IAS-8

ACCOUNTING POLICIES, CHANGES IN

ACCOUNTING ESTIMATES AND ERRORS
OBJECTIVE

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
Definitions:

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:
a) The requirements and guidance of
accounting standards dealing with similar and
related issues; and
b) 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.

Retrospective application

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 introductions 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
recognized, 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

Definition

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 recognized 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.

ERRORS

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.
QUESTIONS AND ANSWERS
QUESTION 1
In February 20X2, an inter-city train did what appeared to be superficial damage
to a storage facility of a local company. The directors of the company expressed
an intention to sue Verge but in the absence of legal proceedings, Verge had not
recognized a provision in its financial statements to 31 March 20X2. In July 20X2,
Verge received notification for damages of $1.2 million, which was based upon
the estimated cost to repair the building. The local company claimed the
building was much more than a storage facility as it was a valuable piece of
architecture which had been damaged to a greater extent than was originally
thought. The head of legal services advised Verge that the company was clearly
negligent but the view obtained from an expert was that the value of the
building was $800,000. Verge had an insurance policy that would cover the first
$200,000 of such claims. After the financial statements for the year ended 31
March 20X3 were authorized, the case came to court and the judge determined
that the storage facility actually was a valuable piece of architecture. The court
ruled that Verge was negligent and awarded $300,000 for the damage to the
fabric of the facility.

A provision is defined by IAS 37 Provisions,

Contingent Liabilities and Contingent Assets as
a liability of uncertain timing or amount. IAS
37 states that a provision should only be
recognized if:

There is a present obligation as the result of

a past event
An outflow of resources embodying
economic benefits is probable; and
A reliable estimate of the amount can be
made.

If these conditions apply, a provision must be

recognized. The past event that gives rise,
under IAS 37, to a present obligation, is known
as the obligating event. The obligation may be
legal, or it may be constructive (as when past
practice creates a valid expectation on the part
of a third party). The entity must have no
realistic alternative but to settle the
obligation.

Year ended 31 March 20X2

In this case, the obligating event is the damage

to the building, and it took place in the year
ended 31 March 20X2. As at that date, no legal
proceedings had been started, and the damage
appeared to be superficial. While Verge should
recognise an obligation to pay damages, at 31
March 20X2 the amount of any provision
would be immaterial. It would a best estimate
of the amount required to settle the obligation
at that date, taking into account all relevant
risks and uncertainties, and at the year end the
amount does not look as if it will be substantial.

Year ended 31 March 20X3

IAS 37 requires that provisions should be

reviewed at the end of each accounting
period for any material changes to the best
estimate previously made. The legal action will
cause such a material change, and Verge will
be required to reassess the estimate of likely
damages. While the local company is claiming
damages of $1.2m, Verge is not obliged to
make a provision for this amount, but rather
should base its estimate on the legal advice
it has received and the opinion of the expert,
both of which put the value of the building at
$800,000. This amount should be provided for
as follows.

DEBIT Profit or loss for the year $800,000

CREDIT Provision for damages $800,000

Some or all of the expenditure needed to settle

a provision may be expected to be recovered
from a third party, in this case the insurance
company. If so, the reimbursement should be
recognized only when it is virtually certain
that reimbursement will be received if the
entity settles the obligation.
The reimbursement should be treated as a
separate asset, and the amount recognized
should not be greater than the provision
itself.
The provision and the amount recognized for
reimbursement may be netted off in profit or
loss for the year.

There is no reason to believe that the insurance

company will not settle the claim for the first
$200,000 of damages, and so the company
should accrue for the reimbursement as
follows.

DEBIT Receivables $200,000

CREDIT Profit or loss for the year $200,000

Verge lost the court case and is required to pay

$300,000. This was after the financial
statements were authorized, however, and so it
is not an adjusting event per IAS 10, Events
after the reporting period. Accordingly the
amount of the provision as at 31 March 20X3
does not need to be adjusted.

QUESTION 61(A)
Due to the complexity of International Financial Reporting Standards (IFRS),
often judgments used at the time of transition to IFRS have resulted in prior
period adjustments and changes in estimates being disclosed in financial
statements. The selection of accounting policy and estimation techniques is
intended to aid comparability and consistency in financial statements. However,
IFRS also place particular emphasis on the need to take into account qualitative
characteristics and the use of professional judgment when preparing the financial
statements. Although IFRS may appear prescriptive, the achievement of all the
objectives for a set of financial statements will rely on the skills of the preparer.
Entities should follow the requirements of IAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors when selecting or changing accounting policies,
changing estimation techniques, and correcting errors.

However, the application of IAS 8 is additionally often dependent upon the

application of materiality analysis to identify issues and guide reporting. Entities
also often consider the acceptability of the use of hindsight in their reporting.
Required
(I) discuss how judgment and materiality play a significant part in the selection of
an entity's accounting policies.

(i) Judgment and materiality in selecting

accounting policies
The selection of accounting policies in the
preparation of financial statements is important
in providing consistency, comparability and
clarity to users of those statements. In general
entities do not have a great deal of discretion,
but must follow the accounting policies required
by IFRS that are relevant to the particular
circumstances of the entity. In certain
circumstances, however, IFRS offers a choice
or does not give guidance. In these situations,
management should select appropriate
accounting policies.

Judgment

Management is required to exercise judgment

in developing and applying an accounting
policy that results in information that is relevant
and reliable. If there is no IFRS standard or
interpretation that is specifically applicable,
management should consider the applicability
of the requirements in IFRS on similar and
related issues, and then the definitions,
recognition criteria and measurement concepts
for assets, liabilities, income and expenses in
the Conceptual Framework. 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 IFRS.

Unless a standard permits or requires

otherwise, accounting policies should be
applied consistently to similar transactions
and events. For example, it is permissible to
carry some items of property, plant and
equipment at fair value and some at historical
cost, but items within any one class of property,
plant and equipment must be treated in the
same way.

Management's judgment will be constrained as

regards its selection of accounting policies (or
changes in accounting policies or estimates) by
the need to follow the requirements of IAS 8
Accounting Policies, Changes in Accounting
Estimates and Errors.

Materiality
IAS 8 states that omissions or misstatements of
items 'are material if they could, by their size or
nature, individually or collectively, influence the
economic decisions of users taken on the basis
of the financial statements'.
In general, IFRS only apply to material items,
and an accounting policy need not be applied if
its effect would be immaterial. Similarly, a
change in accounting policy or estimate would
only be necessary if the item was material.

Specifically in the context of IAS 8 and errors,

materiality 'depends on the size and nature of
the omission or misstatement judged in the
surrounding circumstances. The size or nature
of the item, or a combination of both, could be
the determining factor'.

In addition, IAS 8 notes that it is inappropriate

to make, or leave uncorrected, immaterial
departures from IFRSs to achieve a
particular presentation, so the principle of
materiality cannot be abused to present the
results in an artificially favorable light.
(ii) Discuss the circumstances where an entity may change its accounting
policies, setting out how a change of accounting policy is applied and the
difficulties faced by entities where a change in accounting policy is made.

(ii) Change in accounting policy

IAS 8 allows a change in accounting policy

only where required by a standard
or if it results in financial statements providing
reliable and more relevant information about
the effects of transactions, other events or
conditions on the entity's financial position,
financial performance, or cash flows. Changes
in accounting policy should be very rare,
because IFRS specifies the accounting policies
for most of the transactions an entity will make.
Changes in accounting estimates, on the other
hand, will be more frequent. 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'. Such
changes may be needed to estimate the figures
correctly in order to comply with an accounting
policy.

IAS 8 notes that changes in accounting policies

do not include applying an accounting
policy to a kind of transaction or event that
did not occur previously or were immaterial.
Such a policy would be applied prospectively,
that is prior period figures would not be
adjusted. For example, if an entity begins to let
out its head office to residents to earn rental
income, this change of use of the building
would mean that it should be accounted for as
an investment property under IAS 40.

However, this is not a change of accounting

policy, rather it is the application of a standard
to an asset to which it did not apply previously,
and so there would be no retrospective
application.

If a change in accounting policy is required by a

new IFRS or interpretation, the change is
accounted for as required by that new
pronouncement if the new pronouncement
includes specific transition provisions. Not all
new standards and interpretations include
transition provisions, and if none are included
then the change in accounting policy is applied
retrospectively.

Retrospective application means that an

entity adjusts the opening balance of each
component of equity that is affected for the
earliest prior period presented in the
financial statements. It also adjusts the other
comparative amounts, that is, amounts in the
statement of profit or loss and other
comprehensive income, and the statements of
financial position, cash flows and changes in
equity and related notes. The comparative
amounts disclosed for each prior period
presented as if the new policy had always
applied. This rule applies except where it is
impracticable to determine either the period-
specific effects of the change or the cumulative
effects of the change.

It is sometimes difficult to compare the

current period with prior periods because there
is insufficient data relating to the prior period.
Perhaps it was not foreseen that such data
would be needed. Even if the data is available,
restatement of prior information often requires
complex and detailed estimates to be made,
although this does not mean that reliable
adjustments cannot be made.

The further in the past the prior period

adjustment relates to, the harder it is for
estimates to reflect the circumstances existing
at the time. Judgment may be clouded by
hindsight, which is influenced by knowledge of
events which have occurred since the prior
period. IAS 8 does not permit the use of
hindsight in estimations of amounts to be
recognized, measured or disclosed in a prior
period, or in making assumptions about
management intentions at that time.

If it is impracticable to determine the cumulative

effect, at the beginning of the current period, of
applying a new accounting policy to all prior
periods, an entity must adjust the comparative
information to apply the new accounting policy
prospectively from the earliest date
practicable. This may in practice be the current
period.
(iii) Discuss why the current treatment of prior period errors could lead to
earnings management by companies, together with any further arguments
against the current treatment.

(iii) IAS 8 and earnings management

IAS 8 requires the correction of prior period

errors to be carried out retrospectively 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. The effect is to
restate the comparatives as if the error had
never occurred. The impact of any prior period
errors will not be included in the current
period's profit or loss, but will be shown – or
perhaps hidden – in retained earnings.

It could be argued that this gives managers an

incentive to use prior period corrections
under IAS 8 as a form of earnings
management, because it allows them to
manipulate current earnings.

Expenses could be miscalculated and the

correction treated as a prior period error in the
following year, with an adjustment through
retained earnings rather than profit or loss.
Earnings per share could be miscalculated, or
liabilities reported as non-current rather than
current. IAS 8 allows such misstatements to be
corrected the following year without any
long-term negative effects in the statement
of financial position.

While IAS 8 does not permit hindsight, in

practice this may be difficult to prove, and
inappropriate hindsight may be used to relegate
bad news to prior periods once the bad news
has passed. Errors are not given the
prominence which users of financial
statements might need in order to assess
management's competence and integrity, as
well as how good the results are. Use of
reserves instead of profit or loss has long been
seen as undesirable this very reason.

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Where there is the introduction of a new accounting standard, the financial
statements will need to reflect the new recognition, measurement and
disclosure requirements which, in turn, will mean that entities will need to
consider the requirements of IAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors. IAS 8 contains a requirement that
changes in accounting policies are fully applied retrospectively unless
there are specific transitional provisions. Further, IAS 8 requires the
disclosure of a number of matters as regards the new IFRS. Additionally,
IAS 1 Presentation of Financial Statements requires a third statement of
financial position to be presented if the entity retrospectively applies an
accounting policy, restates items, or reclassifies items, and those
adjustments had a material effect on the information in the statement of
financial position at the beginning of the comparative period.

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