CHAPTER 12: PAS 8 - ACCOUNTING POLICIES, ESTIMATE AND ERRORS

ACCOUNTING POLICIES
Accounting policies are the specific principles, bases, conversions, 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 principles which is different
from the one previously used by the entity.

Example of change in accounting policy are:

a. Change in the method of inventory 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 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 transition 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 operating balance of retained earnings.
CHAPTER 12: PAS 8 - ACCOUNTING POLICIES, ESTIMATE AND ERRORS

The amount of the adjustment is determined as of the beginning of the year of change.

If the 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 of inventory valuation since it began operation in 2019.

The entity decided to change the weighted average method for determining inventory cost at the beginning of 2020.

Period FIFO Weighted average

December 31, 2019 1,000,000.00 750,000.00
December 31, 2020 1,500,000.00 1,200,000.00

FIFO inventory - January 1, 2020 1,000,000.00

Weigthed average inventory - January 1, 2020 750,000.00
Decrease in beginning inventory 250,000.00

Adjustment of the decrease in beginning inventory

Retained earnings 250,000.00

Inventory - January 1 250,000.00

The computation of the cost of goods sold for 2020 would then show beginning inventory of P750,000 and ending
inventory at P1,200,000 to conform with the weighted average method.

The statement of changes in equity for the year ended December 31, 2020 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, manage shall use judgement in selecting and applying an accounting policy 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 used 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
CHAPTER 12: PAS 8 - ACCOUNTING POLICIES, ESTIMATE AND ERRORS
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 estimates

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 judgement 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 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 is estimated to have a life of 5 years.

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

The procedure is not to correct past depreciation.

CHAPTER 12: PAS 8 - ACCOUNTING POLICIES, ESTIMATE AND ERRORS
Instead, the remaining carrying amount of P300,000 (P500,000 minus P200,000 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 50,000.00
Accumulated depreciation 50,000.00

Prior period errors

Prior period errors are omissions and misstatements in the financial statements for one or more periods arising from
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 retrospectively restatement.