CHAPTER 12 – ACCOUNTING POLICIES, ESTIMATE AND ERRORS

ACCOUNTING POLICIES
• Specific principles, bases, conventions, rules and practices applied by an entity in preparing and
presenting financial statements.
• Essential for a proper understanding of the information contained in the financial statements.

CHANGE IN ACCOUNTING POLICY

• Accounting policies must be applied consistently for similar transactions and events.
• A change in accounting policy shall be made only when:
o Required by an accounting standard
o Change will result in more relevant and faithfully represented information about the
financial position, financial performance and cash flows of the entity.

EXAMPLES OF CHANGE IN ACCOUNTING POLICY

• A change in accounting policy arises when an entity adopts a generally accepted accounting
principle which is different from the one previously used by the entity.

HOW TO REPORT A CHANGE IN ACCOUNTING POLICY

• A change in accounting policy required by a standard or an interpretation shall be applied in
accordance with the transitional provisions therein.
• If the standard or interpretation contains no transitional provisions or if an accounting policy is
changed voluntarily, the change shall be applied retrospectively or retroactively.

RETROSPECTIVE APPLICATION
• Any resulting adjustment from the change in accounting policy shall be reported as an adjustment
to the opening balance of retained earnings.
• Amount of adjustment is determined as of the beginning of the year of change.
• If comparative information is presented, the financial statements of the prior period presented
shall be restated to conform with the new accounting policy.

ABSENCE OF ACCOUNTING STANDARD

• Management shall use judgment in selecting and applying an accounting policy that results in
information that is relevant to the economic decision making needs of users and faithfully
represented.
• Hierarchy of guidance which management may use when selecting accounting policies in such
circumstances:
o Requirements of current standards dealing with similar matters
o Definition, recognition criteria and measurement concepts for assets, liabilities, income
and expenses in the Conceptual Framework for Financial Reporting
o Most recent pronouncements of other standard-setting bodies that use a similar
Conceptual Framework, other accounting literature and accepted industry practices.

ACCOUNTING ESTIMATE
• Is a normal recurring correction or adjustment of an asset or liability which is the natural result of
the use of an estimate.
 • An estimate may need revision if changes occur regarding the circumstances on which the
estimate as based or as a result of new information, more experience or subsequent
development.
• Sometimes it is difficult to distinguish a change in accounting estimate and a change in accounting
policy. In such a case, the change is treated as a change in accounting estimate, with appropriate
disclosure.

EXAMPLES OF ACCOUNTING ESTIMATE

• Doubtful accounts
• Inventory obsolescence
• Useful life, residual value and expected pattern of consumption of benefit of depreciable asset
• Warranty cost
• Fair value of asset and liability

HOW TO REPORT CHANGE IN ACCOUNTING ESTIMATE

• The effect of change in accounting estimate shall be recognized currently and prospectively by
including it in income or loss of:
o The period of change if the change affects that period only
o The period of change and future periods if the change affects both
• A change in accounting estimate shall not be accounted for by restating amounts reported in
financial statements of prior periods.
• Prospective recognition of the effect of change in accounting estimate means that the change is
applied to transactions, other events and conditions from the date of change in estimate.

PRIOR PERIOD ERRORS

• Omissions and misstatements in the financial statements for one or more periods arising from a
failure to use or misuse of reliable information.
• Errors may occur as a result of mathematical mistakes, mistakes in applying accounting policies,
misinterpretation of facts, fraud or oversight.

HOW TO TREAT PRIOR PERIOD ERRORS

• Shall be corrected retrospectively by adjusting the opening balance of retained earnings and
affected assets and liabilities.
• If comparative statements are presented, the financial statements of the prior period shall be
restated so as to reflect the retroactive application of the prior period errors as a retrospective
restatement.
 Scope of PAS 8 Description Accounting treatment Effect of adjustment

a. Transitional provision On the beginning

b. Retrospective balance of retained
Change in accounting Change in
application earnings, if
policy measurement basis
c. If (b) is impracticable, accounted for
prospective application retrospectively

Changes in the
realization (or In profit or loss of
incurrence) of current period or
Change in accounting
expected inflow or Prospective application current and future
estimate
outflow of economic periods if the change
benefits from assets or affects both.
liabilities
Intentional and
unintentional
On the beginning
misapplication of a. Retrospective
balance of retained
Correction of prior principles, restatement
earnings, if
period error misinterpretation of b. If (a) is impracticable,
accounted for
facts and prospective application
retrospectively
mathematical
mistakes.