IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors – Comprehensive Study Notes

A. ACCOUNTING POLICIES

  • Definition

    • Accounting policies are the specific principles, bases, conventions, rules and practices adopted by an entity in preparing and presenting financial statements.
    • Policies are normally developed by reference to:
    • (a) The applicable IFRS or Interpretation together with any relevant Implementation Guidance issued by the IASB.
    • (b) The basic principles in the Conceptual Framework, e.g., recognition criteria and measurement concepts for assets, liabilities and expenses.
    • Immaterial effect exception: if the policy’s effect is immaterial, it may be ignored for reporting purposes.

  • Examples of policy choices

    • (a) Inventory measurement: FIFO vs weighted-average (WA) method (IAS 2).
    • (b) PPE valuation: Cost model vs Revaluation model (IAS 16).
    • (c) Intangible assets: Cost model vs Fair Value model (IAS 38 for IP, IAS 40 for investment property as relevant).

  • Selection & application of accounting policies

    • If there is a IFRS/IFRIC/SIC dealing with a specific transaction or situation, you apply it.
    • If there is no specific standard, management must develop its own policy, but the policy should provide information that is reliable and relevant.
    • How to develop the policy:
    • Step 1: Look at IFRS/IFRIC/SIC dealing with similar or related issues.
      • Example: artwork policy might relate to IAS 16 (PPE) or IAS 40 (Investment Property).
    • Step 2: Apply concepts from the Conceptual Framework.
    • Step 3: Look to other standard-setting bodies for guidance.
    • Step 4: Many companies do this regularly; some software companies look to US GAAP guidance for revenue recognition (IFRS 15 Contracts with Customers).
    • Policy must be applied consistently to all transactions within the same category or type.
    • When IFRS permits categorisation, different policies may be applied to different categories.
    • In the absence of a Standard or Interpretation, management must use judgement and refer to:
      1) The requirements and guidance in IASB standards and interpretations dealing with similar issues; and
      2) The Framework’s definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses.
    • Management may also consider:
    • (a) Recent pronouncements of other standard-setting bodies with similar conceptual frameworks.
    • (b) Other accounting literature.
    • (c) Accepted industry practices, to the extent they do not conflict with the sources above.

  • Consistency of accounting policies

    • Once selected, policies should be applied consistently for similar transactions, events and conditions.
    • Exception: IFRS may require or allow categorisation of items where different policies may apply to each category.
    • The same accounting policies are usually adopted period to period to enhance comparability and aid trend analysis.

  • Changes in accounting policies (IAS 8)

    • IAS 8 views changes in accounting policies as rare and to be made only if:
    • (a) Required by an IFRS; or
    • (b) Will result in financial statements providing reliably more relevant information about the effects of transactions, events or conditions on the entity’s financial position, performance or cash flows. (A voluntary change.)
    • Not changes in accounting policies:
    • (a) Adopting a policy for a new type of transaction or event not dealt with previously.
    • (b) Adopting a new policy for a transaction or event which has not occurred before or was not material.
    • Changes in accounting policies not within IAS 8 (exclusion):
    • If a policy for tangible non-current assets adopts a revaluation for the first time, this is treated as a revaluation under IAS 16 (not as a policy change under IAS 8). The transitional rules for changes in policy under IAS 8 do not apply to this revaluation.
    • Revaluations under IAS 16/IAS 38 (from cost model to revaluation model) are treated separately from a change in accounting policy under IAS 8.

  • Retrospective vs. prospective application of a policy change

    • Retrospective application (the default): applying the new policy to transactions, events and conditions as if the policy had always been applied.
    • If required by a new IASB standard or interpretation, the change is accounted for as required by that pronouncement.
    • If the new pronouncement has no specific transition provisions, apply the change retrospectively.
    • The accounting requires:
      • (a) Restating comparative amounts for each prior period presented as if the policy had always been applied;
      • (b) Adjusting the opening balance of each affected component of equity for the earliest period presented;
      • (c) Including the adjustment to opening equity as the second line of the Statement of Changes in Equity (SOCE).
    • If it is impracticable to restate retrospectively, apply the change prospectively.
    • Prospective application: apply the new policy to transactions/events after the date of change.

  • Key disclosures for policy changes

    • (1) The nature of the change in accounting policy.
    • (2) The reason for the change.
    • (3) The amount of the adjustment for the current period and for each prior period presented for each line item affected.
    • (4) The amount of the adjustment to opening equity for the earliest period presented.

  • Illustrative problem: borrowing costs capitalised on qualifying assets under construction

    • Example data (RM’000): 1: 100; 2: 300; 3: 400; Total = 800.
    • In Year 4, borrowing costs incurred that could be capitalised: 250.
    • Change in policy: write off interest cost when incurred (instead of capitalising).
    • Implications: affects current and prior years’ amounts in the SOCE and equity; disclosures required as above.

  • Practical note on retrospective restatement and equity effects

    • When a policy change is treated retrospectively, comparative periods are adjusted; opening equity is adjusted and shown in SOCE.
    • When a prospective approach is used (e.g., in certain IAS 16 revaluations), there is no retroactive restatement of prior periods.

B. CHANGES IN ACCOUNTING ESTIMATES

  • Definition

    • Changes in accounting estimates are adjustments to the carrying amount of an asset or liability, or related expense, resulting from reassessing expected future benefits and obligations.
    • These estimates arise from uncertainties; revisions occur due to changes in circumstances or new information and are not corrections of errors.
    • Examples include:
    • (a) Irrecoverable debt allowance.
    • (b) Obsolescence of inventory.
    • (c) Useful lives of depreciable assets.
    • (d) Warranty obligations.

  • Accounting treatment

    • Changes in estimates are recognised prospectively: include the effect in the period of the change and, if it affects future periods, also in those future periods.
    • If a change in estimate affects related asset, liability, or equity items, adjust the carrying amount of the related item in the period of the change.
    • Changes in estimates are not corrections of errors and do not affect prior periods.
    • The same expense classification used for the original estimate should be used for the revised estimate.

  • Illustrative depreciation/asset example

    • Example 1 (depreciation): A machine with original cost £100,000, originally estimated life 10 years, residual value £0. Annual straight-line depreciation =
      rac{£100,000}{10} = £10,000 ext{ per year}.
      After 3 years, revised remaining life becomes 3 years (total remaining = 6 years). New annual depreciation becomes:
      ext{Depreciation in Year 4} = rac{£70,000}{3} = £23,333.

    • Past three years’ depreciation remains unchanged; only future depreciation is affected.

    • The effect in the current year and the next two years must be disclosed.

    • Example 2 (change in useful life of an NCA):

    • Original data: cost RM120,000, useful life 6 years, residual value nil, depreciation method straight line.

    • After 2 years, revised remaining life is now 3 more years (total life becomes 5).

    • Pre-change depreciation: RM120,000 × (1/6) = RM20,000 per year for Year 1; Year 2 depreciation was also RM20,000.

    • After change, remaining NBV after Year 2 is RM120,000 − 2×RM20,000 = RM80,000.

    • New depreciation for Years 3–5:
      ext{Depreciation (new)} = rac{RM80,000}{3} = RM26,667 ext{ per year}.

    • Past depreciation remains unchanged; disclose the effect on current and future periods.

    • Example 3 (inventory write-down):

    • If the carrying amount of an inventory item (e.g., RM3,000) becomes obsolete, write it down to the lower of cost and net realisable value, or recognise a loss in profit or loss in the period of the change.

  • Differences between accounting policy and accounting estimate (summary)

    • Policy vs estimate:
    • Policy: a principle, rule or measurement base (e.g., fair value vs historical cost).
    • Estimate: an amount determined by a measurement basis over time (e.g., provision for bad debts, depreciation life).
    • Example distinction: updating a provision for depreciation due to a change in fair value is a change in estimate, not a policy change.
    • Treatment of changes:
    • Changes in accounting policy are generally retrospective.
    • Changes in accounting estimates are prospective.
    • When in doubt, IAS 8 requires treating as a change in accounting estimate.

  • Key disclosures for changes in accounting estimates

    • (a) The nature and amount of the changes in accounting estimates that affect current and/or future periods.
    • (b) The materiality of the changes.

C. ERRORS

  • Definition

    • Errors are omissions or misstatements in FSs for one or more prior periods arising from a failure to use reliable information that was available or obtainable and could reasonably be expected to be obtained and used in preparing those statements.
    • Causes: mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, fraud.

  • Correction approach

    • If the error is immaterial, correct in the current period profit or loss.
    • If material, correct all material prior period errors retrospectively in the first set of financial statements issued after discovery, by:
    • (i) Restating the comparative amounts for the prior periods presented;
    • (ii) If the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest period presented; and
    • (iii) Including any adjustment to opening equity as the second line of the SOCE.
    • In practice, this presents the FS as if the error had never occurred.
    • If it is impracticable to determine the period-specific effects or the cumulative effect, correct the error from the earliest practicable date and disclose the facts.
    • Treatment for errors is akin to the treatment for a change in accounting policy when presenting retrospective corrections.

  • Materiality and disclosure

    • Material errors require retrospective restatement with full disclosure of:
    • (a) The nature of the prior period error.
    • (b) The amount of the correction for each prior period presented for each line item.
    • (c) The amount of the correction at the beginning of the earliest prior period presented.
    • Subsequent periods do not require repeating these disclosures.

  • Illustrative examples from the transcript

    • Question 4 (inventory misstatement):
    • Products costing RM100,000 sold in Year 1 were incorrectly included in closing inventory in Year 1 (overstated closing inv).
    • In Year 2, opening/closing inventories also affected; the misstatement would affect cost of sales, gross profit, and net profit across the two years; restatement of comparative figures is required for consistency and comparability in the financial statements.
    • Question 5 (Twinkle-bell Bhd):
    • 2017: (i) a credit sale omitted (RM45,000) from books; (ii) goods with cost RM97,000 sold in 2017 were included in closing inventory at 31 December 2017.
    • These are prior-period errors that require retrospective restatement of 2017 comparatives and opening 2017 equity where applicable.
    • 2018: Twinkle-bell changed its policy to capitalise borrowing costs on construction of the factory; capitalised amounts for 2016, 2017 and 2018 were RM48,000; RM75,500; RM85,200 respectively, with a 26% tax rate assumed for both years.
    • The retained earnings balance for 31 December 2016 and 31 December 2017 were RM110,200 and RM278,000 respectively; the effect on 2018 and the comparative figures is determined by applying the above adjustments.

  • Preparation of the statement of retained earnings (SRE) after errors and policy changes

    • The SRE for 2018 and comparatives should reflect:
    • Opening retained earnings (as at 1 January 2018) adjusted for prior period errors and policy changes.
    • Profit for the year 2018 (adjusted for changes in estimates or errors impacting the period).
    • Any other changes (e.g., capitalisation of borrowing costs) affecting retained earnings.
    • The transcript provides a worked example (W1): starting from the carried amounts, applying prior-period errors and the capitalisation policy, and arriving at the restated ending retained earnings.
    • Important notes:
    • The comparative figures must be restated to reflect the corrections.
    • The effect of the changes on the SOCE opening balance is shown as an adjustment to opening retained earnings.

  • Practical insights from the Twinkle-bell example

    • Prior period errors require clear disclosure and restatement of prior period figures.
    • Changes in accounting policy (e.g., capitalisation of borrowing costs) can be applied retrospectively or prospectively depending on IFRS guidance; IAS 8 generally supports retrospective treatment unless impracticable, in which case prospective treatment may be used.
    • The decision between modifying depreciation estimates vs. changing policy is strategic: adjusting useful lives (an estimate) is often preferred to avoid altering the accounting policy; however, if adopting a new policy (e.g., capitalisation of borrowing costs) is required or would provide more reliable/relevant information, it may be justified with appropriate retrospective adjustments where feasible.

  • Practical note on IAS 16 and revaluation considerations (for long-term learners)

    • IAS 16 allows two models for subsequent measurement of PPE: cost model and revaluation model.
    • Revaluation is common for buildings and land due to ease of fair value measurement; for machinery used in production, revaluations are less common and can present practical challenges (e.g., determining fair value and applying to an entire class).
    • If a change to the revaluation model is considered, IAS 8 allows prospective application of the policy change if it is not required by IFRS or if it does not provide more reliable information; however, a retrospective approach is generally preferred for policy changes.
    • IFRS 13 (Fair Value Measurement) may be required to determine fair values, which can be difficult or impracticable for specialized machinery.
    • The recommended practical approach is to review estimated useful lives annually and adjust estimates prospectively, rather than switching accounting policy solely to cure a past issue. Revaluation of machinery should be evaluated carefully, considering the practicality and long-term impact on financial reporting.

  • Real-world relevance and ethics

    • Transparent disclosure of policy changes, estimation revisions, and error corrections is essential for user decision-making and comparability.
    • Management must exercise judgment in the absence of direct IFRS guidance, ensuring that information remains reliable and relevant for users, and that changes are adequately disclosed.
    • Ethical considerations include avoiding manipulation of profits through policy changes and ensuring consistent treatment across periods.

  • Formulas and key numerical references (LaTeX format)

    • Depreciation (straight-line):
      ext{Depreciation per year} = rac{ ext{Cost} - ext{Residual value}}{ ext{Useful life}}
    • Revised depreciation after change in estimate (example 1):
      ext{Depreciation}_{ ext{Year 4}} = rac{ ext{NBV (end of Year 3)}}{ ext{Revised remaining life}}
    • Example 1 numbers (illustrative): if NBV = RM 70,000 and remaining life = 3 years, then
      ext{Depreciation}_{ ext{Year 4}} = rac{70{,}000}{3} = ext{RM } 23{,}333.
    • Inventory write-down (example): write down from cost to write-down value in P&L when obsolescence occurs.
    • Prior-period error disclosure requirements (summary): nature, amount for each prior period, and beginning balance adjustments in opening equity.

Summary comparisons and quick references

  • Accounting policies vs accounting estimates vs errors

    • Policy: rule or principle used to prepare FS; retrospective change; always applied consistently; requires disclosure of nature, rationale and effect.
    • Estimate: amount based on measurement of future benefits/obligations; prospective change; affects the period of change and future periods; disclosed as part of the period’s results.
    • Error: prior period misstatement or omission; retrospective correction with restated comparatives and opening equity; disclosed with nature and amount.

  • Disclosures are essential to maintain comparability and support user decisions.