The ESMA IAS 8 issues case study

Michael (Mike) Wells prepared this case study to support class discussion designed to develop understanding of the
differences between principles and other types of financial reporting requirements and to foster the development of capacity
to make/audit/regulate/analyse the judgements in general purpose financial information necessary to differentiate between:
(i) changes in accounting policies; (ii) changes in accounting estimates; and (iii) transfers due to a change in the use to which
an asset is put.

In July 2013 the IFRS Interpretations Committee1 received a request from the European
Securities and Markets Authority (ESMA)2 to clarify the criteria to distinguish between a
change in an accounting policy from a change in an accounting estimate, in the context of
applying IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.3

ESMA’s request
ESMA’s original agenda request is reproduced in the Appendix to Agenda Reference 12D for
the September 2014 meeting of the International Accounting Standards Board (IASB).4
Examples of changes that ESMA purports to be problematic to classify are:5
• In the context of measuring fair value in accordance with IFRS 13 Fair Value
Measurement:
o a change in the assessment of own credit risk for measurement of financial
liabilities at fair value; eg from using a credit default swap curve to using the
spread of the most recent debt issuance.
o a change of credit value adjustment (CVA) calculation to determine the
probability of default.
o a change in the valuation technique to measure fair value, eg from a market
approach to an income approach (Level 3).
• In the context of measuring grant-date fair value in accordance with IFRS 2 Share-
based Payment: a change in the option pricing model for share options from Black and
Scholes to Monte Carlo.
• In the context of IAS 16 Property, Plant and Equipment:
o a change in the depreciation method: from straight-line to the units-of-
production method when the expected pattern of consumption has changed.
o a change from the cost model to the revaluation model for measuring a class of
property, plant and equipment.

1
The interpretative body of the IFRS Foundation that provides authoritative guidance on International Financial Reporting Standards in
the form of IFRIC Interpretations (see http://www.ifrs.org/groups/ifrs-interpretations-committee/)
2
an independent EU Authority that contributes to enhancing the protection of investors and promoting stable and well-functioning
financial markets in the European Union (EU)
3
source: http://www.ifrs.org/-/media/feature/meetings/2015/may/iasb/disclosure-initiatives/ap11a-disclosure-initiative.pdf
4
see http://www.ifrs.org/-/media/feature/meetings/2014/september/iasb/ifrs-ic-issues/ap12d-ias-8-accounting-policies.pdf
5
source: http://www.ifrs.org/-/media/feature/meetings/2015/may/iasb/disclosure-initiatives/ap11a-disclosure-initiative.pdf

© Michael JC Wells 2019. This material has benefited greatly from the feedback and comments from people attending a series of workshops on
the Framework-based approach to teaching general purpose financial information and from peer review by a number of anonymous reviewers.

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 The ESMA IAS 8 issues case study

• In the context of applying IAS 19 Employee Benefits: a change in the basket of high
quality corporate bonds (HQCB) used to determine the discount rate for a defined
benefit obligation, eg from AA-rated bonds to A-rated bonds.
• In the context of measuring historical cost in accordance with IFRS 6 Exploration for
and Evaluation of Mineral Resources: a change in the expenditures included in the
initial measurement of exploration and evaluation assets.
• In the context of applying IAS 2 Inventories:
o inventory has been measured at cost but it has become obsolete and its net
realisable value (NRV) is lower than cost.
o a change in the cost formula used for inventories: from FIFO to weighted
average cost.
ESMA suggests that there may be a need to clarify the interaction between the following
requirements:
(a) paragraph 66 of IFRS 13 Fair Value Measurement states that a change in a valuation
methodology is a change in an accounting estimate;
(b) paragraph 35 of IAS 8 notes that a change in the measurement basis applied is a
change in an accounting policy; and
(c) paragraph 118 of IAS 1 Presentation of Financial Statements states that measurement
bases (for example, historical cost, current cost, net realisable value, fair value and
recoverable amount) are accounting policies.

IASB’s deliberations

The IFRS Interpretations Committee considered the issue raised by ESMA and responded by
informing the IASB about divergent practices in assessing whether a change constitutes
a change in an accounting policy, or a change in an accounting estimate, in applying
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.

The IASB discussed the issue in a number of meetings from 2014 through 2017, issue for
public comment, proposed amendments to IAS 8 in September 2017 and began deliberating
the feedback in 2018. On 10 April 2019 the IASB discussed the staff’s analysis of feedback
on the Exposure Draft Accounting Policies and Accounting Estimates (Proposed amendments
to IAS 8) and the staff’s preliminary views on the project’s direction. On 30 August 2019 the
next step remained as ‘Decide Project Direction’.6

Principles versus other financial reporting requirements

I suggest that to differentiate a change in accounting policy from a change in accounting
estimate it might be useful first to understand whether the change relates to a financial reporting
requirement that is a principle.
A measurement principle necessarily has a measurement objective providing a clear ‘target’
that is deeply rooted in the objective of general purpose financial information (GPFI) designed

6
Source: https://www.ifrs.org/projects/work-plan/accounting-policies-and-accounting-estimates/

© Michael JC Wells 2019. This material has benefited greatly from the feedback and comments from people attending a series of workshops on
the Framework-based approach to teaching general purpose financial information and from peer review by a number of anonymous reviewers.

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 The ESMA IAS 8 issues case study

to reflect faithfully relevant information about the underlying economic phenomenon.7

Consequently, if not the correction of a prior period error, a change in the model or the inputs
to the model used when applying a measurement principle is a change in an accounting estimate
because, before and after the change, the target remains the same.
On the other hand, when the measurement basis is not a principle (ie it does not provide a clear
target deeply rooted in the objective and concepts that underlie GPFI) a change in the formula
(ie the model and inputs to that model) is a change in accounting policy because the new
formula provides a new and different target. I classify such a measurement as:
• a notion when it takes the form of a broadly stated requirement codifying old (and
sometimes newly invented conventions) specifying an opaque measurement objective;8
or
• a rule when application of the requirement requires blind rigidity rather than judgement.

You are required to:

A. Classify the measurement used for the item in each example of change raised by EMSA as:
1) a principle that is deeply rooted in the underlying concepts specifying a clear
measurement objective;
2) a convention that is a notion specifying an opaque measurement objective; or
3) a convention that is specified as a clear rule the application of which requires blind
rigidity rather than judgement.
Provide a brief explanation of your judgement in respect of each example.
B. Classify, in accordance with IAS 8, the change in each example raised by ESMA as either:
1) a voluntary change in accounting policy;
2) a mandated change in accounting policy;
3) a change in accounting estimate; or
4) a transfer due to a change in the use to which an asset is put.
C. Why do you think European regulators experience difficulty in distinguishing between a
change in an accounting policy from a change in an accounting estimate?
D. In your assessment do the changes that the IASB is proposing to IAS 8 better enable one
to distinguish between a change in an accounting policy from a change in an accounting
estimate? Can you suggest any further improvements?

7
For example, fair value measurement aims to estimate the price at which an orderly transaction to sell the asset or to transfer the
liability would take place between market participants at the measurement date under current market conditions (paragraph 9 of
IFRS 13 Fair Value Measurement)
8
For example, the equity method is “a method of accounting whereby the investment is initially recognised at cost and adjusted
thereafter for the post-acquisition change in the investor’s share of the investees net assets.” (paragraph 3 of IAS 28) Because the target
is opaque although IAS 28 provides mandatory guidance on how to apply the equity method many unanswered questions remain,
including, perhaps most fundamentally ‘what is the objective of the equity method?’.

© Michael JC Wells 2019. This material has benefited greatly from the feedback and comments from people attending a series of workshops on
the Framework-based approach to teaching general purpose financial information and from peer review by a number of anonymous reviewers.