CHAPTER 21
ACCOUNTING POLICIES,
CHANGES IN ACCOUNTING
ESTIMATES AND ERRORS
Connolly – International Financial Accounting and Reporting – 4th Edition
21.1 INTRODUCTION
•
•
Conceptual Framework for Financial Reporting 2010
(See Chapter 1, Section 1.3)
IAS 1 Presentation of Financial Statements (See
Chapter 2)
Connolly – International Financial Accounting and Reporting – 4th Edition
21.2 IAS 8 ACCOUNTING POLICIES, CHANGES IN
ACCOUNTING ESTIMATES AND ERRORS
Objective:
•
To prescribe the criteria for selecting and changing
accounting policies, together with the accounting treatment
and disclosure of changes in accounting policies, changes in
accounting estimates and correction of errors
Scope:
•
All financial statements prepared in accordance with
IASs/IFRSs
Connolly – International Financial Accounting and Reporting – 4th Edition
Key definitions
•
•
Accounting Polices
The specific principles, bases, conventions, rules and
practices applied by an entity in preparing and presenting FS
Prior Period Errors
Omissions from, and misstatements in, the entity’s FS for
one or more prior periods arising from a failure to use, or
misuse of, reliable information that:
 was available when FS for those periods were authorised
for issue; and
 could reasonably be expected to have been obtained and
taken into account in the preparation and presentation of
those FS.
Such errors include the effects of mathematical mistakes,
mistakes in applying accounting policies, oversights or
misinterpretations of facts, and fraud.
Connolly – International Financial Accounting and Reporting – 4th Edition
Accounting policies
• Select in accordance with IAS/IFRS or interpretation, or
judgement if none available
• APs normally kept the same to ensure comparability of FS
over time.
• Change when
 Required by an IFRS – therefore follow transitional
arrangements if provided, otherwise apply change
retrospectively
 Voluntarily, i.e. results in better quality financial statements
– therefore apply change retrospectively
Connolly – International Financial Accounting and Reporting – 4th Edition
Retrospective changes in accounting policies



Adjust the opening balance of each effected component
and any other relevant comparative amounts as if the new
accounting policy had always been applied. This means
that there will be a PPA to the balance of retained earnings
b/f in the statement of changes in equity
Comparative information should be restated unless
impracticable to do so
When a change in AP has a material effect on the current
period or any prior period presented, or may have a
material effect in subsequent periods, the following
disclosures should be made:
o Reasons for change;
o Amount of adjustment recognised in the current period;
o Amount of adjustment included in each period prior to
those included in the FS.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 21.1: Retrospective change in accounting policy
Raven Limited has traditionally valued its inventory using the weighted
average method of valuation. During the year ended 31 December 2012, the
directors of Raven Limitd decided to change the method of inventory
valuation to the FIFO method in order to give a fairer presentation of the
company’s results and financial position.
The reported retained earnings of Raven Limited at 31 December 2010 were
€/€2,500,000 and extracts from the company’s financial statements for each
of the last three year, on the basis of inventory being valued on a weighted
average basis, are provided below are:
Year End
2010 (€)
2011 (€)
2012 (€)
Cost of sales
830,000
904,000
968,000
Profit after tax
50,000
80,000
105,000
Inventory valuation:
Weighted Average
275,000
257,000
304,000
FIFO
296,000
294,000
365,000
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 21.1: Retrospective change in accounting policy
Cont’d
Requirement
Based on the information provided, show how the change in
inventory valuation method will be reflected in the financial
statements of Raven Limited for the year ended 31 December
2012.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 21.1: Retrospective change in accounting policy
Solution:
Statement of Profit or Loss and Other Comprehensive Income
2012 (€)
2011 (€)
Cost of Sales
944,000
888,000
Profit after Tax
129,000
96,000
Statement of Financial Position
2012 (€)
2011 (€)
365,000
294,000
Current Assets
Inventory
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 21.1: Retrospective change in accounting policy
Solution (Cont’d):
Statement of Changes in Equity (Extract)
Retained Earnings
€
At start of period
Change in accounting policy
Restated
Profit for year
At end of period
Connolly – International Financial Accounting and Reporting – 4th Edition
2,580,000
37,000
2,617,000
129,000
2,746,000
Example 21.3: Change in presentation
The directors of Texas have decided to include the depreciation
charge for the year ended 31 December 2012 in cost of sales
rather than administrative expenses, as was previously the
policy.
Requirement
Outline the impact of this change, if any on the presentation of
the financial statements for the year ended 31 December 2012.
Solution:
In the 2012 FS, while no changes are required to the figures,
additional disclosures are required. For example, comparative
information (2011) should be re-stated (unless it is impractical
to do so), together with an explanation as to why the new policy
will provide reliable and more relevant information
Connolly – International Financial Accounting and Reporting – 4th Edition
Accounting estimates
•
•
Estimates may be required for:
 bad debts;
 warranty obligations;
 inventory obsolescence; and
 useful lives of depreciable assets etc.
Changes in estimates result from new information or new
developments relating to assets and liabilities. Accordingly, they are
not corrections of errors.
i.e. if changes occur in the circumstances on which the estimate was
based or as a result of new information. This does not relate to prior
periods and is not the correction of an error.
The effect of a change in estimate should be recognised
prospectively in the SPLOCI in the period of the change and/or future
periods (e.g. bad debts, RUEL of PPE).
If the effect of the change is material, its nature and amount must be
disclosed.
See Chapter 21, Examples 21.4-21.6
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 21.4: Change in accounting estimate (1)
Previously, Blackbird Limited depreciated plant and equipment
using the reducing balance method at 20% per annum.
The company is proposing to depreciate plant and equipment
using the straight line method over five years.
Requirement
Explain the appropriate accounting treatment in accordance
with IAS 8 and IAS 16.
Solution:
This decision involves a change in estimate (not accounting
policy) as the policy is still to write off the cost of the plant and
equipment over its EUEL. The change is made prospectively.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 21.5: Change in accounting estimate (2)
Apple Limited reviews its depreciation policy annually. At the
most recent review for the year ended 31 December 2012, the
directors decided that the remaining useful life of the machine
at 1 January 2012 was three years. Additional information in
relation to machinery is as follows:
Machinery - cost at the date of acquisition 1-1-09
€3,600,000
Estimated useful life at 1-1-09
10 years
Estimated residual value as at 1-1-09
Nil
Requirement
Explain how to account for this change in the useful economic
life of machinery in the financial statements of Apple Limited for
the year ended 31 December 2012.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 21.5: Change in accounting estimate (2)
Solution:
Cost at 1 January 2009
Depreciation year ended 31 December 2009
Depreciation year ended 31 December 2010
Depreciation year ended 31 December 2011
Carrying Amount as at 31 December 2011
€
3,600,000
( 360,000)
( 360,000)
( 360,000)
2,520,000
Revised remaining useful life
3 years
Depreciation for year ended 31 December 2012
840,000
The change in the useful economic life of machinery is a
change in accounting estimate and should be applied
prospectively.
Connolly – International Financial Accounting and Reporting – 4th Edition
Correction of prior period errors
•
•
•
•
Errors are material omissions from or misstatements in FS
e.g. mathematical mistakes, mistakes in applying accounting policies,
oversights or misinterpretation of facts and fraud
Current period errors are corrected before the FS are issued
Sometimes material errors are not discovered until a later period. These
should be corrected retrospectively in the first set of FS issued after
their discovery by:
 restating the opening balance of assets, liabilities and equity as if the
error had never occurred, and presenting the necessary adjustment,
to the opening balance of accumulated profits in the statement of
changes in equity; and
 restating the comparative figures, as if the error had never occurred.
Disclosure:
 nature of the PPE;
 amount of correction to each FS line item presented for the prior
periods; and
 amount of correction at the beginning of the earliest prior period
presented.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 1
Honda Limited made a provision for corporation tax of €500,000
for the year ended 31 December 2013. In March 2014 this
provision was agreed by the Revenue and paid at €540,000.
Requirement
Explain how this should be accounted for in Honda Limited’s
financial statements.
Solution
This is the correction of an accounting estimate and not an error.
The correction will be made by increasing the tax charge for the
year ended 31 December 2014 by €40,000. The effect of the
correction on the 2014 profits needs to be disclosed.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 21.7: Prior period error
Angel plc has a retained profit of €32,781 for the year ended 31 December 2012 and
its balance on retained earnings stood at €709,311 on 1 January 2012. It has been
discovered, while producing the 2012 financial statements, that the closing inventory
figure as at 31 December 2011 was overstated by €48,099, thus overstating the profit
for the year ended 31 December 2011 by €48,099 (the retained profit figure for the
year ended 31 December 2012 has been determined by using the correct inventory
figure as at 1 January 2012). The retained profit for the year ended 31 December
2011 was originally stated at €90,342, using the incorrect closing inventory figure.
In the statement of changes in equity, under movements on reserves, this adjustment
would be shown as follows:
Angel plc – SCE (Extract)
Balance at 31 December 2011
€
As previously reported
709,311
Prior period adjustment (note x)
(48,099)
Restated
661,212
Retained profit for year
32,781
Balance at 31 December 2012
693,993
Connolly – International Financial Accounting and Reporting – 4th Edition
21.3 DISCLOSURES
1. Changes in Accounting Policies (see Example 21.1 and Example 21.2)
(a) reason for change;
(b) amount of the adjustment on the current period and for each period
presented; and
(c) the fact that comparative figures have been restated or that it was not
practicable to do so.
2. Correction of Errors (see Example 21.7)
(a) the nature of the prior period error;
(b) the amount of the correction for each period presented;
(c) the amount of the correction at the start of the earlier prior period presented;
and
(d) if retrospective correction is not practicable, a description of how and when
the error was corrected.
3. Changes in Accounting Estimates (see Example 21.4 and Example 21.5)
(a) the nature of the change;
(b) the effect on the current periods financial statements; and
(c) the effect in future periods if this is practicable.
Connolly – International Financial Accounting and Reporting – 4th Edition
SUMMARY
Change in
accounting policy
Current
Prior Period
Period
Adjustment
Adjustment

Correction of
material errors
Change in
accounting estimate


Connolly – International Financial Accounting and Reporting – 4th Edition