FINANCIAL ACCOUNTING & REPORTING 3

1
Statement of Changes in Equity, Accounting Policies, Changes in Accounting
Estimates and Errors

Module 014 Week005- Statement of Changes in

Equity, Accounting Policies, Changes in
Accounting Estimates and Errors
In April 2001 the International Accounting Standards Board (the Board)
adopted IAS 8 Net Profit or Loss for the Period, Fundamental Errors and
Changes in Accounting Policies, which had originally been issued by the
International Accounting Standards Committee in December 1993. IAS 8 Net
Profit or Loss for the Period, Fundamental Errors and Changes in Accounting
Policies replaced IAS 8 Unusual and Prior Period Items and Changes in
Accounting Policies (issued in February 1978).
In December 2003 the Board issued a revised IAS 8 with a new title—
Accounting Policies, Changes in Accounting Estimates and Errors. This
revised IAS 8 was part of the Board's initial agenda of technical projects. The
revised IAS 8 also incorporated the guidance contained in two related
Interpretations (SIC-2 Consistency—Capitalization of Borrowing Costs and
SIC-18 Consistency—Alternative Methods).
IAS 8 therefore has identified two main categories of accounting changes
namely:
 Change in accounting estimate
 Change in accounting policy
Accounting changes can have a great impact on an entity’s reported earnings.
Thus, it is critically important that the users of financial statements
understand the nature and effect of accounting changes and must not rely
solely on the bottom line which is the net income or loss.
At the end of this module, you will be able to:
1. Understand the concept of accounting policies
2. Identify the basis for selecting accounting policies
3. Explain the application of accounting policies
4. Identify and explain the changes in accounting estimate
5. Understand the treatment of a change in accounting estimate

Course Module
 FINANCIAL ACCOUNTING & REPORTING 3
2
Statement of Changes in Equity, Accounting Policies, Changes in Accounting
Estimates and Errors

Accounting policies

Accounting policies are defined as “the specific principles, methods, practices, rules, bases
and conventions adopted by an entity in preparing and presenting the financial statements.
Accounting policies are essential for a proper understanding of the information contained
in the financial statements. An entity is required to outline all significant accounting
policies applied in preparing financial statements.
Under accounting standards, alternative treatments are possible. In this case, it becomes all
the more important for an entity to clearly state the accounting policies used in preparing
financial statements.

Basis for selecting accounting policies

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.
IFRSs set out accounting policies that the IASB has concluded result in financial statements
containing relevant and reliable information about the transactions, other events and
conditions to which they apply. Those policies need not be applied when the effect of
applying them is immaterial. However, it is inappropriate to make, or leave uncorrected,
immaterial departures from IFRSs to achieve a particular presentation of an entity's
financial position, financial performance or cash flows.
IFRSs are accompanied by guidance to assist entities in applying their requirements. All
such guidance states whether it is an integral part of IFRSs. Guidance that is an integral part
of the IFRSs is mandatory. Guidance that is not an integral part of the IFRSs does not
contain requirements for financial statements.
Management’s judgement for selecting accounting policies
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 the entity;
(ii) reflect the economic substance of transactions, other events and conditions, and
not merely the legal form;
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Statement of Changes in Equity, Accounting Policies, Changes in Accounting
Estimates and Errors

(iii) are neutral, i.e. free from bias;

(iv) are prudent; and
(v) are complete in all material respects.
In making the judgement described above, management shall refer to, and consider the
applicability of, the following sources in descending order:
(a) the requirements 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
In addition, 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 these sources.

Application of accounting policies

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

Changes in accounting policies

A change in accounting policy arises when an entity adopts a generally accepted

accounting principle which is different from the one previously used by the entity.
Once selected, accounting policies must be applied consistently for similar transactions and
events. A change in accounting policy shall be made only when:
 Required by an accounting standard or an interpretation of the standard.
 The change will result in more relevant and faithfully presented information about the
financial position, financial performance and cash flows of the entity.
Examples of change in accounting policy are:
a.Change in the method of inventory pricing from the FIFO to weighted average method.
b.Change in the method of accounting for long term construction contract.
c.The initial adoption of policy to carry assets at revalued amount.
d.Change from cost model to fair value model in measuring investment property and
property, plant and equipment.
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Statement of Changes in Equity, Accounting Policies, Changes in Accounting
Estimates and Errors

e. Change to a new policy resulting from the requirement of a new IFRS

The following are not changes in accounting policy:
a. The application of an accounting policy for events or transactions that differ in
substance from previously occurring events or transactions.
b. The application of a new accounting policy for events or transactions which did not
occur previously or that were immaterial.
Reporting a change in accounting policy
A change in accounting policy required by a standard or an interpretation shall be applied
with the transitional provisions therein.
If the standard or interpretation contains no transitional provisions or if an accounting
policy is changed voluntarily, the change shall be applied retrospectively or
retroactively.
Retrospective application
Retrospective application is applying a new accounting policy to transactions, other events
and conditions as if that policy had always been applied.
IAS 8, paragraph 22, provides that “an entity shall adjust the opening balance of each
affected component of equity for the earliest prior period presented and the comparative
amounts disclosed for each prior period presented as if the new policy had always been
applied.
Simply stated, retrospective application means that any resulting adjustment from the
change in accounting policy shall be reported as an adjustment to the opening balance of
retained earnings. The amount of the adjustment is determined as of the beginning of the
year of change.
However, the adjustment may be made to another component of equity, not retained
earnings, in order to comply with another standard.
If comparative information is presented, the financial statements of the prior period
presented shall be restated to conform with the new accounting policy.
The impact of the new policy on the retained earnings prior to the earliest period
presented shall be adjusted against the opening balance of retained earnings.
Limitation of retrospective application
Retrospective application of a change in accounting policy is not required if it is
impracticable to determine the cumulative effect of the change.
Applying a requirement of a standard is impracticable when the entity cannot apply it after
making every effort to do so.
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Statement of Changes in Equity, Accounting Policies, Changes in Accounting
Estimates and Errors

For a particular prior period, it is impracticable to supply a change in an accounting policy

when:
 The effects of the retrospective application are not determinable
 The retrospective application requires assumptions about what management’s
intentions would have been at that time.
 The retrospective application required significant estimate, and it is impossible to
distinguish objectively information about the estimate that:
a. Provides evidence of circumstances that existed at that time, and
b. Would have been available at that time.
Prospective application
When it is impracticable for an entity to apply a new accounting policy retrospectively
because it cannot determine the cumulative effect of applying the policy to all prior
periods, the entity shall apply the new policy prospectively from the earliest period
practicable.
In other words, if the amount of the adjustment on the opening balance of retained
earnings cannot be reasonably determine, the change in accounting policy shall be applied
prospectively.
Prospective application means that the new accounting policy is applied to events and
transactions occurring after the date at which the policy is changed.
No adjustment relating to prior period are made either to the opening balance of retained
earnings or other component of equity because existing balances are not recalculated.
Change in reporting entity
A change in reporting entity is a change whereby entities change the nature and report
their operations in such a way that the financial statements are in effect those of a different
reporting entity.
For example, this accounting change may result from changing the specific subsidiaries
comprising the group of entities for which consolidated financial statements are presented.
A change in reporting entity is actually a change in accounting policy and therefore shall
be treated retrospectively or retroactively to disclose what statements would have looked
like if the current entity had been existence in the prior year.
In other words, the financial statements of all prior periods presented shall be restated to
show financial information for the new reporting entity.

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Statement of Changes in Equity, Accounting Policies, Changes in Accounting
Estimates and Errors

Treatment of a change in accounting estimate

IAS 8, paragraph 5, defines a change in accounting estimate as an “adjustment of the

carrying amount of an assets or a liability, or the amount of the period consumption of an
asset that results from assessment of the present status and expected future benefit and
obligation associated with the asset and liability.
Simply stated, a change in accounting estimate is a normal recurring correction or
adjustment of an asset or liability which is the natural result of the use of an estimate.
The use of reasonable estimate is an essential part of the preparation of financial
statements and does not undermine their reliability.
An estimate may need revision if changes occur regarding the circumstances on which the
estimate was based or as a result of new information, more experience or subsequent
development.
By its very nature, the revision of the estimate does not relate to prior periods and is not a
correction of an error.
A change in measurement basis is a change in accounting policy and not a change in
accounting estimate.
Sometimes it is difficult to distinguish a change in accounting estimate and a change in
accounting policy.
In such a case, the change is treated as a change in accounting estimate, with appropriate
disclosure.
Examples of accounting estimate:
As a result of uncertainties in business activities, many items in financial statements cannot
be measured with precision but can only be estimated. Estimation involves judgement
based on the latest available and reliable information.
Estimates may be required for the following:
 Bad debts
 Inventory obsolescence
 Useful life, residual value, and expected pattern of consumption of benefit of
depreciable asset
 Warranty cost
 Fair value of financial assets and financial liabilities

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Statement of Changes in Equity, Accounting Policies, Changes in Accounting
Estimates and Errors

How to report change in accounting estimate

The effect of a change in accounting estimate shall be recognized currently and
prospectively by including it in income or loss of:
 The period of change if the change affects that period only.
 The period of change and future periods if the change affects both.
To the extent that a change in accounting estimate gives rise to changes in assets and
liabilities, or related to item of equity, it shall be recognized by adjusting the carrying
amount of the related asset, liability or equity in the period of change.
A change in an accounting estimate shall not be accounted for by restating amounts
reported in financial statements of prior periods.
Otherwise stated, changes in accounting estimates are not prior period errors and,
therefore, no adjustment is necessary to effect the change.
Changes in accounting estimates are to be handled currently and prospectively, if necessary.
For example, a change in the estimate of the amount of uncollectible accounts receivable
affects only the current period and therefore is recognized immediately.
However, a change in the estimated useful life or expected pattern of consumption of
benefits of a depreciable asset affects the depreciation expense in the current period and in
each period during the remaining useful life of the asset.
Prospective recognition of the effect of a change in accounting estimate means that the
change is applied to transactions, other events and conditions from the date of change in
estimate.
Change in depreciation method
A change in depreciation method is accounted for as a change in accounting estimate.
IAS 16, paragraph 61, provides that “the depreciation method shall be reviewed at least at
each financial year-end and if there has been a significant change in the expected pattern of
consumption of the future economic benefits embodied in an asset, the method shall be
changed to reflect the changed pattern, and such change shall be accounted for as a change
in accounting estimate.”

Course Module
 FINANCIAL ACCOUNTING & REPORTING 3
8
Statement of Changes in Equity, Accounting Policies, Changes in Accounting
Estimates and Errors

References and Supplementary Materials

Books and Journals

Valix, C., Peralta, J. & Valix, C.A; 2016; Financial Accounting Volume 3; Metro Manila,
Philippines; GIC Enterprises & Co., Inc.

Valix, C., Peralta, J. & Valix, C.A; 2016; Financial Accounting Volume 1; Metro Manila,
Philippines; GIC Enterprises & Co., Inc.
Barry Elliot, Jamie Elliot; 2011; Financial Accounting and Reporting; Essex CM20 2JE,
England; Pearson Education Limited

Online Supplementary Reading Materials:

International Financial Reporting Standards – IAS 8 Accounting Policies, Changes in

Accounting Estimates and Errors; http://www.ifrs.org/issued-standards/list-of-
standards/ias-8-accounting-policies-changes-in-accounting-estimates-and-errors/;
October 29, 2017

Preparing Statements of Changes in Owner’s Equity;

https://www.sophia.org/tutorials/preparing-statements-of-changes-in-owners-equity--3;
October 29,2017

Changes in Equity: Revenue and Expenses; http://www.understand-

accounting.net/revenue.html; October 29, 2017

Online Instructional Videos:

Financial Statements- Lecture 6- Statement of Changes in Equity;

https://www.bing.com/videos/search?q=statement+of+changes+in+equity&&view=detail
&mid=4BD8DBCAFBD3B1A8E00F4BD8DBCAFBD3B1A8E00F&FORM=VRDGAR; January
10, 2018

Module 1 Video 5 – Preparing the Statement of Changes in Equity- Problem 1-3A ;

https://www.bing.com/videos/search?q=statement+of+changes+in+equity&&view=detail
&mid=F5B0ADB47BA15C699AA7F5B0ADB47BA15C699AA7&&FORM=VDRVRV ; January
10, 2018
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9
Statement of Changes in Equity, Accounting Policies, Changes in Accounting
Estimates and Errors

Course Module