ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS
The objective of this Standard is to prescribe the criteria for selecting and changing accounting policies, the accounting treatment and disclosure of changes in accounting policies, accounting estimates and corrections of errors.
Accounting Policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements.
Material Omissions or misstatements of items are material if they could, influence the economic decisions that users make on the basis of the financial statements.
SELECTION OF ACCOUNTING POLICIES
Management selects accounting policies by applying accounting standards or using judgment:
Compulsory – Where a specific standard relates to a transaction or event, the accounting policy applied to that item shall be determined by applying that standard.
Voluntary – Where there is no specific standard to deal with a particular transaction, event or condition, management shall develop and apply accounting policies resulting in reliable .and more relevant information.
In developing accounting policy management should consider:
- The requirements and guidance of accounting standards dealing with similar and related issues; and
- The contents of the Accounting Framework for the Preparation and Presentation of Financial statements (The Framework).
CHANGE IN ACCOUNTING POLICIES
The management can change accounting policy under the following circumstances:
Compulsory – Where a change is required by a specific standard or interpretation (external).
Voluntary – Management determines that a change in policy will result in the financial statements providing reliable and more relevant information (internal).
Consistency in accounting policies
Although accounting policies can and sometimes must be changed in order to achieve comparability there is an underlying requirement to be consistent in the selection and application of accounting policies.
To improve comparability, consistency requires that the same accounting policies should be applied to similar items within each period, and from one period to the next.
Meaning of Relevant and Reliable
Relevant information helps the user to make economic decisions.
Reliable financial statements:
- Present faithfully the effects of transaction on financial position, financial performance and cash flows;
- Reflect the economic substance or transactions, other events and conditions
- Be neutral (no bias or error)
- Be prudent
- Be complete in all material respects.
Application of Changes in Accounting Policy
The change in accounting policy is applied retrospectively
Compulsory/Specific – Where a new standard/Interpretation forces a change in accounting policy and that standard has specific transitional provisions then the entity must apply those provisions in accounting for the change.
Compulsory/Non-Specific – Where the change in accounting policy is compulsory but with no specific transitional provisions, the change shall be applied retrospectively.
Voluntary – Where the change is voluntary, the change shall be applied retrospectively.
It is applying a new accounting policy to transactions and other events as if that policy had always been applied, i.e. make prior period adjustments.
This means restating the opening balance 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.
Items NOT changes in accounting policy
IAS 8 states that the introduction of an accounting policy to account for transactions where circumstances have changed are not a change in accounting policy.
Similarly, a policy for transactions that did not occur previously or that were immaterial is not a change in policy and therefore would be applied prospectively.
Limitations of Retrospective Application
IAS 8 does not permit the use of hindsight when applying a new accounting policy, either in making assumptions about what management’s intentions would have been in a prior period or in estimating amounts to be recognised, measured or disclosed in a prior period.
When it is impracticable to determine the effect of a change in accounting policy on comparative information, the entity is required to apply the new policy to the carrying amounts of the assets and liabilities as at the beginning of the earliest period for which retrospective application is practicable. This could actually be the current period but the entity should attempt to apply the policy from the earliest date possible.
The application of the requirement of a standard or interpretation is “impracticable” if the entity cannot apply it after making every effort to do so.
Disclosures for Changes in Accounting Policies
When initial application of the standard or interpretation has an effect on current or prior periods, would have an effect but it is impracticable to determine, or might have an effect, then entities shall disclose:
- The title of the Standard or Interpretation;
- If applicable, that the changes were made in accordance with the transitional provisions; The nature of the change;
In addition, for voluntary changes in accounting policies, a description must be provided of the reason for the new policy providing reliable and more relevant information.
CHANGES IN ACCOUNTING ESTIMATES
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.
Where the basis of measurement for the amount to be recognised is uncertain, an entity will use an estimation technique, which is a normal part of the preparation of the financial statements without undermining their reliability.
Estimates involve judgments based on the latest available, reliable information and are applied in determining the useful lives of property, plant and equipment, provisions, fair values of financial assets and liabilities and actuarial assumptions relating to defined benefit pension schemes.
Many items in financial statements cannot be measured with precision but will be estimated. Estimation involves judgment based on the latest available reliable information. Examples include:
- Estimating the recoverability of receivables at the year end, i.e. bad debts
- Inventory obsolescence
- Fair values of assets/liabilities
- Determining the remaining useful lives of; or the expected patterns of consumption of depreciable assets
- Estimating Income tax expenses
Comparison between change in accounting policy and estimate
Accounting estimates need to be distinguished from accounting policies as the effect of a change in an estimate is reflected in the Statement of profit or loss and other comprehensive income, whereas a change in accounting policy will generally require a prior period adjustment. If there is a change in the circumstances on which the estimate was based or new information has arisen or more experience relating to the estimation process has occurred, then the estimate may need to be changed. A change in the measurement basis is not a change in an accounting estimate, but is a change in accounting policy. For example, if there is a move from historical cost to fair value, this is a change in accounting policy but a change in the method of depreciation is a change in accounting estimate.
Accounting for changes in estimates
The effect of a change in an accounting estimate shall be recognized prospectively by including it in profit or loss in:
- The period of the change, if the change affects that period only e.g. change is estimated irrecoverable and doubtful debts; or
- The period of the change and future periods, if the change affects both e.g. change in useful life of a depreciable asset.
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 shall be recognized by adjusting the carrying amount of the related asset, liability or equity item in the period of the change.
Prior period errors are omissions from, and misstatements in, the entity‘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 authorized for issue; and
- Could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements.
Accounting for errors
An entity shall correct material prior period errors retrospectively in the first set of financial statements authorized for issue after their discovery by:
- 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