Accounting Policy Changes, Estimates, and Errors

In the world of finance, changes happen—sometimes in IAS accounting policies, estimates, or even errors. It’s like adjusting the recipe for financial reporting to make it more accurate. In this blog, we’ll unravel the simplicity behind accounting policy changes, adjustments in estimates, and the unexpected errors that can pop up in the world of numbers.

Overview of International Accounting Standard 8 [IAS 8]

The principles of International Accounting Standard 8 – Accounting Policies, Changes in Accounting Estimates and Errors are utilized to choose and implement accounting policies, manage modifications in estimates, and rectify errors from previous periods.  So, IAS 8 is applied for accounting policies, estimates and errors.

The standard mandates adherence to any particular IFRS related to a transaction, event, or circumstance, and offers advice on establishing accounting policies for other matters that produce significant and dependable information. 

Normally, when it comes to accounting policies and the rectification of errors, they are usually dealt with by retrospectively adjusting the financial statements. On the other hand, changes in accounting estimates are typically adjusted by considering their impact on future financial statements.

Meaning of certain terms related to IAS 8 

• Accounting policies: These refer to the specific principles, guidelines, conventions, rules, and practices followed by a company when creating and presenting its financial statements.
• An alteration in an accounting estimate: It refers to modifying the recorded value of an asset, liability, or associated expense due to revaluating the projected benefits and obligations connected to that asset or liability.
• The concept of materiality: If leaving out, stating incorrectly, or hiding certain information could reasonably be expected to affect the decisions made by the main users of general financial statements, then that information is considered material. These financial statements provide information about a specific reporting entity.
• Prior period errors: These errors refer to any omissions or mistakes in an entity’s financial statements from one or more previous periods, resulting from a failure to use or misuse reliable information that was available and should have been used when preparing those statements. These errors occur due to miscalculations in mathematics, errors made when implementing accounting practices, unintentional omissions or misunderstandings of information, and fraudulent activities.

Accounting policy selection and applicability

• If a transaction, event, or condition is directly covered by a Standard or Interpretation, the accounting policy for that particular item must be decided by following the Standard or Interpretation. This decision should also take into account any relevant Implementation Guidance provided by the IASB for that specific Standard or Interpretation. The following information needs to be disclosed about significant accounting policies: accounting basis, measurement unit, revenue recognition, government grants, foreign currency transactions, events after the reporting period, and other relevant policies.
• If there is no established guideline or explanation that directly addresses a transaction, event, or situation, it is up to management to make an informed decision in creating and implementing an accounting policy that generates relevant and trustworthy information.

According to IAS 8 accounting policies when making a decision, management should prioritize and evaluate the relevance of the following sources in a descending order.

• The stipulations and directions outlined in IASB standards and interpretations pertaining to comparable and connected matters; along with the explanations, criteria for identification, and principles for assessment of assets, liabilities, revenue, and expenses as presented in the Framework. 
• Management may take into account the latest statements from other standard-setting bodies that follow a similar conceptual framework for creating accounting standards, as well as other accounting writings and widely accepted practices in the industry.

Accounting policy consistency

An entity is required to choose and implement its accounting policies consistently for similar transactions, other events, and conditions. However, if a Standard or Interpretation specifically allows for different policies to be used for certain items, the entity may categorize them accordingly. If a Standard or an Interpretation mandate or allows for such classification, an adequate accounting policy should be chosen and applied consistently to every category.

Accounting policy changes

An accounting policy can only be altered or changes in IAS accounting policies can only be done by an entity if:

• It is needed according to a set rule or explanation; or leads to the financial records offering dependable and more significant details about the impact of transactions, other occurrences, or circumstances on the company’s financial status, financial efficiency, or cash flow. 
• According to IAS 8, entities are required to disclose changes in accounting policies that are made during the reporting period.
• Please be aware that modifications to accounting policies do not encompass the implementation of an accounting policy to a type of transaction or event that has not occurred before or is deemed insignificant. 
• If a new standard or interpretation from the IASB requires a change in accounting policy, the change will be implemented in accordance with the requirements stated in that new pronouncement. In cases where the new pronouncement does not provide specific guidelines for transitioning, the change in accounting policy will be applied retrospectively.
• Retrospective application refers to the adjustment of the starting balances of every relevant equity component for the earliest period previously shown, as well as the disclosure of other comparative amounts for each prior period presented, as if the new accounting policy had been consistently applied from the beginning.
• Nevertheless, if it is not feasible to calculate the specific impact of the change on past periods, the entity should implement the new accounting policy to the initial values of assets and liabilities at the start of the earliest period where retrospective application is possible, which could be the current period. Additionally, the entity must make an appropriate modification to the initial balance of each affected part of equity during that period.
• Additionally, if it is not feasible to calculate the overall impact of implementing a new accounting policy on previous periods at the start of the present period, the organization must modify the comparative data to implement the new policy going forward from the earliest possible date.

Changes in Accounting policies disclosures

Informative statements regarding modifications in accounting practice due to the implementation of a fresh guideline or explanation comprise:

• The standard or interpretation’s title that leads to a modification, the shift in accounting policy, an explanation of the transitional provisions, including their potential impact on future periods for the current and prior periods (where possible), and the extent of the adjustment.
• If retrospective application is not feasible, an explanation and description of how the change in accounting policy was implemented should be provided, along with the amount of adjustment for each affected financial statement line item and for basic and diluted earnings per share. 
• These disclosures do not need to be repeated in the financial statements of future periods.

Accounting policy voluntarily changes disclosure requirements.

In accordance with IAS 8, the following shall be recorded:

• The accounting policy has been altered, and the reasons for the change are to ensure that the new policy provides accurate and meaningful information for both the current period and previous periods. If feasible, the adjustment amount will be specified.
• If it is not feasible to apply retrospective application, the explanation and description of how the change in accounting policy was implemented should include the adjustment amount relevant to each impacted line item in the financial statements, as well as basic and diluted earnings per share (only if IAS 33 is being followed), for periods prior to the ones being presented, to the extent possible.
• There is no requirement for future financial statements to duplicate or restate these disclosures.
• If a company has not implemented a recently issued but not yet effective standard or interpretation, it must disclose this information along with any known or reasonably estimated details that are important in evaluating the potential impact of the new requirement when it takes effect in the coming year.

Disclosure about mistakes made in previous time periods.

According to IAS 8, in what manner should a company disclose information about changes in accounting policies?

• To the best of our ability, we will disclose the nature and amount of correction made for each prior period error.
• An explanation and description of the correction amount for each impacted financial statement line item, as well as for basic and diluted earnings per share (only if IAS 33 is applied), should be provided at the start of the earliest prior period presented if retrospective restatement is not feasible. 
• Additionally, a thorough explanation should be given regarding how the error has been rectified.
• It is unnecessary to repeat these disclosures in the financial statements of future periods.

Modifications in accounting estimates

The impact of a modification in an accounting estimate should be acknowledged going forward by incorporating it in the financial statement’s profit or loss section.

• In accordance with International Accounting Standard 8, paragraph 36, or as stated in IAS 8 IFRS, paragraph 36. If the change impacts only a specific period, then that period is considered as the duration of the change. 
• However, if the change affects both the present period and future ones, then the duration includes both the current period and the subsequent periods.

Accounting estimates changes disclosures

If it is not possible to determine the amount of a change in an accounting estimate that will affect the current period or future periods, the entity must disclose this fact.

Errors

• According to IAS 8, the main rule is that any significant errors from previous periods must be rectified in the first set of financial statements approved for release after they are identified. This correction should be applied retrospectively.
• Revising the comparative amounts for the previous period(s) in which the mistake happened, or if the mistake occurred before the earliest previous period, revising the starting values of assets, liabilities, and equity for the earliest previous period.”
• However, in cases where it is not feasible to ascertain the specific impact of an error on comparative information for one or more past periods, the organization is required to adjust the initial values of assets, liabilities, and equity for the earliest period that can be reasonably restated (which could be the present period).
• Additionally, if it is not feasible to calculate the overall impact of a mistake on all previous periods at the start of the present period, the organization must revise the comparative data to rectify the error going forward starting from the earliest possible date.

Takeaway

To sum it up, think of accounting like refining a recipe over time. Adjusting policies, estimates, and fixing errors is a way of making sure the financial story told by the numbers is as clear and accurate as possible. While it might seem like number juggling, these changes play a vital role in ensuring financial reports truly reflect the health and performance of a business.