IAS 8: Past exam Question
‘During a break-out session I heard someone talking about accounting policies and accounting estimates. He said that when there’s a change of these items sometimes the change is made retrospectively and sometimes it’s made prospectively. Please explain the difference between an accounting policy and an accounting estimate and give me an example of each.
Please also explain the difference between retrospective and prospective adjustments and how this applies to accounting policies and accounting estimates.’ (7 marks)
Proposed Solution I (Best answer)
· Accounting policies are the specific principles, rules, bases, conventions and practices adopted by an entity for preparation and presentation of financial statements.
· The estimates relates to judgments made based on most up to date information available at the time of preparation and presentation of financials. So, estimates having inherent uncertainties.
When changes come under IAS 8:
The change in accounting policies should be made only if:
a) The change is required by IFRS standard
b) The changes will results into more appropriate presentation of financials. i.e. more reliable and relevant
· The changes in estimates are applicable if the changes will results into more reliable preparation and presentation of information.
Main difference between change in accounting policy and accounting estimates:
· Basis: Accounting policy is a principle or rule, or a measurement basis, accounting estimate is the amount determined based on selected basis or some pattern of future consumption of the asset.
· Application of Changes: Change accounting policy is accounted for retrospectively, but change in accounting estimate prospectively.
Example: Choice fair value vs. historical cost is a choice in accounting policy (measurement basis), but updating some provision based on fair value change is a change in accounting estimate.
Prospective Application: means adjustment in calculations of the current and future reporting periods through statement of change in income and no adjustments are required in comparatives and equity.
Proposed Solution II (Good answer)
Accounting policies are accounting principles, rules, practices used by an entity to record the transactions in books of accounts and in preparation and presentation of financial statements. e.g. Choosing straight line or written down value depreciation method is accounting policy choice. Change in accounting policies are accounted for retrospectively. Retrospective application means new/revised accounting policy shall be applied to transactions as if this new policy had always been implemented. Accounting estimate is judgement(s) made to record the transactions in books of accounts. e.g. Decision of useful life of depreciable property, plant and equipment assets is accounting estimate. Change in accounting estimates are accounted for prospectively.
Point to consider:
Method of depreciation is not an example of accounting policy - rather it is an accounting estimate. A common example would be inventory valuation.
Proposed Solution III (Good answer)
Diff b/w Accounting Policy & Accounting estimate
IAS 8 provides guidelines for capturing any changes in the accounting policy, estimate and errors.
Accounting Policies- are basically the principles, conventions, rules followed by any organization in preparing of their FS, disclosures, treatment of errors in books (if any) and is meant to be consistently followed. 1 mark
Accounting policies can be changed if:-
1. If required by IFRS – If the IFRS require changes in accounting policies, the entity is require to change those. Transitional provisions are given under the standard for applicability. for e.g IFRS 16 where in it was advised by IFRS that all the existing long term leases of any company to be recognized under ROU Asset & Liability-Jan19 onwards. Any changes initiated by IFRS can be applied PROSPECTIVELY. 1.5 marks
2. Voluntary change:
If such change results in more reliable, convenient presentation, more transparent. for eg if a company believes that obtaining FIFO criteria of Inventories gives a better representation and reliable picture than LIFO.
Any such changes in accounting policy –if VOLUNTARY- must be dealt with RESTROSPECTIVELY. 1.5 marks
If it is impracticable to apply those changes retrospectively, the changes must be done from the earliest date practicable. However, the entity is required to give appropriate disclosures. 1 mark
Accounting Estimates: These are monetary estimates and majorly based on best information available in the current scenario. It may change or revised due any unpredictable scenario. For eg. During the COVID-19 situation the Provision of bad debt increased for many companies.
Any changes in accounting estimates is always Prospective. 1 mark