03-IAS 8 Accounting Policies, Changes in Estimates and Correction of Errors

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C-6 Financial Accounting

IAS 8 Accounting Policies, Changes in Estimatesand Correction of Errors

A Study For Success Scheme 2009-2010College of Accounts and Finance

Imran Ahmad Khan ACA


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Overview

Objectives, Scope and Definitions Selection and Application of Accounting Policies

Changes in Accounting Policies

Changes in Accounting Estimates Prior Period Errors

Impracticability in respect of Retrospective

Application and Retrospective Restatement

Class Practice Questions

Exam Type Questions

12-Aug-13 03- IAS 8 Accounting Policies, Changes inEstimates and Correction of Errors

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Objectives, Scope and Definitions


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Objective & Scope

To enhance the relevance, reliability and comparability of financial statements

Should be applied by an entity to select and apply its accounting policies.

In addition, IAS 8 should be applied where an entity changes its accounting policies orestimates, and for the correction of errors arising in prior periods.

Definitions

Accounting policies are the specific principles, bases, conventions, rules and practices applied by

an entity in preparing and presenting financial statements.A change in accounting estimate is an adjustment of the carrying amount of an asset or aliability, or the amount of the periodic consumption of an asset, that results from the assessmentof the present status of, and expected future benefits and obligations associated with, assets andliabilities. Changes in accounting estimates result from new information or new developmentsand, accordingly, are not corrections of errors.

Prior Period Errors are omissions from, and misstatements in, the entitys FS for one or more

prior periods arising from a failure to use, or misuse of, reliable information that:a) was available when financial statements for those periods were authorised for issue; and

b) could reasonably be expected to have been obtained and taken into account in thepreparation and presentation of those financial statements.

Such errors include the effects of mathematical mistakes, mistakes in applying accountingpolicies, oversights or misinterpretations of facts, and fraud.


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Selection and Application of Accounting Policies1. When an IFRS specifically applies to a transaction, other event or condition, the accounting

policy or policies applied to that item shall be determined by applying the IFRS and

considering any relevant Implementation Guidance issued by the IASB for the IFRS.

2. In the absence of an IFRS that specifically applies to a transaction, other event or condition,

management shall use its judgement in developing and applying an accounting policy that

results in information that is:

a) relevant to the economic decision-making needs of users; and

b) reliable, in that the financial statements:

i. represent faithfully the financial position, financial performance and cash flows of theentity;

ii. reflect the economic substance of transactions, other events and conditions, and not

merely the legal form;

iii. are neutral, ie free from bias;

iv. are prudent; and

v. are complete in all material respects.3. In making the judgement described above, management shall refer to, and consider the

applicability of, the following sources in descending order:

a) the requirements and guidance in IFRSs dealing with similar and related issues; and

b) the definitions, recognition criteria and measurement concepts for assets, liabilities,

income and expenses in the Framework.


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Changes in Accounting Policies An existing accounting policy should only be changed where a new

accounting standard requires such a change or where the new policy will

result in reliable and more relevant information being presented. IAS 8 requires changes in accounting policies to be accounted for

retrospectively except where it is not practicable to determine the effectin prior periods.

Retrospective application is where the FS of the current period and eachprior period presented are adjusted so that it appears as if the new policy

had always been followed. This is achieved by restating the profits in eachperiod presented and adjusting the opening position by restating retainedearnings (i.e. cumulative profits held in the statement

Where it is not practicable to determine either the specific effect in aparticular period or the cumulative effect of applying a new policy to pastperiods, the new policy should be applied from the earliest date that it is

practicable to do so. of financial position as part of equity). The reasons for and effects of a change in accounting policy should be

disclosed


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Illustration 1

Multi Ltd commenced trading two years ago, on 1 January

2006, and adopted the accounting policy (then allowed by

IAS 23 )of recognising all interest costs in profit or loss.

Its draft statement of financial position at 31 December

2007, and its final statement of financial position for the

previous year are as follows:

2007 2006

CUm CUm

Property, plant and equipment 284 241

Other assets 899 900

1,183 1,141

Share capital 100 100

Retained earnings

year ended 2006 41 41

year ended 2007 42 -

Liabilities 1,000 1,000

1,183 1,141

Borrowing costs attributable to qualifying assets of CU10

million have been recognised in P/L in each year.

The revised IAS 23 requires borrowing costs attributable to

qualifying assets to be recognised as part of the cost of

those assets. Multi Ltd has designated 1 January 2006as

the date on which the new standard should be adopted.


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This change in accounting policy should be

applied retrospectively as follows (the tax

implications as a consequence of this

change and the potential impact on

depreciation have been ignored for the

purposes of this illustration):

Restated

2007 2006

Cum CUm

Property, plant & equip

(284+10+10) / (241+10) 304 251Other assets 899 900

1,203 1,151

Share capital 100 100

Retained earnings

year ended 2006 (41+10) 51 51

year ended 2007 (42+10) 52 -Liabilities 1,000 1,000

1,203 1,151

Changes

in

Accou

ntingPo

licies


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Changes in Accounting Estimates The preparation of FS requires many estimates to be made on the

basis of the latest available, reliable information. Key areas in which

estimates are made include, for example, the recoverability of amounts owed by customers,

the obsolescence of inventories and

the useful lives of non-current assets.

As more up-to-date information becomes available estimates

should be revised to reflect this new information. These arechanges in estimates and are not changes in accounting policies orthe correction of errors

By its very nature the revision of an estimate to take account ofmore up to date information does not relate to prior periods.Instead such a revision is based on the latest information available

and therefore should be recognised in the period in which thatchange arises. The effect of a change in an accounting estimateshould therefore be recognised prospectively, i.e. by recognising thechange in the current and future periods affected by the change.


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Illustration 2

An entitys accounting policy is to recognise assets at no more than their recoverable amounts.

Consistent with this and based upon experience it has always provided in full against tradereceivables which have been outstanding for five months or more.

Because the economy is entering a period of recession, it reconsiders the recoverability of its

receivables and decides to provide in full for amounts outstanding for four months or more.

This is not a change in accounting policy. What has changed is the level of the receivables that are

thought to be recoverable. This is a change in estimate.

Illustration 3

A machine tool with an original cost of CU100,000, has an originally estimated useful life of ten

years, and residual value of nil. The annual straight-line depreciation charge will be CU10,000 per

annum and the carrying amount after three years will be CU70,000.

If in the fourth year it is decided that, as a result of changes in market conditions, the remaining

useful life is only three years (so a total of six years), then the depreciation charge in that year(and in the next two years) will be the carrying amount brought forward divided by the revised

remaining useful life, CU70,000/3 = CU23,333. There should be no change to the depreciation

charged for the past three years.

The effect of the change (in this case an increase in the annual depreciation charge from

CU10,000 to CU23,333) in the current year, and the next two years, should be disclosed.


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Changes in Accounting Estimates


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PriorPeriod

Errors

Examples of such errors are:

mathematical errors;

mistakes in applying an accounting policy;

oversights or misinterpretation of facts; and

Fraud. IAS 8 requires that these errors are adjusted in those past periods in which the error arose

rather than in the current period. Adjustment in the current period would lead to a distorted

result in the period in which the error was identified.

Retrospective restatement corrects the FS as if the prior period error had never occurred.

If it is impracticable to determine the effect on an individual period of an error, then the

adjustment should be made to the opening balance of the earliest period in which it ispossible to identify such information.

It is important to distinguish between prior period errors and changes in accounting estimates.

Accounting estimates are best described as approximations, being the result of considering

what is likely to happen in the future, for example how many customers will pay their

outstanding invoices and the period over which non-current assets can be used productively

within the business. By their very nature estimates result from judgments made on the basis

of information available at the time they are made, so they may need to be adjusted in the

future, in the light of additional information becoming available.

Prior period errors, on the other hand, result from discoveries which undermine the reliability

of the previously published FS, for example unrecorded income and expenditure, fictitious

inventory or the incorrect application of accounting policies such as classifying maintenance

expenses as part of the cost of non-current assets. Prior period errors should be rare.


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Prior Period ErrorsIllustration 4

During 20X2, Beta Co discovered that some products that had been sold during 20X1were incorrectly included in inventory at 31 December 20X1 at CU6,500.

Betas accounting records for 20X2 show sales of CU104,000, cost of goods sold ofCU86,500 (including CU6,500 for the error in opening inventory), and income taxes ofCU5,250.

In 20X1, Beta reported:

CU

Sales 73,500

Cost of goods sold (53,500)Profit before income taxes 20,000

Income taxes (6,000)

Profit 14,000

20X1 opening retained earnings was CU20,000 and closing retained earnings wasCU34,000.

Betas income tax rate was 30 per cent for 20X2 and 20X1. It had no other income orexpenses.

Beta had CU5,000 of share capital throughout, and no other components of equityexcept for retained earnings. Its shares are not publicly traded and it does not discloseearnings per share.


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Prior Period Errors

Illustration 4

Beta Co

Extract from the Statement of

Comprehensive Income

(restated)

20X2 20X1

CU CU

Sales 104,000 73,500

Cost of goods sold (80,000) (60,000)

Profit before income

taxes 24,000 13,500

Income taxes (7,200) (4,050)

Profit 16,800 9,450


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Beta Co

Statement of changes in equity

Share

Capital

CU

Retained

Earnings

CU

Total

CU

Balance at 31.12. X0 5,000 20,000 25,000

Profit for the year

31.12.X1 (restated)9,450 9,450

Balance at 31.12.X1 5,000 29,450 34,450

Profit for the year31 .12. X2

16,800 16,800

Balance at 31.12.X2 5,000 46,250 51,250


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Prior Period Errors

Illustration 4

Beta Co

Extracts from the notes

Some products that had been sold in 20X1 were incorrectly included in inventory at 31 December

20X1 at CU6,500. The financial statements of 20X1 have been restated to correct this error. The

effect of the restatement on those financial statements is summarised below. There is no effect in

20X2.

Effect on

20X1

CU

(Increase) in cost of goods sold (6,500)

Decrease in income tax expense 1,950

(Decrease) in profit (4,550)(Decrease) in inventory (6,500)

Decrease in income tax payable 1,950

(Decrease) in equity (4,550)


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ImpracticabilityImpracticable

Applying a requirement is impracticable when the entity cannot apply it after makingevery reasonable effort to do so. For a particular prior period, it is impracticable to

apply a change in an accounting policy retrospectively or to make a retrospective

restatement to correct an error if:

a) the effects of the retrospective application or retrospective restatement are not

determinable;

b) the retrospective application or retrospective restatement requires assumptions

about what managements intent would have been in that period; or

c) the retrospective application or retrospective restatement requires significant

estimates of amounts and it is impossible to distinguish objectively information

about those estimates that:

i. provides evidence of circumstances that existed on the date(s) as at whichthose amounts are to be recognised, measured or disclosed; and

ii. would have been available when the financial statements for that prior period

were authorized for issue

from other information.


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Class

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Class

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Exam Type Questions


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Exam Type Questions


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03-IAS 8 Accounting Policies, Changes in Estimates and Correction of Errors

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