SBR Notes IAS 8

IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors

Scope: IAS 8 is applied in:

• Selecting and applying accounting policies.

• Accounting for changes in accounting policies and estimates.

• Correction of prior period errors.

Key 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 liability, or related expense, resulting from reassessing the expected future benefits and obligations associated with that asset or liability for example: A receivable balance that becomes irrecoverable, Change in estimated useful life of an asset of depreciable asset.

• International Financial Reporting Standards are standards and interpretations adopted by the International Accounting Standards Board (IASB). They comprise:

¾     International Financial Reporting Standards (IFRSs)

¾     International Accounting Standards (IASs)

¾     Interpretations developed by the International Financial Reporting Interpretations Committee (IFRIC) or the former Standing Interpretations Committee (SIC) and approved by the IASB.

• Materiality. Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general purpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity.

• Prior period errors are omissions from, and misstatements in, an entity's financial statements for one or more prior periods arising from a failure to use, or misuse of, reliable information that was available and could reasonably be expected to have been obtained and taken into account in preparing those statements. Such errors result from mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud. If any prior period found in the financial statement it need to be applied retrospectively.

Accounting policies: Accounting policies are the principles and rules applied by an entity which specify how transactions are reflected in the financial statements.

Where a standard exists in respect of a transaction, the accounting policy is determined by applying that standard or when an IFRS applies to a transaction the accounting policy or policies applied to that transaction is determined by applying the relevant IFRS and any relevant implementation guidance issued by the IASB.

Where there is no applicable standard or interpretation, management must use its judgement to develop and apply an accounting policy which will provide information that:

1. It is relevant to economic decision making of users

2. It represents faithfully

3. It reflects the economic substance of the transaction

4. It is neutral

5. It is complete in all material aspects.

Management should refer to:

• Standards dealing with similar and related issues

• Definition and recognition criteria in the framework.

Provided they do not conflict with the sources above, management may also consider:

• Pronouncements from other standard-setting bodies, as long as they use a similar conceptual framework

• Other accepted industry practices.

Selection and application of accounting policies: When a Standard or an Interpretation specifically applies to a transaction, other event or condition, the accounting policy or policies applied to that item must be determined by applying the Standard or Interpretation and considering any relevant Implementation Guidance issued by the IASB for the Standard or Interpretation.

In the absence of a Standard or an Interpretation that specifically applies to a transaction, other event or condition, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. [IAS 8.10]. In making that judgement, management must refer to, and consider the applicability of, the following sources in descending order:

• The requirements and guidance in IASB standards and interpretations dealing with similar and related issues; and

• The definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.

Management may also consider the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework to develop accounting standards, other accounting literature and accepted industry practices, to the extent that these do not conflict with the sources in paragraph 11.

Consistency of accounting policies: An entity shall select and apply its accounting policies consistently for similar transactions, other events and conditions, unless a Standard or an Interpretation specifically requires or permits categorisation of items for which different policies may be appropriate. If a Standard or an Interpretation requires or permits such categorisation, an appropriate accounting policy shall be selected and applied consistently to each category.

Changes in accounting policies: An entity is permitted to change an accounting policy only if the change:

• Is required by a standard or interpretation; or

• Results in the financial statements providing reliable and more relevant information about the effects of transactions, other events or conditions on the entity's financial position, financial performance, or cash flows.

Example: If organization change from Cost model to revaluation model it is change in accounting policy.

Note that changes in accounting policies do not include applying an accounting policy to a kind of transaction or event that did not occur previously or were immaterial.

If a change in accounting policy is required by a new IASB standard or interpretation, the change is accounted for as required by that new pronouncement or, if the new pronouncement does not include specific transition provisions, then the change in accounting policy is applied retrospectively.

Retrospective application means adjusting the opening balance of each affected component of equity for the earliest prior period presented and the other comparative amounts disclosed for each prior period presented as if the new accounting policy had always been applied. [IAS 8.22]

• However, if it is impracticable to determine either the period-specific effects or the cumulative effect of the change for one or more prior periods presented, the entity shall apply the new accounting policy to the carrying amounts of assets and liabilities as at the beginning of the earliest period for which retrospective application is practicable, which may be the current period, and shall make a corresponding adjustment to the opening balance of each affected component of equity for that period.

• Also, if it is impracticable to determine the cumulative effect, at the beginning of the current period, of applying a new accounting policy to all prior periods, the entity shall adjust the comparative information to apply the new accounting policy prospectively from the earliest date practicable.

Where a change is applied retrospectively, IAS 1 revised requires an entity to include in its financial statements a statement of financial position at the beginning of the earliest comparative period. In practice this will result in 3 statements of financial position.

• At the reporting date

• At the start of the current reporting period

• At the start of the previous reporting period.

Disclosures relating to changes in accounting policies/Change due to new IAS/IFRS: Disclosures relating to changes in accounting policy caused by a new standard or interpretation include:

• The title of the standard or interpretation causing the change

• The nature of the change in accounting policy

• A description of the transitional provisions, including those that might have an effect on future periods

• For the current period and each prior period presented, to the extent practicable, the amount of the adjustment:

¾     for each financial statement line item affected, and

¾     for basic and diluted earnings per share (only if the entity is applying IAS 33)

• The amount of the adjustment relating to periods before those presented, to the extent practicable

• If retrospective application is impracticable, an explanation and description of how the change in accounting policy was applied.

Financial statements of subsequent periods need not repeat these disclosures.

Disclosures relating to voluntary changes in accounting policy include:

• The nature of the change in accounting policy

• The reasons why applying the new accounting policy provides reliable and more relevant information

• For the current period and each prior period presented, to the extent practicable, the amount of the adjustment:

¾     for each financial statement line item affected, and

¾     for basic and diluted earnings per share (only if the entity is applying IAS 33)

• The amount of the adjustment relating to periods before those presented, to the extent practicable

• If retrospective application is impracticable, an explanation and description of how the change in accounting policy was applied.

Financial statements of subsequent periods need not repeat these disclosures.

If an entity has not applied a new standard or interpretation that has been issued but is not yet effective, the entity must disclose that fact and any and known or reasonably estimable information relevant to assessing the possible impact that the new pronouncement will have in the year it is applied.

Changes in accounting estimates: Many items in the financial statements must be measured with an element of estimation attached to them:

1. Non-current assets are depreciated the charge takes into account the expected pattern of consumption of the asset and its expected useful life. Both depreciation method reflect consumption pattern and useful life are estimates.

2. As per IAS 37 “Provisions” is often a Best estimate of future economic benefits which need to be paid out.

3. Inventory is measured at lower of cost or NRV with allowance made for obsolescence etc

4. Trade receivables are measured after allowing for estimated irrecoverable amounts.

A change in an accounting estimate is not a change in accounting policy.

According to IAS 8, a change in accounting estimate must be recognised prospectively by including it in the statement of profit or loss and other comprehensive income for the current period and any future periods that are also affected.

However, to the extent that a change in an accounting estimate gives rise to changes in assets and liabilities, or relates to an item of equity, it is recognised by adjusting the carrying amount of the related asset, liability, or equity item in the period of the change.

Disclosures relating to changes in accounting estimates: Disclose:

• The nature and amount of a change in an accounting estimate that has an effect in the current period or is expected to have an effect in future periods

• If the amount of the effect in future periods is not disclosed because estimating it is impracticable, an entity shall disclose that fact.

Errors: The general principle in IAS 8 is that an entity must correct all material prior period errors retrospectively in the first set of financial statements authorised for issue after their discovery by: [IAS 8.42]

• Restating the comparative amounts for the prior period(s) presented in which the error occurred; or

• If the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented.

However, if it is impracticable to determine the period-specific effects of an error on comparative information for one or more prior periods presented, the entity must restate the opening balances of assets, liabilities, and equity for the earliest period for which retrospective restatement is practicable (which may be the current period). [IAS 8.44]

Further, if it is impracticable to determine the cumulative effect, at the beginning of the current period, of an error on all prior periods, the entity must restate the comparative information to correct the error prospectively from the earliest date practicable. [IAS 8.45]

Prior period errors: Prior period errors are mis-statements and omissions in the financial statements of prior periods as a result of not using reliable information that should have been available.

IAS 8 says that material prior period errors should be corrected retrospectively in the first set of financial statements authorised for issue after their discovery. Opening balances of equity or retain earning is restated and the comparative figures, should be adjusted to correct the error.

IAS 1 also requires that where a prior period error is corrected retrospectively, a statement of financial position is provided at the beginning of the earliest comparative period.

Disclosures relating to prior period errors: Disclosures relating to prior period errors include: [IAS 8.49]

• The nature of the prior period error

• For each prior period presented, to the extent practicable, the amount of the correction:

¾     for each financial statement line item affected, and

¾     or basic and diluted earnings per share (only if the entity is applying IAS 33)

• The amount of the correction at the beginning of the earliest prior period presented

• If retrospective restatement is impracticable, an explanation and description of how the error has been corrected.

Financial statements of subsequent periods need not repeat these disclosures.

Problems with IAS 8: It has been argued that the requirements of IAS 8 to adjust prior period errors retrospectively may lead to earnings management. By adjusting prior period errors through opening reserves, the impact is never shown within a current period statement of profit or loss.

ED/2017/5: Accounting policies and accounting estimates: There is diversity in practice in the way entities distinguish accounting policies from accounting estimates. The distinction is important as changes in these are accounted for in a different way. A change in an accounting policy to be accounted for retrospectively but a change in an accounting estimate is normally recognised in the current period.

The ED proposes amendments which aim to help distinguish accounting policies from accounting estimates by clarifying how they relate to each other, by explaining that accounting estimates are used in applying accounting policies.

The proposed definition of accounting estimates is that they are judgements or assumptions used in applying an accounting policy when, because of estimation uncertainty, an item in financial statements cannot be measured with precision. Selecting an estimation technique (or valuation technique) to measure an item involves the use of judgement or assumptions in applying the accounting policy for that item. Therefore, selecting an estimation technique (valuation technique) constitutes making an accounting estimate.

The ED proposes specific guidance on the selection of the FIFO cost formula or the weighted average cost formula for interchangeable inventories. The selection does not involve the use of judgement or assumptions to determine the sequence in which those inventories are sold. Therefore, the selection of a cost formula does not constitute making an accounting estimate but constitutes selecting an accounting policy.