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Chapter 18 Accounting Policies, Estimates and Errors Reference: IAS 8, IAS 1

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Chapter 18 Accounting Policies, Estimates and Errors Reference: IAS 8, IAS 1 Gripping IFRS Accounting Policies, Estimates and Errors Chapter 18 Accounting Policies, Estimates and Errors Reference: IAS 8, IAS 1 Contents: Page 1. Introduction 570 2. Accounting policies 570 2.1 Overview 570 2.2 Choosing and applying accounting policies 570 2.3 Developing your own accounting policy 570 2.3.1 Relevance 570 2.3.2 Reliability 570 2.3.3 Judgement 571 3. Changes in accounting policy 571 3.1 Overview 571 3.2 How to adjust for a change in accounting policy 571 3.2.1 Retrospective application 572 3.2.2 Prospective application 572 3.3 Disclosure of a change in accounting policy 572 Example 1: change in accounting policy 573 4. Changes in accounting estimates 577 4.1 Overview 577 4.2 How to adjust for a change in accounting estimate 577 Example 2: change in estimated useful life: reallocation 578 Example 3: change in estimated useful life: cumulative catch-up 579 4.3 Disclosure of a change in an accounting estimate 580 Example 4: disclosure of a change in accounting estimate 580 Example 5: change in estimated residual value: reallocation 581 Example 6: change in residual value: cumulative catch-up 583 5. Correction of errors 585 5.1 Overview 585 5.2 How to correct an error and disclose the corrections 585 5.2.1 All errors that occurred in the current period 585 Example 7: correction of errors occurring in the current period 585 5.2.2 Immaterial errors that occurred in a prior period/s 586 Example 8: correction of immaterial errors occurring in a prior 587 year/s 5.2.3 Material errors that occurred in a prior period/s 588 Example 9: correction of a material errors occurring in a prior 588 period/s Example 10: correction of a material error occurring in a prior 591 period/s 6. Summary 596 569 Chapter 18 Gripping IFRS Accounting Policies, Estimates and Errors 1. Introduction IAS 8 covers four main areas, namely: • selecting accounting policies; • changes in accounting policies; • changes in accounting estimate; and • correction of prior period errors. 2. Accounting policies (IAS 8.7 - .13) 2.1 Overview Accounting policies are defined as ‘the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements’. It is important to emphasise to you that an ‘accounting policy’ is very different to any ‘policy’. The business entity may have a ‘policy’ of donating 10% of its profits to a charity each month and you may have a ‘policy’ of not taking your worries home with you at night. You may even have an insurance policy. We are, however, only concerned with the policies that are adopted by the accountant in connection with the preparation and presentation of financial statements. These policies are really the rules, as set out in the IFRSs, and the practices used by the entity when drawing up the annual financial statements. Accounting policies must be applied consistently from one period to the next. This will ensure that a user is able to compare the financial statements of the current period with financial statements of previous periods and in so doing be able to assess what the trends are within the entity (e.g. rising profits or reducing investment in assets). 2.2 Choosing and applying accounting policies (IAS 8.7 - .9) Accounting policies used must comply with the requirements of the relevant IFRSs. On rare occasions, it may happen that you cannot find an accounting policy suitable to the transaction or event affecting your entity. In this case, the management of the entity (which will mean you, the accountant) will need to develop your own accounting policy! 2.3 Developing your own accounting policy (IAS 8.10 - .12) When forced to develop your own accounting policy, the most important thing to remember is that you need to prepare financial statements that provide relevant and reliable information. 2.3.1 Relevance In order to ensure relevance, ask yourself whether the item is material to the user in his decision-making: it stands to reason that users are not interested in immaterial information. 2.3.2 Reliability For items to be reliable, it means that the information provided • is a faithful representation of the events and transactions that affected the entity; • shows the substance rather than the legal form of the transaction (legal jargon can often be misleading, for example, if you carefully read what the lawyers call a ‘finance lease agreement’ you will see that it really relates to the purchase of an item – not the lease thereof, in which case we record such a transaction as a purchase (the substance/ reality) – not a lease (its legal form)); • be neutral (i.e. it must not include material error/ bias); • be prudent (always be on the more cautious or pessimistic side but not so much so that you end up hiding reserves or profits belonging to the entity!); • be complete (within the confines of materiality and cost). 570 Chapter 18 Gripping IFRS Accounting Policies, Estimates and Errors 2.3.3 Judgement (IAS 8.11 - .12) On occasion, it may be difficult to understand an accounting policy or how to apply it and you may need to use your professional judgement. Professional judgement is required even more so if you find yourself having to develop your own accounting policy for a certain transaction. This judgement of yours should be based on the following (and in this order!): • the official interpretation of the standard (if any); • any standards and interpretations on similar issues; • the definitions, recognition criteria and measurement concepts in the Framework; and • any recent pronouncements of other standard setting bodies, other accounting literature and industry accepted practices to the extent that these do not conflict with the interpretations, similar standards and the Framework. 3. Changes in accounting policy (IAS 8.14 - .31) 3.1 Overview (IAS 8.14 - .18 In order to achieve comparability and consistency from one year to the next, the accounting policies adopted by an entity are very rarely changed. This does not mean that they never change. IAS 8 refers to two reasons for which a change would be considered acceptable: • when required by an IFRS; or • when the change will result in reliable and more relevant presentation of information. In order to maintain a measure of comparability, substantial disclosure is required when there is a change in accounting policy. The treatment and disclosure required varies depending on whether the change is one that is required as a result of: • the initial application of an IFRS in which: − transitional provisions are furnished; or − no transitional provisions are furnished; or • a voluntary change in accounting policy. IAS 8 specifically refers to two situations when the adoption of an accounting policy should not be considered a ‘change in policy’. These two situations are when the adoption of an accounting policy relates to an event or transaction that either: • differs in substance from previously occurring events or transactions; or • did not occur previously or that were previously immaterial. 3.2 How to adjust for a change in accounting policy (IAS 8.19 - .27) In the event that the change in accounting policy is as a result of the initial application of an IFRS in which transitional provisions are given, these provisions should take precedence over the general guidance supplied in IAS 8. If the change is as a result of the initial application of an IFRS in which transitional provisions are not given or it is a voluntary change in accounting policy, the general guidance given in IAS 8 needs to be followed. Only the general guidance in IAS 8 will be discussed in this chapter. A change in accounting policy that results from: • applying an IFRS for the first time where there are no transitional provisions, or • a voluntary change in accounting policy must be applied retrospectively unless it is impracticable to do so. IAS 8 defines an impracticable requirement as a requirement that is simply not possible to apply ‘after making every reasonable effort to do so’. 571 Chapter 18 Gripping IFRS Accounting Policies, Estimates and Errors 3.2.1 Retrospective application (IAS 8.22 - .27) The retrospective application of a change in accounting policy entails stating both the current year’s figures based on the new policy as well as adjusting all prior years’ figures in accordance with the new policy (i.e. as if the ‘policy had always been applied’). It may not, however, always be possible to calculate the effect on all the prior years’ figures, in which case the new policy is applied from the earliest prior period possible and the cumulative effect on the assets, liabilities and equity before this period are simply disregarded. All prior periods that are given as comparatives in an annual report (even if not part of the financial statements for example any additional reports provided) must be restated based on the new policy. All prior periods that are not given as comparatives must still be adjusted, but with the cumulative effect on the opening balance of retained earnings disclosed as a single adjustment (e.g. in the statement of changes in equity). Where the calculation of the adjustment to a specific prior period/s is impracticable (not possible), the accounting policy is simply applied to the elements from as early as possible with a net adjustment made to the opening retained earnings from this ‘earliest year’. 3.2.2 Prospective application Applying a new policy prospectively means that the policy is applied to only the current and future years with prior years’ figures remaining unchanged.
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