for Accounting Professionals
IAS 8 Accounting policies, changes in accounting estimates and errors
2011
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2
2011 Reviewed
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IAS 8 Accounting policies, changes in accounting estimates and errors
CONTENTS
PREFACE
2
1. Accounting Policies Changes in Accounting Estimates and Errors - Introduction 4
2. PRINCIPLE, STANDARD, POLICY, PROCEDURE RELATIONSHIPS 4
3. Definitions 4
4. IAS 8 - Impact for Banks 5
5. Accounting Policies 7
6. Changes in Accounting Policies
8
7. Changes in Accounting Estimates 14
8. Errors, including Fraud
16
9. Multiple Choice Questions
21
10. Answers to Multiple Choice Questions 23
Note: Material from the following PricewaterhouseCoopers publications has been used in this workbook:
-Applying IFRS
3
1. Accounting Policies Changes in Accounting Estimates and
Errors - Introduction
Aim
The aim of this workbook is to assist in understanding Accounting
Policies Changes in Accounting Estimates and Errors according to
IFRS.
Objective
The objective of IAS 8 is to prescribe the criteria for selecting and
changing accounting policies and disclosing the effects of estimates
and errors.
Disclosure of accounting policies is set out in IAS 1
Presentation of Financial Statements.
Scope
IAS 8 covers:
1. Selecting or changing accounting policies;
2. Changes in accounting estimates;
3. Correction of prior-period errors.
Tax related errors / adjustments are dealt with under IAS 12 Income
Taxes.
2. PRINCIPLE, STANDARD, POLICY, PROCEDURE
RELATIONSHIPS
PRINCIPLES are guiding concepts.
STANDARDS are written guidelines for the treatment of various
types of functions and activities. They apply to all commercial
banks. Standards include acceptable alternatives for appropriate
accounting under international financial reporting standards.
POLICIES discuss specific accounting for certain types of assets
and activities. They apply to all commercial banks. Policies indicate,
where applicable, which method of accounting is required when
alternatives exist.
PROCEDURES give detailed instruction on the handling of specific
transactions arising from activities, or in accounting for assets or
liabilities. They are written by individual banks for internal use. A
number of separate procedures are typically necessary to cover all
the various activities associated with accounting for one type of
function.
3. Definitions
Accounting policies are rules and practices applied in presenting
financial statements.
A change in accounting estimate is an adjustment of the carrying
amount of an asset or a liability or the consumption of an asset.
Changes in estimates result from new information or new
developments and are not corrections of errors.
Impracticable. Error correction may be impracticable if:
1. the impact cannot be determined;
2. assumptions on management’s intent must be made;
3. restatement requires evidence that is not available.
Accounting Policies Changes in Accounting Estimates and Errors
Material omissions or misstatements of items are material if they
could influence the decisions of users.
reporting standards (when necessary) and to adopt new standards
when they are introduced.
Materiality depends on the size and nature of the omission or
misstatement, judged in the surrounding circumstances.
Though few banks change financial reporting standards once they
have adopted IFRS, mandatory new standards, such as IFRS 7,
have increased the disclosure required by banks in financial
statements.
Prior-period errors are omissions, or misstatements in the financial
statements of prior-periods.
Information that was available and should have been taken into
account is classified as an error.
Much of the additional information required by new standards needs
to be provided not only for the current year, but also for previous
years that are presented as comparatives in the financial
statements.
Errors include:
1.
2.
3.
4.
calculation error;
incorrect application of accounting policies;
oversights or misinterpretations;
fraud.
Most accountants find that the compilation of the comparative figures
for such changes is best prepared long in advance, because tracing
records of transactions from previous periods may take considerable
time.
The following are not changes in accounting policies:
Prospective application is applying a change in current and future
periods
Retrospective application is applying a new policy as if that policy
had always been applied.
Retrospective restatement is restating financial statements as if a
prior-period error had never occurred.
4. IAS 8 - Impact for Banks
IAS 8 is an important standard for banks and other financial
institutions. It provides the methodology to change financial
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i. the application of an accounting policy for transactions, other
events or conditions that differ in substance from those previously
occurring; and
ii. the application of a new accounting policy for transactions, other
events or conditions that did not occur previously, or were
immaterial.
Changes in a bank’s activities, such as becoming involved in
insurance, leasing and investment property, require the use of the
appropriate standards covering those topics (IFRS 4, IAS 17 and
IAS 40 respectively).
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Accounting Policies Changes in Accounting Estimates and Errors
A bank selects and applies its accounting policies consistently for
similar transactions, other events and conditions, unless a standard
or an interpretation specifically requires or permits categorisation of
items for which different policies may be appropriate.
If a standard, or an interpretation, requires or permits such
categorisation, an appropriate accounting policy is selected and
applied consistently to each category.
Apart from the introduction of new standards and interpretations,
accounting policies are only changed when they result in the
financial statements providing reliable and more relevant information
about the effects of transactions, other events or conditions on the
bank's financial position, financial performance or cash flows.
IAS 8 requires a bank to provide disclosures when it has not yet
applied a new standard or interpretation that has been issued, but is
not yet effective.
The bank is required to disclose that it has not yet applied the
standard or interpretation, and known or reasonably-estimable
information relevant to assessing the possible impact that initial
application of the new standard or interpretation will have on the
bank’s financial statements in the period of initial application.
IAS 8 also includes guidance on specific disclosures the bank should
consider when applying this requirement.
Estimates are used by banks for loan loss provisions and for the
lives of tangible and intangible assets. IAS 8 identifies what are
estimates and what are errors and prescribes the accounting
treatment for each element.
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Revisions of estimates are not applied retroactively. Financial
information presented for prior periods should not be restated.
IFRS consider prior period-financial statements to have been
properly prepared, even though estimates are revised in a
subsequent period. The effect of revisions to estimates should be
included in income in the period of the change, and future periods
where relevant.
IAS 8 defines material omissions or misstatements. It stipulates that:
i..the accounting policies in IFRSs need not be applied when the
effect of applying them is immaterial. This complements the
statement in IAS 1 that disclosures required by IFRSs need not be
made if the information is immaterial.
ii. financial statements do not comply with IFRSs if they contain
material errors.
iii. material prior period errors are to be corrected retrospectively in
the first set of financial statements authorised for issue after their
discovery.
Errors are omissions from, and misstatements in, the bank's
financial statements for one or more prior periods arising from a
failure to use, or misuse of, reliable information that:
i) was available when financial statements for those periods were
authorised for issue; and
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Accounting Policies Changes in Accounting Estimates and Errors
ii) could reasonably be expected to have been obtained and taken
into account in the preparation and presentation of those financial
statements.
IAS 8 requires detailed disclosure of the amounts of adjustments
resulting from changing accounting policies, or correcting prior
period errors. It requires those disclosures to be made for each
financial statement line item affected and, if IAS 33 Earnings per
Share applies to the bank, for basic and diluted earnings per share.
Comparative information for prior periods is presented as if new
accounting policies had always been applied and prior period errors
had never occurred.
Material and materiality are defined in the IASB Framework, and
guidance is given in this workbook. Errors include misinterpretations
and incorrect application of standards, which may come to light only
after the IASB has issued an interpretation about a particular
presentation issue.
IAS 8 states that errors must be corrected in the (previous) period in
which they were made. They must not be corrected in the current
period.
IAS 8 defines when it is impractical to correct an error in a previous
period. This differs from it being costly in time or money to make the
correction, which are not valid reasons not to make the correction.
5. Accounting Policies
Selection and Application of Accounting Policies
Apply the relevant Standard when determining Accounting Policies.
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EXAMPLE – application of a Standard
You have leased an asset for your use. You refer to IAS 17 Leasing
to determine the accounting treatment.
Guidance is available from specific IFRS Standards, the Framework
and interpretations. Other standard-setting bodies may also be a
source of reference where the issue is not covered by IFRS.
EXAMPLE – Deviation of accounting policy from general
Framework definitions
Issue
Management must use its judgment in developing an accounting
policy in the absence of a specific IFRS or Interpretations. The
factors to consider in making this judgement include the definitions,
recognition and measurement criteria for assets, liabilities, income
and expenses set out in the Framework.
How should redundancy costs incurred as part of a restructuring to
reduce costs be treated?
Background
The management of Bank K, based in Europe, is facing severe
competition. Management therefore decides to reduce costs by
moving all of Bank K’s call centres to Asia. The costs incurred in
relocating will significantly reduce cash outflows from operations.
Part of the costs of relocation will be the redundancy costs of the
staff working in the factory in Europe.
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Accounting Policies Changes in Accounting Estimates and Errors
Management proposes that the costs of relocation, including
redundancy costs, be capitalised because they lead to a substantial
reduction in future operating costs.
Solution
The redundancy payments should not be recognised as an asset.
The redundancy payment has not given the bank control over a
resource even though it results in the bank reducing its future cash
outflows. An asset should only be recognised if the bank controls
certain resources.
The redundancy payments should therefore be expensed.
Consistency of Accounting Policies
An undertaking shall apply its policies consistently for similar
transactions or categories.
6. Changes in Accounting Policies
A change in presentation and classification of items from one period
to the next is permitted only when it is a result of;
i) a significant change in the nature of the bank's operations;
ii) identification of a more appropriate presentation; or
iii) the requirements of a new IFRS or interpretation.
A change in accounting policy should be accounted for
retrospectively. Any adjustment should be reported as an adjustment
to the opening balance of each affected component of equity for the
earliest period presented.
EXAMPLE-categorisation of items
Where such changes are made, the corresponding figures for prior
periods should also conform to the new presentation. The nature,
amounts and reasons for the amendments should also be disclosed.
You have a portfolio of properties. These include both
investment and owner-occupied properties. IAS 16+ IAS 40
require these categories to be accounted for separately, so
each requires an accounting policy.
Other comparative amounts disclosed shall be presented as if the
new accounting policy had always been applied, unless it is
impracticable to determine either the period-specific effects or the
cumulative effect of the change.
Policies should be consistent from period to period to allow
comparisons to be made.
An undertaking should disclose the reason for not reclassifying
comparative information if it is impossible, or economically
unreasonable, to determine comparable amounts for previous
periods. The nature of changes that would have been made if the
amendments had been practicable should also be given.
EXAMPLE- consistency
Your financial instruments are now being accounted for using
FIFO. This must be used in each period to allow users to
compare one period with another.
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Accounting Policies Changes in Accounting Estimates and Errors
Changes on the basis of a more appropriate presentation should
only be made where the benefit of the alternative presentation is
clear. Such changes will therefore be infrequent.
When an undertaking presents summary financial information (such
as five and ten year summaries), the presentation should be
consistent with the most recent presentation adopted in the financial
statements. Management should disclose the fact where a
consistent presentation is not feasible.
The adoption of an accounting policy for events or transactions that
differ in substance from previously occurring events or transactions
is not a change in accounting policies.
EXAMPLE- new accounting policy in respect of an existing asset
How should management recognise the adoption of a new
accounting policy in respect of an existing asset?
Background
H owns an office building which it uses for its own administrative
purposes. Accordingly, the building is classified as property, plant
and equipment and is carried at depreciated historical cost.
During the current year, management moved the workforce to a new
building and leased the old building to a third party. Accordingly, the
old building was reclassified as investment property and carried at
fair value. H had not previously earned rental income on any of its
properties.
Solution
Management should recognise the effects prospectively, since it is
not a change in accounting policy but there is a change in use of the
property. No
restatement of the comparative amounts should be made. The
different accounting treatment applied to the same property in the
current and prior years is appropriate, because the building was
used for different purposes in the two years.
Depending on the materiality of the rental revenue in relation to the
bank’s
revenue as a whole, management should consider whether a new
reportable
operating segment now exists. This is not the same as a situation
where an existing operating segment becomes reportable.
Management should not restate operating segment reporting
information.
Accounting policies are changed as required by IFRS, or where
better information results.
EXAMPLE-change in policy
Your financial instruments had been accounted for using LIFO. IAS 2
Inventories has now removed LIFO as an option. You change your
policy for financial instruments to FIFO in accordance with IFRS.
The effects of any changes must be clearly stated.
Management has questioned whether the comparative amounts for
the old building should be restated to fair value to aid comparability
with the prior period.
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Accounting Policies Changes in Accounting Estimates and Errors
EXAMPLE- new transaction types
You are hedging financial instruments for the first time and apply the
relevant sections of IAS 39 Financial Instruments. This is not a
change of policy.
EXAMPLE- application of a new policy for transactions that
were previously immaterial
Property was previously rented to your business and the rental was
expensed. A small amount of the property was sublet.
Early application of a standard or interpretation is not a voluntary
change in accounting policy.
EXAMPLE new Standard not yet in force
A new Standard has been issued which will come into force in 2XX8.
You introduce its provisions into your 2XX7 financial statements
which is permitted but not compulsory. This is not a voluntary
change in policy so no change of comparative figures is necessary.
You buy a group that has an investment property portfolio and
account for the property according to IAS 40. This is not a change of
policy.
EXAMPLE new Standard – interim financial statements
The accounting policies applied in the interim financial report
should be the same as those applied in the annual financial
statements.
Applying Changes in Accounting Policies
Transitional provisions may apply when first applying a Standard.
Should an undertaking apply the requirements of a new standard
effective for the current year in its interim financial reports?
EXAMPLE- transition provisions
You have just purchased a bank that has some intangible assets.
These were accounted for under a non-IFRS regime. You wish to
account for them under IFRS. You use the IAS 38 Intangible Assets
transition provisions.
Background
The initial application of a policy to revalue assets in accordance
with IAS 16 Property, Plant and Equipment, or IAS 38 Intangible
Assets, is a change in an accounting policy to be dealt with as a
revaluation in accordance with IAS 16 or IAS 38, rather than in
accordance with IAS 8.
Bank A is preparing its quarterly financial information for the
period ending 31 March 2007. Management is aware that IFRS 7
is effective for annual financial statements covering periods
beginning on or after 1 January 2007, but is unclear whether it
should first adopt IFRS 7 in the interim financial report or in its
2007 annual financial statements.
Bank A operates in the financial services industry. It is publicly
traded and publishes quarterly financial information in
accordance with IAS 34.
For a voluntary change of policy, comparative figures must also be
changed if the standard has no transitional provisions.
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Accounting Policies Changes in Accounting Estimates and Errors
Solution
Bank A must adopt IFRS 7 in its first quarter financial report at 31
March 2007.
Management should apply IFRS 7 in preparation of the first
quarter financial information in the same way in which it will apply
the standard in the annual financial statements.
IFRS 7 does not establish any specific transitional provisions. To
reflect the change in accounting policy, Bank A will apply IFRS 7
retrospectively unless it is impracticable to determine either the
period-specific effects or the cumulative effect of the change.
Retrospective application
Accounting policy applied retrospectively requires adjustment
of the prior opening balance of each component of equity. Also
affected may be historical summaries.
The effect is as if the new accounting policy had always been
applied.
EXAMPLE- retrospective application
Your jointly-controlled bank has been accounted for at equity
method. You change your policy to the proportionate
consolidation for the benefit of users. This is a voluntary
change of policy. The change must be made retrospectively.
This requires you to change the figures for all periods that
feature in your financial statements.
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Limitations on retrospective application
A change in accounting policy shall be applied retrospectively from
when it is practicable.
EXAMPLE- limitations on retrospective application
Your financial instruments have been accounted for using FIFO.
You change your policy to weighted-average cost for the
benefit of users. The change must be made retrospectively.
This requires you to change the figures for all periods that
feature in your financial statements.
Your financial instruments records are only available for the
last three years though your financial statements are presented
with comparatives for the last five years.
Adjustments are limited to the last three years due to the
impracticality of securing the information for the other two
years.
Retrospective application is not practicable, unless cumulative
impact in both the opening and closing balance sheets, in the period,
can be determined.
EXAMPLE – Adjustments: no opening balance sheet
You have previously expensed borrowing costs, but now have
to capitalise them under IAS 23, due to the revisions to IAS 23.
Your records are only available for the last 3 years but you have
no adequate analysis for the earliest period.
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Accounting Policies Changes in Accounting Estimates and Errors
Adjustments have to be limited to the last 2 years due to the
impracticality of not having a detailed opening balance sheet for the
earliest period.
Disclosure
Disclosure is required in respect of a change in accounting policy:
-nature and reasons for the change;
-amount of the adjustment for the current period and for each period
presented;
-the amount of the adjustment relating to periods prior to those
presented; and (if appropriate);
-the fact that the retrospective application is impracticable, and the
reasons why.
When initial application of a Standard has an impact on the current,
past or future period disclose the:
1. title of the Standard ;
2. that
the changes in accounting policy are made in
accordance with transitional provisions (if applicable) and
description of them;
3. the nature of the change in accounting policy;
You decide to revalue property previously held at cost. The
revaluation gains will increase your depreciation charges in
the current and future periods and will need to be quantified
and noted.
Show:
5. the adjustment for the current period and each prior-period for
each financial statement line;
6. adjustment to Earnings per Share, if applicable;
7. if retrospective application is impracticable, disclose how and
when the change in accounting policy has been applied;
8. the amount of the adjustments relating to periods before
those presented, to the extent practicable;
EXAMPLE – retrospective adjustments
You change your policy on intangible assets and retroactively
apply them to the last 7 years’ figures. You only present 5
years’ figures in your financial statements. You detail the
reasons for the change and the impact on the 2 years prior to
those presented.
9. reasons for applying a voluntary change in policy and how it
provides more reliable and relevant information.
Financial statements of subsequent periods need not repeat these
disclosures.
4. present and future impact;
EXAMPLE - transitional provisions that have an impact
on future periods
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When a voluntary change in accounting policy has an impact on the
current period or any prior or future period, but it is impracticable to
determine the amount of the adjustment a bank shall disclose:
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Accounting Policies Changes in Accounting Estimates and Errors
1. the nature of the change in accounting policy;
2. the reasons why applying the new accounting policy provides
reliable and more relevant information;
3. for the current period and each prior period presented, to the
extent practicable, the amount of the adjustment:
i.
for each financial statement line item affected; and
ii. if IAS 33 applies to the bank, for basic and diluted earnings per
share;
4. the amount of the adjustment relating to periods before those
presented, to the extent practicable; and
5. if retrospective application is impracticable for a particular prior
period, or for periods before those presented, the circumstances
that led to the existence of that condition and a description of
how and from when the change in accounting policy has been
applied.
If a new standard or interpretation has been issued but is not yet
effective, disclose the likely impact in the period of initial application.
Optional disclose:
1. nature of the impending changes in accounting policy;
2. effective date for application of the standard or interpretation
and mandatory date;
3. discussion of the impact of the standard or interpretation or a
statement that the impact is not known.
EXAMPLE – Standard not yet effective - 2
An accounting policy shall be changed only if:
i) a standard or interpretation requires it; or
ii) it results in the financial statements providing reliable and
more relevant information about the effects of transactions,
other events or conditions on the undertaking’s financial
position, financial performance or cash flows.
The IASB issued revised standards in December 20X3 which
must be applied for annual periods beginning or after 1 January
20X5. Early adoption is encouraged.
Can some, but not all, of the revised standards be adopted early?
Background
EXAMPLE – Standard not yet effective - 1
A new Standard has been issued which will come into force in 2XX8.
You decide not to apply it to your 2XX7 financial statements.
However, in your 2XX7 financial statements, you will need to
disclose the likely impact on future application in 2XX8.
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Bank X’s management plans to adopt some, but not all, of the
revised standards for the 20X3 financial statements. The financial
statements of Bank X will be issued in July 20X4.
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Accounting Policies Changes in Accounting Estimates and Errors
provisions, inventory obsolescence, fair values, useful lives and
warranty obligations.
Solution
Yes. There is no requirement for the improvements to be adopted
as a single package. Bank X’s management may choose which
standards it early adopts. However, all changes of each individual
standard must be implemented at the same time. Selective
application of different elements within an individual standard is
not permitted.
An estimate may need revision if changes occur as a result of new
information or experience.
The revision of an estimate does not relate to prior periods and is not
the correction of an error. Financial information presented for prior
periods should not be restated.
Selective adoption of certain standards might not reflect well on
the credibility of management and the organisation as a whole.
IFRS consider prior-period financial statements to have been
properly prepared, even though estimates are revised in a
subsequent period.
Each standard should be considered separately. Changes in
accounting policies should be treated in accordance with IAS 8.
The effect of revisions to estimates should be included in income in
the period of the change, and future periods where relevant.
IAS 8 requires banks that have not adopted a new standard, or
interpretation, to disclose this fact and the known, or reliably
estimable, information relevant to assessing the possible impact
that the new standard, or interpretation, will have on the
undertaking's financial statements in the period of initial
application.
7. Changes in Accounting Estimates
Some financial statement items can only be estimated, rather than
measured precisely. These are forecasts of the future.
Estimation involves judgments based on the latest available
information. For example estimates may be required of loan loss
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EXAMPLE- revision of estimates-useful lives - 1
Your bank has an interest in a corporate aircraft fleet. New
legislation will ban them for use on international flights, reducing
their useful lives. You will need to accelerate depreciation and
review their residual values. This is a revision of estimates and will
have no impact on prior periods, but will increase depreciation in the
current and later periods.
EXAMPLE- revision of estimates-useful lives - 2
Should management adjust the carrying amount of an
undertaking’s asset to recognise a change in the asset’s
estimated useful life?
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Accounting Policies Changes in Accounting Estimates and Errors
Background
Management purchased a money-counting machine on 1
January 20X1 for 1,000. The asset’s useful life was originally
estimated to be ten years. Management reviewed the useful life
in January 20X3 and concluded that the asset had a remaining
useful life at that date of ten years (twelve years in total).
Solution
No, management should not adjust the asset’s carrying amount
but instead adjust the depreciation charges prospectively.
The asset’s net carrying amount at January 20X3 was 800.
Management should not restate the results for 20X1 or 20X2.
Management should instead reduce the annual depreciation
charge from 100 to 80 for 20X3 and subsequent years.
Management should disclose, in a note to the undertaking’s
financial statements, details of the nature of the change, and the
related amounts if the change in accounting estimate has a
material effect on the current period.
A change in the measurement basis is a change in a policy, and is
not a change in an estimate. An example is to change from
presenting assets at cost to presenting them at revalued amounts.
EXAMPLE – loan loss provision
Just before your 2XX9 accounts are approved for issue, a client
goes into liquidation owing you $4 million. You adjust your 2XX9
accounts (see IAS 10) by increasing bad debts in the income
statement. This is a change in estimate.
When it is difficult to distinguish a change in a policy from a change
in an estimate the change is treated as a change in an estimate.
Record a change in an estimate from the period of change onwards.
This is called prospective recognition. The effect of the change in
an accounting estimate should be included in the same income
statement classification as was used previously for the estimate.
EXAMPLE- revision of warranty provision
You sell televisions and videos. You provide an after-sale warranty
to cover service for the first two years. Experience has shown that
5% of the sets will need service under the warranty scheme.
A new range of sets indicates that the only 3% of sets will need to be
serviced.
The warranty will be adjusted in this period onwards.
EXAMPLE-estimation of a warranty provision
EXAMPLE- measurement basis
Your investment property has been accounted for at cost. You
revalue your property. This is a change in the measurement basis:
this is a change in a policy and is not a change in an estimate.
Issue
The measurement of an undertaking’s annual results should not
be affected by the frequency of the reporting (annual, half-yearly,
or quarterly). The undertaking should make the measurement for
reporting purposes on a year-to-date basis.
How should management estimate a warranty provision at the
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Accounting Policies Changes in Accounting Estimates and Errors
end of an interim reporting period?
understatement of the warranty provision.
Background
Disclosure
The nature and amount of a change in accounting estimate that has
a material effect in the period and potentially subsequent periods is
to be disclosed.
P sells vacuum cleaners on which it provides a standard warranty
of one-year for parts and labour. It prepares interim financial
statements in accordance with IAS 34.
P’s experience is that 3% of vacuum cleaners sold will be the
subject of warranty claims. The undertaking’s provision for
warranty claims in the first quarter of 20X5 reflects that
experience. It discovered a fault with the newly manufactured
cleaners in the second quarter, however, and has revised its
estimate of warranty claims from 3% to 5%.
Changes in estimates are disclosed, except when it is
impracticable to estimate the impact and then reason for nondisclosure should be disclosed.
8. Errors, including Fraud
The provision stands at 3,000, based on sales of 100,000 in the
first quarter; P sold a further 100,000 units in the second quarter.
Solution
Management should calculate the second quarter warranty cost
on the basis of year-to-date sales and the new estimate of
warranty claims of 5%.
This approach is illustrated as follows:
Sales – Q1 + Q2
Warranty cost @ 5%
Warranty cost recognised in Q1
Change recognised in Q2
200,000
10,000
3,000
7,000
The determination of the warranty cost for Q2 using sales for the
quarter is not appropriate, and would have resulted in an
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Accounting Policies Changes in Accounting Estimates and Errors
Financial statements do not comply with IFRS if they contain
material errors.
Errors are omissions from, and misstatements in, the bank's financial
statements for one or more prior periods arising from a failure to use,
or misuse of, reliable information that:
i. was available when financial statements for those periods were
authorised for issue; and
ii. could reasonably be expected to have been obtained and taken
into account in the preparation and presentation of those financial
statements.
The amount of the correction of an error shall be accounted for
retrospectively. An error shall be corrected by restating the
comparative amounts for the period(s) in which the error occurred,
so that the financial statements are presented as if the error had
never occurred.
When the error occurred before the earliest period presented, a bank
should restate the opening balance of assets, liabilities and equity
for that period.
The nature and materiality of the information affects its relevance,
and in some cases the nature of information alone is sufficient to
determine its relevance.
Information will also be material where the nature and circumstances
of the transaction or event are such that users of the financial
statements should be made aware of them.
Determining whether information is material or not is a matter of
professional judgement. The test is whether omission or
misstatement of the information could influence decisions a user of
the financial statements might make.
The following items will often qualify as material, regardless of their
individual size:
i) related party transactions;
ii) a transaction or adjustment that changes a profit to a loss, and
vice versa;
iii) a transaction or adjustment that takes an undertaking from
having net current assets to net current liabilities, and vice versa;
The correction of a prior period error is excluded from the
determination of profit or loss for the period in which the error is
discovered. Any information presented about prior periods,
including any historical summaries of financial data, is restated as far
back as is practicable.
iv) a transaction or adjustment that affects an undertaking’s ability to
meet analysts’ consensus expectations;
Materiality
vi) a transaction or adjustment that concerns a segment, or other
portion, of the undertaking’s business that has been identified as
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v) a transaction or adjustment that masks a change in earnings or
other trends;
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Accounting Policies Changes in Accounting Estimates and Errors
playing a significant role in the undertaking’s operations or
profitability;
vii) a transaction or adjustment that affects an undertaking’s
compliance with loan covenants or other contractual
requirements;
viii)a transaction or adjustment that has the effect of increasing
management’s compensation, for example by satisfying
requirements for the award of bonuses;
ix) changes in laws and regulations;
x) non-compliance with laws and regulations;
xi) fines against the undertaking;
xii) legal cases;
xiii)deterioration in relationships with individual or groups of key
suppliers, clients or employees; and
xiv)
dependency on a particular supplier, client or employee.
EXAMPLE- materiality
Information is material if its omission or misstatement could,
individually or collectively, influence the users’ economic
decisions that are based on the financial statements.
Background
An undertaking reclassifies certain items of PPE, from PPE used
for industrial purposes to PPE used for administrative purposes.
The related depreciation expense was previously part of cost of
sales and has subsequently been reclassified to administrative
expenses.
Management has decided not to disclose this change in
classification because the asset’s carrying value and depreciation
expense for the period is not material. Presented below is an
extract from the income statement after the adjustment.
Revenue
Cost of sales
Gross profit
Loss for the year
Depreciation reclassified from cost of
sales to administrative expenses
Shareholders’ equity
Total assets
200 000
199 000
1 000
45 000
1 200
130 000
270 000
Solution
Yes. The undertaking should disclose the change in
classification. The undertaking has reported a ‘gross profit’ as a
result of the reclassification rather than a ‘gross loss’. The
presentation of a gross profit (even a small one) rather than a
gross loss might alter the users’ perception of the undertaking’s
performance.
Should management disclose a change in the classification of an
expense that is not material in relation to the equity and net
income?
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Accounting Policies Changes in Accounting Estimates and Errors
EXAMPLE- errors last period - 1
During your audit for 2XX6 it is found that the 2XX5 revenue figure
had been materially inflated by fictitious invoices. The comparative
figures for 2XX5 should be restated to correct this error.
EXAMPLE – error before last period
You run a leasing firm. You find that revenue has been recognised
too early for the last 7 years in order to inflate profits. Your financial
statements only report 5 years. You restate the opening balances of
assets liabilities and equity for the earliest period presented and the
adjustments thereafter.
Limitations on Retrospective Restatement
Where impracticable to correct the prior period, restate the opening
balances for the earliest period practicable.
EXAMPLE- Limitations on Retrospective Restatement
For at least the last 10 years, administration overheads have
been incorrectly capitalised into computer software. You can
eliminate the overhead from the last 2 years’ figures but do no
information to correct figures before then. So only two years
can be corrected.
EXAMPLE - Period of correction
Revenue had been overstated in 2XX5 but this was only found in
2XX6.
The adjustment will be made to the 2XX5 comparative figures, not
corrected in 2XX6. An error from a prior period is reflected in that
period, not in the current period.
Disclosure of Prior-Period Errors
An undertaking shall disclose the nature and amount of each priorperiod error:
1. for each financial statement line item affected;
2. the effect on earnings per share;
3. the amount of the correction at the beginning of the earliest
period presented;
4. if retrospective restatement is impracticable, a description of
how and when the error has been corrected.
EXAMPLE- errors last period - 2
How should management present the correction of an error
related to a prior year?
Background
Management discovered, when calculating the deferred tax for
20X3, that the deferred tax for 20X2 was materially misstated due
to a mathematical error in the calculation.
Management had correctly determined the (gross) temporary
differences of 12,000,000 but had applied an incorrect tax rate of
70% instead 30%.
Solution
Management should restate the 20X2 comparatives in the
undertaking’s 20X3 financial statements. Management should
present in a note to the financial statements the following
information:
i) the nature of the error;
ii) amount of the correction for each period presented;
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Accounting Policies Changes in Accounting Estimates and Errors
iii) amount of the correction at the beginning of the earliest prior
period presented; and
iv) if retrospective application is impracticable, the nature and
reasons for the circumstances.
apparent for the first 18 months after the introduction of that product.
It would be wrong to use the 20% figure for historic periods, before
the full extent of the problem was known.
Retrospectively applying a new policy or correcting a prior-period
error requires evidence that other information was available when
the financial statements for that period were approved for issue.
An example of the disclosure is as follows:
The comparative amounts for deferred tax expense and deferred
tax liability have been restated to correct an error in the
calculation of the 20X2 deferred tax expense and deferred tax
liability. The result of the restatement is a reduction in the
deferred tax expense and the deferred tax liability of 4,800,000.
Impracticability
Sometimes it is impracticable to adjust comparative information to
achieve comparability with the current period.
The objective of estimates is to reflect the circumstances that existed
when the transaction occurred.
EXAMPLE – warranties- circumstances that existed when the
transaction occurred
You decide to make provisions for warranties for product repair. To
provide retrospective figures you need to consider the level of
warranty that management would have made at the balance sheet
dates of the comparative figures as compared to the actual claims
that subsequently occurred that related to the products sold in that
period.
Your average number of products serviced is 6% of those that you
have sold. This would be a fair basis to provide a warranty provision.
An earlier product range had a service rate of 20%, but this was not
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If this information is not available it is not practicable to make the
adjustment.
Hindsight should not be used in making assumptions about what
management’s intentions would have been in a prior-period or
estimating the amounts recorded in a prior-period.
EXAMPLES-no change to decisions made previously in
comparatives
Financial assets classified as “held-to-maturity” are sold before
maturity. This does not change their prior basis of measurement
although will now be marked to market for “traded” securities.
When correcting a prior-period error in staff accumulated sick leave,
you disregard a high-level of illness during the next period, which
was only known after the financial statements were approved for
issue.
Impact of tax on changes
Changes to the figures in any period may have an impact on the tax
figures. (See IAS 12 Income Taxes). Adjustments may need to be
made to reflect the changes in deferred taxliabilities.
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Accounting Policies Changes in Accounting Estimates and Errors
9. Multiple Choice Questions
1. Specific principles bases conventions rules and practices
applied in presenting financial statements. This defines:
1. Accounting estimates.
2. Accounting policies.
3. Prospective application.
2.Adjustment of the carrying amount of an asset or a liability
or the consumption of an asset. This defines:
1. A change in accounting estimate.
2. Accounting policies.
3. Misstatements.
3. Errors include:
i Mathematical mistakes.
ii Mistakes in applying accounting policies.
iii Oversights or misinterpretations of facts.
iv Fraud.
v Changes in provisions for bad debts.
1.
2.
3.
4.
i - ii
i - iii
i - iv
i-v
4. Applying a new policy to transactions as if that policy had
always been applied. This is:
1. Retrospective restatement.
2. Retrospective application.
3. Change in accounting estimate.
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5. Correcting the recognition measurement and disclosure of
amounts in financial statements as if a prior-period error had
never occurred. This is:
1. Retrospective restatement.
2. Retrospective application.
3. Change in accounting estimate.
6. You accept advice to accelerate your depreciation policy. To
make the change, you will need:
1. Retrospective restatement.
2. Retrospective application.
3. Prospective application.
7. In selecting an accounting policy you should review:
1. The Standards only.
2. The Interpretations only.
3. The Framework only.
4. Standards Interpretations and Framework.
8. In the absence of a Standard
or an Interpretation
management shall use judgement in developing an accounting
policy that results in information that is relevant to the needs of
users; and reliable in that the financial statements:
i Represent the financial position financial performance and cash
flows of the undertaking.
ii Reflect the economic substance of transactions other events and
conditions and not merely the legal form.
iii Are free from bias.
iv Are prudent.
v Are complete in all material respects.
vi Comply with national tax laws.
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Accounting Policies Changes in Accounting Estimates and Errors
1.
2.
3.
4.
5.
i - ii
i - iii
i - iv
i-v
i - vi
9. Changes in accounting policies:
1.
Should be applied only in the year of the change.
2.
Should make the change to all periods reported.
3. Should only make the change in the following period.
10. It is impractical to make a retrospective application to a
period unless you can determine the impact of the change in:
1. The opening balance sheet.
2. The closing balance sheet.
3. Both opening and closing balance sheets
11. If it
period
1.
2.
3.
is impractical to make a retrospective application to a
Make the change only to the current period.
Apply the change to the earliest period that is practical.
Do not make the change at all.
12. When you have not applied a new Standard that has been
issued but is not yet effective:
1. You should note this and estimate its impact.
2. Your accounts will not comply with IFRS.
3. You should ignore it.
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13. Accounting estimates are made for:
i
Bad debts.
ii
Inventory obsolescence.
iii The fair value of financial assets or financial liabilities.
iv The useful lives of or expected consumption of the benefits
embodied in depreciable assets.
v Warranty obligations.
vi Changes in accounting policy.
1. i - ii
2. i - iii
3. i - iv
4. i - v
5. i - vi
14. A change of estimate should be made to the income
statements of:
1. The period of the original estimate.
2. All previous periods reported.
3. The current period and future periods.
4. Future periods only.
15. Prior-period errors, including fraud, should be corrected:
1. Only in the period when the error has been discovered.
2. In the earliest period that is practical.
3. In future periods only.
16. A gain recorded on the outcome of a contingency, such as a
lawsuit, is:
1. A change in estimate.
2. A correction of an error.
3. A retrospective restatement.
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Accounting Policies Changes in Accounting Estimates and Errors
17. You are introducing a new policy to provide a warranty
provision of 2% of product sales. When you review past
warranty data the average was 2% but in one year the cost was
10% and in another year it was 0%.
When applying your retrospective figures as a provision you
use:
1. The actual costs incurred.
2. 2%.
3. 2% unless there was no charge in a particular year.
12.
13.
14.
15.
16.
17.
18.
1
4
3
2
1
2
1
18. Retrospective application involves using information that
was available:
1. Only at the balance sheet date.
2. When the accounts were approved.
3. At any time.
10. Answers to Multiple Choice Questions
Question
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
Answer
2
1
3
2
1
3
4
4
2
3
2
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