IAS 8 Changes in accounting policies, estimates and errors
Entities have a choice as to how to account for transactions and other events (the
why question) when preparing financial statements. The policy adopted (the
what/which question) will have a profound effect as to the measurement of assets
recognized.
A policy refers to the method that has to be used when implementing a model. The
rules governing the application are set out in accounting standards eg IFRS. For
example, in IAS 16 an entity can use the cost model or revaluation model to account
for PPE. The policy chosen should be intended to present information faithfully and
be relevant. The revaluation model would be more relevant when there are
significant increases in market value of the asset, and gains taken to OCI reflecting
capital appreciation to support this model.
An entity should not implement a model to deceive users. For example, in IAS 2 the
entity has a choice of whether to use FIFO method or weighted average. The
weighted average method will result in a higher per unit cost of inventory as the
lower and higher value items are mixed together. The FIFO method will usually give
a lower per unit cost of inventory as older stock is assumed to be sold first.
Therefore, an entity may try use the weighted average method to receive higher tax
deductions for cost of sales purposes.
Once a policy is adopted, it has to applied for all or similar transactions for that
asset class. So, for example, you cannot measure some units of inventory using
FIFO and other units using weighted average.
An entity is permitted to change an accounting policy if it will result in more relevant
and reliable information. When an entity changes its accounting policy (either by
choice or compulsory), it has to apply the change retrospectively. This means that
all accounts affected by the change have to be restated as if the accounting policy
had always applied.
Changes in estimates are when there is new information (in the current period) that
comes to light that effects the inputs used in a calculation methodology. Prior period
errors are distinguished as the information existed at the time the error was made
and should have been accounted for. The information was either not taken into
account or misapplied. Changes in accounting estimates are accounted for
prospectively. This means that the change is made in the current year and in all
future years.
An example of a difference of a change in policy vs. a change in estimate is that
policy refers to the method used to calculate the balance of the asset and an
estimate refers to an input used in the calculation to arrive at the balance. For
example, the straight-line depreciation method. Inputs include the useful life and
residual value. A change in either of the useful life or residual value does not
change the principles applied to calculate depreciation i.e the formula. A change in
policy would be if the entity chose the reducing value method.
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