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Chapter 2 - IAS 8 Accounting Policies, Changes in 1.1. IAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors Accounting Estimates and Errors
Definitions

Accounting policies – specific principles, bases, conventions, rules and practices applied in preparing and
presenting financial statements.
Change in accounting estimate – an adjustment to the carrying amount of an asset or liability (or the
amount of annual consumption of an asset) which results from a current assessment of expected future
benefits and obligations.

Changes in accounting estimates result from new information or developments and are not corrections of
errors. Examples include:
• a receivable balance that becomes irrecoverable;
• a change in the estimated useful life of a depreciable asset.

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1.1. IAS 8 Accounting Policies, Changes in 2.1. Selection and Application

Accounting Estimates and Errors 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.

Definitions
Key Point
Prior period errors – omissions and misstatements, relating to the financial statements for one or more If there is no applicable IFRS for a transaction, management must use its judgment in developing and
periods which arose from a failure to use, or the misuse of, reliable information which: applying an accounting policy which will provide information that:
• was available when the financial statements for those periods were authorised for issue; •is relevant to the economic decision-making needs of primary users;
• could reasonably be expected to have been obtained and taken into account when those financial •is reliable in that the financial statements;
statements were prepared and presented. • represent faithfully the entity’s financial position, performance and cash flows;
Errors may include the effects of mathematical mistakes, mistakes in the application of accounting policies, • reflect the economic substance of the transaction;
oversights and fraud. • are neutral;
• are prudent; and
• are complete, in all material aspects.

Management may consider:

•requirements of IFRS Standards dealing with similar transactions;
•the definitions and recognition criteria in the Framework;
•recent pronouncements of other standard-setting bodies which use a similar conceptual framework;
and
3 •any other accounting literature denoting best practice in a particular industry. 4

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2.1. Selection and Application 2.2. Consistency

Example 2 Inventory Valuation
Example 1 Absence of a Specific IFRS Standard
IAS 2 Inventories requires inventory to be measured at the lower of cost and net realisable value. In
identifying cost, it allows a choice of cost formulae: first-in, first-out (FIFO) and weighted average. The
Kitty has recently purchased a Van Gogh painting to display in a client reception area, with the hope
selection of a formula is an accounting policy. The same cost formula must be applied to similar items
that it will lead to more contracts and that the painting will appreciate.
of inventory, but a different cost formula can be applied to a different classification of inventory.
There is no specific IFRS Standard that deals with these types of asset, but IAS 40 Investment
Property does deal with a particular type of asset which is held for capital appreciation.
It would therefore seem appropriate to use IAS 40 as justification to remeasure the painting to fair value
year-on-year. If the fair value model of IAS 40 is used, IFRS 13 Fair Value Measurement will apply to
Key Point
the subsequent measurement of the painting.
The selection and application of accounting policies to transactions of a similar nature must
be consistent. This helps to achieve comparability

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2.3. Changes in Accounting Policy 2.3. Changes in Accounting Policy

2.3.1 When? 2.3.2 How?
A new or revised IFRS generally contains "transitional provisions" which should be applied to any
Key Point
change of accounting policy.
An entity can only change an accounting policy if:
•it is required to do so by an IFRS (i.e. a mandatory change); or Key Point
•the change would result in the financial statements providing more relevant and reliable information (i.e.
If there are no transitional provisions or the change in policy is voluntary, a change in policy is
a voluntary change).
applied retrospectively.
These restrictions are necessary because users need to be able to appreciate trends in reported
financial performance. Retrospective application means that:
An example of a voluntary change is adopting the fair value model of IAS 40 Investment Property. •the opening balance of each affected part of equity for the earliest period presented is adjusted; and
•the comparative amounts are disclosed for each prior period as if the new policy had always been
Key Point applied.
The requirements for accounting for a change to the revaluation model of IAS 16 Property, Plant and If it is not practicable to apply the effects of a change in policy to prior periods, the change is made
Equipment are prescribed in IAS 16 rather than IAS 8. from the earliest period for which retrospective application is practicable.

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2.3. Changes in Accounting Policy 2.4. Disclosure

2.3.3 Presentation (IAS 1) When a change is due to a new IFRS, the following must be disclosed:
• Title of new IFRS and the nature of the change in policy.
• When applicable, that the change is made in accordance with the IFRS's transitional provisions, a
description of those provisions and the effect that the provisions might have on future periods.
Key Point
Under IAS 1, when a change of policy occurs, or a prior period error is rectified, an additional statement For a voluntary change in policy, disclose:
of financial position must be presented at the start of the previous period presented (i.e. three • Nature of the change in policy.
statements). • Reasons why the new policy provides more reliable and relevant information.

For any change, the following should also be disclosed:

• For the current period and each prior period presented, the amount of the adjustment for each line
item affected in the financial statements.
• The amount of the adjustment relating to periods before those presented.
• If retrospective restatement is not practicable, the circumstances that led to the existence of the
condition and a description of how and from when the change has been applied.

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2.4. Disclosure 2.4. Disclosure

Example 3 Change in Accounting Policy Example 3 Change in Accounting Policy
Alpha, an incorporated entity, has previously followed a policy of capitalisation of development During the year ended 31 December 20X6, the company has expensed all expenditure in the period on
expenditure. It has recently decided to adopt the provisions of IAS 38 Intangible Assets for the year projects in respect of which, expenditure had previously been capitalised, and no amortisation has
ending 31 December 20X5. Alpha has been advised by their auditors that the expenditure previously been charged in the statement of profit or loss in 20X6.
capitalised does not qualify for capitalisation under the recognition criteria set out in the standard.The The following are extracts from the draft accounts for the year ended 31 December 20X6.
notes to the accounts for the year ended 31 December 20X5 in respect of the deferred development
expenditure was as follows: Statement of profit or loss 20X6 20X5
$ (as previously published)
$ $
Balance at 1 January 20X5 $1,000
Revenue 1,200 1,100
Additions 500
Expenses (800) (680)
Amortisation (400)
Profit for the year 400 420
Balance at 31 December 20X5 1,100
Statement of changes in equity
(extract) $ $
Balance as at 1 January 3,000 2,580
Profit for the year 400 420
11 Balance as at 31 December 3,400 3,000 12

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2.4. Disclosure 2.4. Disclosure

Example 3 Change in Accounting Policy Example 3 Change in Accounting Policy

Required: Solution
Show how the statement of profit or loss and statement of changes in equity would appear in the
financial statements for the year ended 31 December 20X6, processing the necessary adjustments in Statement of profit or loss 20X6 20X5
respect of the change in accounting policy by applying the new policy retrospectively. (as restated)
$ $
Revenue 1,200 1,100
Expenses (800) (780)

Profit for the year (Note 1) 400 320

Statement of changes in equity
(extract) $ $

Balance as at 1 January 20X6 1,900 2,580

Prior period adjustment (Note 2) − (1,000)

Restated balance 1,900 1,580
Profit for the year 400 320
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Balance as at 31 December 20X6 2,300 1,900

2.4. Disclosure 3.1. Estimation

Example 3 Change in Accounting Policy Example 3 Change in Accounting Policy

Solution
Many items recognised in the financial statements must be measured with an element of estimation
Notes: attached to them:
1.Alpha amortised $400 in 20X5 but spent $500. The policy would have been to write off the amount of •Receivables are reported net of an allowance for expected credit losses;
expenditure directly to the statement of profit or loss; therefore, last year's figures need to be adjusted •Inventory is measured at lower of cost and net realisable value with allowance made for obsolescence,
for an extra $100 expense.The adjustment against last year's statement of profit or loss ($100) restates etc;
it to what it would have been if the company had been following the same policy last year. This is •A provision under IAS 37 is often only a "best estimate" of the liability;
important because the statement of profit or loss must be prepared and presented on a comparable •Non-current assets are depreciated; the charge takes into account the expected pattern of
basis. consumption of the asset and its expected useful life. Both the depreciation method (reflecting the
2.The balance left on the deferred expenditure account at the start of the previous year ($1,000) is consumption pattern) and useful life are estimates.
written off against the accumulated profit which existed at that time.

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3.2. Accounting Treatment 3.3. Disclosure

Key Point •The nature and amount of a change in estimate which has an effect in the current period or is expected
to have an effect in future periods.
When a change in circumstances occurs which affects the estimates previously made, the effect of
•If it is not possible to estimate the effects on future periods, that fact must be disclosed.
that change is recognised prospectively in the current and future (where relevant) periods' profit or
loss.

A change in estimate is not an error or a change in accounting policy and therefore does not affect
prior period statements.
If the change in estimate affects the measurement of assets or liabilities, the change is recognised by
adjusting the carrying amount of the asset or liability.

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4.1. Accounting Treatment 4.1. Accounting Treatment

Key Point
Example 4 Prior Period Error Accounting Treatment
An error is corrected retrospectively.
In the year ended 31 December 20X6, a prior period error of $12m is identified. Of this error, $2m
relates to 20X6; $3m relates to 20X5; $4m relates to 20X4; and $3m relates to 20X3.
The financial statements of the current period are presented as if the error had never been made: The opening retained earnings as of 1 January 20X5 will be adjusted by the sum of the error for
• comparatives are restated; and 20X3 and 20X4 of $7m; 20X5's profits will be adjusted for the error of $3m; and the $2m relating to
• if the error affected a period earlier than the comparative period, the opening equity balance at the 20X6 will be reflected in that year's profit or loss.
start of the comparative period is adjusted.

IAS 1 requires an entity to include an additional statement of financial position (i.e. three statements)
whenever it makes a retrospective restatement.

If it is not practicable to determine the period-specific effects of an error on comparative information

for prior periods presented, the opening balances are restated for the earliest period for which
retrospective restatement is practicable.

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4.2. Disclosure Summary

The disclosure requirements that accompany the retrospective restatement are: • Changes in accounting policies are not changes in estimates.
• Nature of the error.
• Changes in accounting estimates are not corrections of errors.
• For each prior period presented the amount of the correction for each line item affected in the
financial statements. • A change in policy may be required by a standard or be voluntary.
• The amount of the correction at the beginning of the earliest period presented.
• A change in estimate is accounted for prospectively.
• If retrospective restatement is not practicable, the circumstances which led to the existence of the
condition and a description of how and from when the error has been corrected. • Changes in accounting policy are accounted for retrospectively unless a new/revised standard specifies
otherwise (in transitional provisions).
• The correction of prior period errors is accounted for retrospectively.
• Retrospective application means:
• adjusting opening balances in equity (e.g. retained earnings) for the earliest prior period
presented; and
• restating comparative amounts.

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