100 to 80 for 20X3 and subsequent years. Management should disclose, in a note to the undertaking’s financial statements, details of the nature of the change, and the related amounts if the change in accounting estimate has a material effect on the current period. |
A change in the measurement basis is a change in a policy, and is not a change in an estimate. An example is to change from presenting assets at cost to presenting them at revalued amounts.
EXAMPLE- measurement basis
Your investment property has been accounted for at cost. You revalue your property. This is a change in the measurement basis: this is a change in a policy and is not a change in an estimate.
EXAMPLE – loan loss provision
Just before your 2XX9 accounts are approved for issue, a client goes into liquidation owing you $4 million. You adjust your 2XX9 accounts (see IAS 10) by increasing bad debts in the income statement. This is a change in estimate.
When it is difficult to distinguish a change in a policy from a change in an estimate the change is treated as a change in an estimate.
Record a change in an estimate from the period of change onwards. This is called prospective recognition. The effect of the change in an accounting estimate should be included in the same income statement classification as was used previously for the estimate.
EXAMPLE- revision of warranty provision
You sell televisions and videos. You provide an after-sale warranty to cover service for the first two years. Experience has shown that 5% of the sets will need service under the warranty scheme.
A new range of sets indicates that the only 3% of sets will need to be serviced The warranty will be adjusted in this period onwards.
| EXAMPLE-estimation of a warranty provision Issue The measurement of an undertaking’s annual results should not be affected by the frequency of the reporting (annual, half-yearly, or quarterly). The undertaking should make the measurement for reporting purposes on a year-to-date basis. How should management estimate a warranty provision at the end of an interim reporting period? Background P sells vacuum cleaners on which it provides a standard warranty of one-year for parts and labour. It prepares interim financial statements in accordance with IAS 34. P’s experience is that 3% of vacuum cleaners sold will be the subject of warranty claims. The undertaking’s provision for warranty claims in the first quarter of 20X5 reflects that experience. It discovered a fault with the newly manufactured cleaners in the second quarter, however, and has revised its estimate of warranty claims from 3% to 5%. The provision stands at 3,000, based on sales of 100,000 in the first quarter; P sold a further 100,000 units in the second quarter. Solution Management should calculate the second quarter warranty cost on the basis of year-to-date sales and the new estimate of warranty claims of 5%. This approach is illustrated as follows: |
| The determination of the warranty cost for Q2 using sales for the quarter is not appropriate, and would have resulted in an understatement of the warranty provision. |
| Sales – Q1 + Q2 | 200,000 |
|
| Warranty cost @ 5% | 10,000 |
|
| Warranty cost recognised in Q1 | 3,000 |
|
| Change recognised in Q2 | 7,000 |
|
Disclosure
The nature and amount of a change in accounting estimate that has a material effect in the period and potentially subsequent periods is to be disclosed.
Changes in estimates are disclosed, except when it is impracticable to estimate the impact and then reason for non-disclosure should be disclosed.
Errors, including Fraud
Financial statements do not comply with IFRS if they contain material errors.
Errors are omissions from, and misstatements in, the bank's financial statements for one or more prior periods arising from a failure to use, or misuse of, reliable information that:
- was available when financial statements for those periods were authorised for issue; and
- could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements.
The amount of the correction of an error shall be accounted for retrospectively. An error shall be corrected by restating the comparative amounts for the period(s) in which the error occurred, so that the financial statements are presented as if the error had never occurred.
When the error occurred before the earliest period presented, a bank should restate the opening balance of assets, liabilities and equity for that period.
The correction of a prior period error is excluded from the determination of profit or loss for the period in which the error is discovered. Any information presented about prior periods, including any historical summaries of financial data, is restated as far back as is practicable.
Materiality
The nature and materiality of the information affects its relevance, and in some cases the nature of information alone is sufficient to determine its relevance.
Information will also be material where the nature and circumstances of the transaction or event are such that users of the financial statements should be made aware of them.
Determining whether information is material or not is a matter of professional judgement. The test is whether omission or misstatement of the information could influence decisions a user of the financial statements might make.
The following items will often qualify as material, regardless of their individual size:
- related party transactions;
- a transaction or adjustment that changes a profit to a loss, and vice versa;
- a transaction or adjustment that takes an undertaking from having net current assets to net current liabilities, and vice versa;
- a transaction or adjustment that affects an undertaking’s ability to meet analysts’ consensus expectations;
- a transaction or adjustment that masks a change in earnings or other trends;
- a transaction or adjustment that concerns a segment, or other portion, of the undertaking’s business that has been identified as playing a significant role in the undertaking’s operations or profitability;
- a transaction or adjustment that affects an undertaking’s compliance with loan covenants or other contractual requirements;
- a transaction or adjustment that has the effect of increasing management’s compensation, for example by satisfying requirements for the award of bonuses;
- changes in laws and regulations;
- non-compliance with laws and regulations;
- fines against the undertaking;
- legal cases;
- deterioration in relationships with individual or groups of key suppliers, clients or employees; and
- dependency on a particular supplier, client or employee.
| EXAMPLE- materiality Information is material if its omission or misstatement could, individually or collectively, influence the users’ economic decisions that are based on the financial statements. Should management disclose a change in the classification of an expense that is not material in relation to the equity and net income? Background An undertaking reclassifies certain items of PPE, from PPE used for industrial purposes to PPE used for administrative purposes. The related depreciation expense was previously part of cost of sales and has subsequently been reclassified to administrative expenses. Management has decided not to disclose this change in classification because the asset’s carrying value and depreciation expense for the period is not material. Presented below is an extract from the income statement after the adjustment. Solution Yes. The undertaking should disclose the change in classification. The undertaking has reported a ‘gross profit’ as a result of the reclassification rather than a ‘gross loss’. The presentation of a gross profit (even a small one) rather than a gross loss might alter the users’ perception of the undertaking’s performance. |
EXAMPLE- errors last period - 1
During your audit for 2XX6 it is found that the 2XX5 revenue figure had been materially inflated by fictitious invoices. The comparative figures for 2XX5 should be restated to correct this error.
EXAMPLE – error before last period
You run a leasing firm. You find that revenue has been recognised too early for the last 7 years in order to inflate profits. Your financial statements only report 5 years. You restate the opening balances of assets liabilities and equity for the earliest period presented and the adjustments thereafter.
Limitations on Retrospective Restatement
Where impracticable to correct the prior period, restate the opening balances for the earliest period practicable.
EXAMPLE- Limitations on Retrospective Restatement
For at least the last 10 years, administration overheads have been incorrectly capitalised into computer software. You can eliminate the overhead from the last 2 years’ figures but do no information to correct figures before then. So only two years can be corrected.
EXAMPLE - Period of correction
Revenue had been overstated in 2XX5 but this was only found in 2XX6.
The adjustment will be made to the 2XX5 comparative figures, not corrected in 2XX6. An error from a prior period is reflected in that period, not in the current period.
Disclosure of Prior-Period Errors
An undertaking shall disclose the nature and amount of each prior-period error:
- for each financial statement line item affected;
- the effect on earnings per share;
- the amount of the correction at the beginning of the earliest period presented;
- if retrospective restatement is impracticable, a description of how and when the error has been corrected.
| EXAMPLE- errors last period - 2 How should management present the correction of an error related to a prior year? Background Management discovered, when calculating the deferred tax for 20X3, that the deferred tax for 20X2 was materially misstated due to a mathematical error in the calculation. Management had correctly determined the (gross) temporary differences of 12,000,000 but had applied an incorrect tax rate of 70% instead 30%. Solution Management should restate the 20X2 comparatives in the undertaking’s 20X3 financial statements. Management should present in a note to the financial statements the following information: i) the nature of the error; ii) amount of the correction for each period presented; iii) amount of the correction at the beginning of the earliest prior period presented; and iv) if retrospective application is impracticable, the nature and reasons for the circumstances. An example of the disclosure is as follows: The comparative amounts for deferred tax expense and deferred tax liability have been restated to correct an error in the calculation of the 20X2 deferred tax expense and deferred tax liability. The result of the restatement is a reduction in the deferred tax expense and the deferred tax liability of 4,800,000. |
Impracticability
Sometimes it is impracticable to adjust comparative information to achieve comparability with the current period.
The objective of estimates is to reflect the circumstances that existed when the transaction occurred.
EXAMPLE – warranties- circumstances that existed when the transaction occurred
You decide to make provisions for warranties for product repair. To provide retrospective figures you need to consider the level of warranty that management would have made at the balance sheet dates of the comparative figures as compared to the actual claims that subsequently occurred that related to the products sold in that period.
Your average number of products serviced is 6% of those that you have sold. This would be a fair basis to provide a warranty provision. An earlier product range had a service rate of 20%, but this was not apparent for the first 18 months after the introduction of that product. It would be wrong to use the 20% figure for historic periods, before the full extent of the problem was known.
Retrospectively applying a new policy or correcting a prior-period error requires evidence that other information was available when the financial statements for that period were approved for issue.
If this information is not available it is not practicable to make the adjustment.
Hindsight should not be used in making assumptions about what management’s intentions would have been in a prior-period or estimating the amounts recorded in a prior-period.
EXAMPLES-no change to decisions made previously in comparatives
Financial assets classified as “held-to-maturity” are sold before maturity. This does not change their prior basis of measurement although will now be marked to market for “traded” securities.
When correcting a prior-period error in staff accumulated sick leave, you disregard a high-level of illness during the next period, which was only known after the financial statements were approved for issue.
Impact of tax on changes
Changes to the figures in any period may have an impact on the tax figures. (See IAS 12 Income Taxes). Adjustments may need to be made to reflect the changes in deferred tax liabilities.
ACCA past papers June 2016 (7 marks)
Question
You are the financial controller of Omega, a listed entity which prepares consolidated financial statements in accordance with International Financial Reporting Standards (IFRS). The managing director, who is not an accountant, has recently attended a business seminar at which financial reporting issues were discussed. Following the seminar, she reviewed the financial statements of Omega for the year ended 31 March 2016. Based on this review she has prepared a series of queries relating to those statements:
‘During a break-out session I heard someone talking about accounting policies and accounting estimates. He said that when there’s a change of these items sometimes the change is made retrospectively and sometimes it’s made prospectively. Please explain the difference between an accounting policy and an accounting estimate and give me an example of each. Please also explain the difference between retrospective and prospective adjustments and how this applies to accounting policies and accounting estimates.’
Provide answers to the the question raised by the managing director. Your answers should refer to relevant provisions of International Financial Reporting Standards.
Answer
IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors – defines an accounting policy as ‘the specific principles, bases, conventions, rules and practices applied by an entity in preparing and
presenting financial statements’.
(Note: Exact words NOT needed here, just the sense of the point.)
An example of an accounting policy would be the decision to apply the cost model or the fair value model when measuring investment properties. (Note: ANY reasonable example accepted.)
When an entity changes an accounting policy, the change is applied retrospectively. This means that the comparative figures are based on the new policy (rather than last year’s actual figures). The opening balance of retained earnings is restated in the statement of changes in equity.
Accounting estimates are made in order to implement accounting policies. An example of an accounting estimate would be (consistent with the above given example) the fair value of an investment property at the reporting date (where the fair value model was being applied).
(Note: ANY reasonable example accepted.)
Changes in accounting estimates are made prospectively. This means applying the new estimates in future financial statement preparation, without amending any previously published amounts. (Note: Exact words NOT needed here, just the sense of the point.)
Examiners Feedback
In general, many candidates scored well in this question. Many candidates scored marks for the correct definition of an accounting policy and providing examples. Majority of the candidates correctly stated that changes in accounting policy were applied retrospectively, whereas changes in accounting estimates were made prospectively. At the same time there were some candidates who did not provide for the correct description of the meaning of the term “retrospective”. They limited their answers to mentioning that this means the accounting policy applies as if it was used always in the past. The advanced candidates scored marks for mentioning that comparative figures were based on the new policy (rather than last year’s actual figures) and that the opening balance of retained earnings was restated in the statement of changes in equity.
Other Resources
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