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C-6 Financial Accounting

IAS 8 Accounting Policies, Changes in Estimates and Correction of Errors A Study For Success Scheme 2009-2010 College of Accounts and Finance
Imran Ahmad Khan ACA

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


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 or estimates, 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 a liability, or the amount of the periodic consumption of an asset, that results from the assessment of the present status of, and expected future benefits and obligations associated with, assets and liabilities. Changes in accounting estimates result from new information or new developments and, 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 the preparation and presentation of those financial statements. Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud.
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Selection and Application of Accounting Policies


1. 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 the entity; 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 effect in prior periods. Retrospective application is where the FS of the current period and each prior 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 each period presented and adjusting the opening position by restating retained earnings (i.e. cumulative profits held in the statement Where it is not practicable to determine either the specific effect in a particular period or the cumulative effect of applying a new policy to past periods, 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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Changes in Accounting Policies

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.

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 2006 CUm 251 900 1,151 100 51 1,000 1,151

2007 Cum Property, plant & equip (284+10+10) / (241+10) 304 Other assets 899 1,203 Share capital 100 Retained earnings year ended 2006 (41+10) 51 year ended 2007 (42+10) 52 Liabilities 1,000 1,203

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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 are changes in estimates and are not changes in accounting policies or the correction of errors By its very nature the revision of an estimate to take account of more 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 that change arises. The effect of a change in an accounting estimate should therefore be recognised prospectively, i.e. by recognising the change in the current and future periods affected by the change.
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Changes in Accounting Estimates


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 trade receivables 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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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 is possible 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 Errors

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Illustration 4 During 20X2, Beta Co discovered that some products that had been sold during 20X1 were 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 of CU86,500 (including CU6,500 for the error in opening inventory), and income taxes of CU5,250. 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 was CU34,000. Betas income tax rate was 30 per cent for 20X2 and 20X1. It had no other income or expenses. Beta had CU5,000 of share capital throughout, and no other components of equity except for retained earnings. Its shares are not publicly traded and it does not disclose earnings per share.
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Prior Period Errors

Prior Period Errors


Illustration 4 Beta Co Extract from the Statement of Comprehensive Income (restated) 20X2 20X1 CU CU 104,000 73,500 (80,000) (60,000) 13,500 (4,050) 9,450

Beta Co Statement of changes in equity Share Capital CU


Balance at 31.12. X0 Profit for the year 31.12.X1 (restated) Balance at 31.12.X1 Profit for the year 31 .12. X2 Balance at 31.12.X2

Retained Earnings CU 20,000 9,450

Total CU 25,000 9,450 34,450 16,800 51,250

5,000

Sales Cost of goods sold Profit before income taxes 24,000 Income taxes (7,200) Profit 16,800

5,000

29,450 16,800

5,000

46,250

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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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Impracticability
Impracticable Applying a requirement is impracticable when the entity cannot apply it after making every 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 which those 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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Class Practice Questions

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Class Practice Questions

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Class Practice Questions

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Exam Type Questions

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Exam Type Questions

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