03-IAS 8 Accounting Policies, Changes in Estimates and Correction of Errors
Transcript of 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
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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 Practice Questions
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Class Practice Questions
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