IAS 8 establishes the criteria for selection and changing accounting policies, changes in accounting estimates and correction of prior period errors. Accounting policies can be considered as the ground rules, principles or practices which are involved in preparing as well as presenting financial statements.
When an IFRS standard is applied to a transaction or any other condition then the entity must apply that Standard. In absence of IFRS standard which applies to that transaction, the management adopts its judgement in formulating and applying an accounting policy that explains the information which is relevant.
While making this decision, the judgement must refer to the necessities and advice in IFRS standards which deal with similar issues.
Next, it should also refer to the definitions, liabilities, recognition criteria, income and expenses in the Conceptual Framework. Changes in accounting policy are applied until it is irrelevant or there are other IFRS standard sets specific transitional conditions.
Change in Accounting Estimate
The adjustment of carrying amount of an asset or a liability or amount of periodic consumption of an asset that concludes in new information or developmental is known as a change in accounting estimate.
However, they are not a correction of errors. Therefore, the effect of a change in accounting estimate is acknowledged by including it in profit or loss in the period of change, only if the change affects that period.
Also, it can be recognized by the period of change and future periods if the change affects both. Prior period errors are omissions and misstatements in an entity’s financial statements.
This is for one or more prior periods arising from a failure to use or misuse of available reliable information.
If it is impractical to determine the effects of error, the entity corrects material prior period errors by rephrasing the comparable amounts for prior periods presented when the error occurred. For instance, errors like the effects of mistakes in applying accounting policies, mathematical errors and fraud are included in such errors.
Corrections of prior period error and changes in accounting policies are affected in retrospect.
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Exemption From Accounting Policy
Retrospective application of a change in accounting policy is exempted in such cases. If a change in accounting policy is needed by a new IFRS or even an existing IFRS and the transitional provisions of these standards require the prospective application of a new accounting policy.
Also, the application of a new accounting policy is in respect of events, circumstances and transactions which are different from those that were developed earlier.
Another circumstance is when the effect of the retrospective application is immaterial of a change in accounting policy. If an entity is unable to collect a sufficient amount of data to allow the objective inspection of a change in account estimate then the retrospective application is impracticable.
Plus, if the entity is unable to apply a change in the accounting policy due to impracticability, the new accounting policy must be applied from the beginning of the earliest period which is possible.
When changes are implemented in the accounting policy, the financial statement of the accounting period should consist of the title of IFRS, nature of change in the policy, reasons for the change in an accounting policy, amount of modifications in the current as well as prior period presented along with the conditions that cause impracticality.
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Consistency of Accounting Policies
An entity must choose and assign its accounting policies consistently for comparable transactions, other events and conditions unless an Interpretation or a Standard permits categorisation of items for which several policies may be relevant.
An accounting policy must be selected and applied to each category if a Standard or an Interpretation needs or authorizes categorisation. A company can only change its accounting policies and methods if there are one or more acceptable justifications and also the modification indicates the entity’s financial position in a better way.
Also, if accounting policies are consistently applied, it results in financial reports of the same structure of different accounting periods. Moreover, an entity is not entitled to change the accounting policies for one transaction for continuous periods.
The concept of consistency of accounting policies comes in handy at times of comparability and enables users of financial statements to compare the financial statements of an entity. However, the consistency principle does not specify that an entity must use an accounting policy forever.
Some companies disclose an entire set of IFRS along with amendments to them whereas others focus only on entity-specific material matters. Yet another considerable thing is how the entities disclose relevant information to assess the possible impact that application of the new IFRS will have on the entity’s financial statements. The disclosure must be entry specific and should explain how the new IFRS or amendment will affect accounting for transactions which are carried out by the entity. It must be mentioned that even if the quantified impact is unknown.
Immaterial Impact of Changes in Accounting Policies
It may be possible that the impact of a change in an accounting policy is immaterial. If it is so then the entities do not have to follow retrospective application. In such cases, one of these two approaches is accepted in practice:
- In the first approach, the assets or liabilities as per opening balance of the current year are recognised or derecognized in line with the new accounting policy. In this case, the related impact is included in current year P/L in line with the operating income, finance costs and more such assets. The total impact on current period P/L should be immaterial to change this accounting policy into immaterial.
- Under this approach, assets or liabilities as per opening balance are not remeasured or recognised in line with the new accounting policy. In this case, no P/L is recognized and the new accounting policy is not completely in practice until the assets or liabilities according to the opening balance are derecognized. Here, materiality is established on questions like what is the materiality of the elements that are missing and what would be the impact of recognising and re-measuring.
IAS 8 clearly states that errors are misstatements in financial statements which result from numerous kinds of mistakes, acquiring the policies that are against IFRS requirements.
IAS 8 consists of impracticability of his retrospective statement, however, it does not include a condition to state if an error was made. Some changes in estimates can be errors while the rest can’t so it is vital to consider if and if yes, then to what extent the previous estimate was affected by the omission of facts.
In such cases, the change in the estimated amount is a correction of an error which requires retrospective adjustment along with a relevant disclosure. Moreover, while changing an accounting policy or creating a reclassification, it is important to take into account whether the previous policy was in line with IFRS and if it was not then this is a correction of error.
International accounting standard 8, adopted by IFRS selects changes in accounting policies, accounting for changes in estimates as well as reflects corrections of prior period errors. It requires that the changes in accounting policies must be applied retrospectively.
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