ACCOUNTING POLICIES

Accounting policies are the specific principles, bases, conventions, rules and practices
applied by an entity in preparing and presenting financial statements.

Accounting policies are essential for a proper understanding of the information contained
in the financial statements.

An entity is required to outline all significant accounting policies applied in preparing

financial statements.

Under accounting standards, alternative treatments are possible.

In this case, it becomes all the more important for an entity to clearly state the
accounting policies used in preparing financial statements. The entity shall select and
apply the same accounting policies each period in order to achieve comparability of
financial statements or to identify trends in the financial position, performance and cash
flows of the entity.

Change in accounting policy

Once selected, accounting policies must be applied consistently for similar transactions
and events.

A change in accounting policy shall be made only when:

a. Required by an accounting standard.

b. The 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.

Examples of change in accounting policy are:

a. Change in the method of inventory pricing from the FIFO to weighted average
method.
 b. Change in the method of accounting for long term construction contract from cost
recovery method to percentage of completion method.

c. The initial adoption of policy to carry assets at revalued amount is a change in

accounting policy to be dealt with as revaluation.

d. Change from cost model to fair value model in measuring investment property.

e. Change to a new policy resulting from the requirement of a new PFRS.

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
Retrospective application means that any resulting adjustment from the change in
accounting policy shall be reported as an adjustment to the opening balance of retained
earnings.

The amount of the 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.

Illustration

An entity has used the FIFO method 0T inventory valuation since it began operations in
2020.

The entity decided to change to the weighted average method for determining inventory
cost at the beginning of 2021.

FIFO Weighted average

December 31, 2020 1,000,000 750,000
December 31, 2021 1,500,000 1,200,000

FIFO inventory - January 1, 2021 1,000,000

Weighted average inventory - January 1, 2021 750,000
Decrease in beginning inventory 250,000
Adjustment of the decrease in beginning inventory
Retained earnings 250,000
Inventory - January 1 250,000

The computation of the cost of goods sold for 2021 would then show beginning inventory
at P 750,000 and ending inventory at P 1,200,000 to conform with the weighted average
method.

The statement of changes in equity for the year ended December 31, 2021 would show
the effect of the change of P250,000 net of tax as a deduction from the beginning
balance of retained earnings.

Absence of accounting standard

PAS 8, paragraph 10, provides that in the absence of an accounting standard that
specifically applies to a transaction or event, 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.
Paragraphs 11 and 12 specify the following hierarchy of guidance which management may
use when selecting accounting policies in such circumstances:

a. Requirements of current standards dealing with similar matters

b. Definition, recognition criteria and measurement concepts for assets, liabilities,
income and expenses in the Conceptual Framework for Financial Reporting
c. Most recent pronouncements of other standard-setting bodies that use a similar
Conceptual Framework, other accounting literature and accepted industry
practices.

ACCOUNTING ESTIMATE
A change in 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 was based or as a result of new information, more experience or subsequent
development.

By very nature, the revision of the estimate does not relate to prior periods and is not a
correction of an error.

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

As a result of the uncertainties in business activities, many items in financial statements
cannot be measured with precision but can only be estimated.

Estimation involves judgment based on the latest available and reliable information.

Estimates may be required for the following:

a. Doubtful accounts
b. Inventory obsolescence
c. Useful life, residual value and expected pattern of consumption of benefit of
depreciable asset
d. Warranty cost
e. Fair value of asset and liability

How to report change in accounting estimate

The effect of a change in accounting estimate shall be recognized currently and
prospectively by including it in income or loss of:

a. The period of change if the change affects that period only.

b. The period of change and future periods if the change affects both.

A change in an accounting estimate shall not be accounted for by restating amounts

reported in financial statements of prior periods.

Changes in accounting estimates are to be handled currently and prospectively, if

necessary.

Prospective recognition of the effect of a change in accounting estimate means that the
change is applied to transactions, other events and conditions from the date of change in
estimate.
Illustration
For example, a depreciable asset costing ₱500,000 estimated to have a life of 5 years.

At the beginning of the third year, the original life is changed to 8 years. Thus, the asset
has a remaining life of 6 years.

The procedure is not to correct past depreciation.

Instead, the remaining carrying amount of ₱300,000 (₱500,000 minus ₱200,000

depreciation for 2 years) is now allocated over 6 years or a subsequent annual
depreciation of ₱50,000.

Thus, the entry to record the annual depreciation, starting the third year is:

Depreciation 50,000
Accumulated Depreciation 50,000

Prior period errors

Prior period errors are 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

Prior period errors shall be corrected retrospectively by adjusting the Opening balances
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.