THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA

POSTGRADUATE DIPLOMA IN BUSINESS AND FINANCE - 2013/201

PRINCIPLES OF FINANCIAL AND COST ACCOUNTING

Nadeeshani Dissanayake
B.Sc. Accounting (Sp), First Class, ACA, ACMA,
CPA (Aust)
Accounting Policies, Changes in Accounting
Estimates and Errors:

LKAS 8
 Key is comparability

 Objectives:
 How to choose accounting policies
 Reporting changes in accounting policies
 Reporting changes in estimates
 Reporting the correction of errors
IAS 8 – SELECTION AND APPLICATION OF ACCOUNTING
POLICIES

For a specific transaction or event -

First, look to the IFRS/SLFRS that deals specifically with that situation:
 International Financial Reporting Standards,
 International Accounting Standards, and
 Interpretations developed by IFRIC or predecessor SIC

Appendices and implementation guidance attached to these are an integral part of

each only if stated on the specific standard.
 IFRS/SLFRS standards and interpretations - top of the GAAP hierarchy

 When applied – information is assumed to be relevant and reliable

 What if no specific IFRS/SLFRS that applies?

 If no specific IFRS/SLFRS that applies:
 Use judgment
 Develop a policy that results in relevant and reliable
information
 Hierarchy of sources to use
 IFRS/SLFRS Conceptual framework basics
 If not in conflict with above, use other sources:
 Pronouncements of other standard setters with similar
frameworks, accounting literature, accepted industry
practice, etc.
IAS 8 – CHANGES IN ACCOUNTING POLICIES

 Accounting policies -
 “specific principles, bases, conventions, rules and
practices applied by an entity in preparing and
presenting financial statements”
 Source of changes in accounting policy:
 required by a new or revised IFRS (most common)
 voluntary change to reliable and more relevant
information
 Examples
 If change due to:
 different economic conditions
 new events or conditions
 previously immaterial effects
 Then NOT a change in accounting policy
 Initial application of an IFRS/SLFRS
– if transitional accounting method provided – follow it
– if no transitional method – retrospective application
 Voluntary change in policy
– retrospective application
 Retrospective (retroactive) application
– means apply new policy as if it had always been applied
– change past amounts
 Retrospective application:
 for the earliest prior period presented
 adjust opening balance of equity affected
 adjust opening balance of other comparative amounts
disclosed
 Unless
 impracticable to determine effects on specific prior
periods or cumulative effect of change
 Impracticable: not able to determine adjustments needed after
making reasonable effort, i.e.,
 effects of retroactive changes not determinable
 assumptions needed about management’s intentions in the prior period
 cannot make estimates without knowing circumstances that existed in the
prior period; can only do using hindsight
 Example: need to estimate fair value of private company three
years ago. Need to know expectations that existed then re cash
flows and risk-adjusted discount rate. Not possible in many
situations.
 If impracticable to apply full retrospective treatment,
then
– apply the change to A, L, and equity accounts at
beginning of earliest possible period for which effects are
known
 If impracticable to determine cumulative effect even
on current period opening balances, then
– apply new policy prospectively
 For all changes in accounting policy, disclose
 nature of the change
 amounts of adjustments to all F/S items, EPS, and to prior periods
 if judged impracticable to apply retrospectively, explain why, and how
applied
 If on application of a new/revised IFRS, also report
 name of IFRS, that transitional provisions are applied, any likely future
effects
 Also disclosures about new IFRS released but not yet effective
LKAS /IAS 8 – CHANGES IN ACCOUNTING ESTIMATES

 Change in accounting estimate – adjustment to

carrying amount of an A/L or amount of asset
consumed in period resulting from its present
status and the expected future
benefits/obligations associated with it.
 Results from new information or new developments
 If uncertain whether a change in policy or a change in
estimate, account for it as a change in estimate
 Estimates are fundamental to the accounting process
 Changes are expected and recurring
 Therefore, account for prospectively
 Prospective application – recognize effect of change
in current and future periods
 Disclose
 Nature of the change
 Amount of the change, unless effect on future periods
impracticable to estimate
LKAS/IAS 8 – CORRECTIONS OF ERRORS
 Prior period error – an omission or misstatement
in previously reported financial statements from
failing to use/misuse of reliable information that
 Was available when F/S were authorized, and
 Could reasonably be expected to have been used in
preparing those F/S
 e.g., arithmetic mistakes, mistakes in applying
accounting policies, oversights,
misrepresentation of facts, fraud
 Accounting for correction of an error –
 Retrospective restatement
 As if error had never been made
 If impracticable to determine period-specific adjustments,
use partial retrospective application, or even prospective
treatment (see change in accounting policy)
 Disclose
 Nature of the error
 Amount of correction for each F/S item, EPS, and to prior
periods
 If judged impracticable to apply retrospectively, explain
why, how applied and date from which error is corrected
PROVISIONS, CONTINGENT LIABILITIES
AND CONTINGENT ASSETS (LKAS 37)
DEFINITIONS
 A Provision – is a liability of uncertain timing or
amount
 A Liability – is a present obligation of the entity
arising from past events, the settlement of which
is expected to result in an outflow from the entity
of resources embodying economic benefits.
 Legal Obligation + Constructive Obligation
 A Contingent Liability – is a possible obligation
that arises from past events and whose
existence will be confirmed only by the
occurrence or non- occurrence of one or more
uncertain future events not wholly within the
control of the entity ; OR
 A present obligation that arises from past events
but is not recognised because , it is not probable
that an outflow of resources embodying
economic benefits will be required to settle the
obligation or the amount of the obligation
cannot be measured with sufficient reliability.
 A contingent Assets – is a possible asset that
arises from past events and whose existence will
be confirmed only by occurrence or non-
occurrence of one ore more uncertain future
events not wholly within the control of the
company
RECOGNITION
 A provision shall be recognized when :
(a) An entity has a present obligation as a result of
past event;
(b) It is probable that an outflow of resources
embodying economic benefits will be required
to settle obligation; and
(c) A reliable estimate can be made of the amount
of the obligation
 Contingent Liability – Not recognised as a
liability in FS. But needs to be disclosed.
 Contingent Assets - Not recognised as a asset in
FS. But needs to be disclosed where an inflow of
economic benefit is probable.
EXAMPLE 1
Entity A is involved in a legal dispute. A customer
claims they slipped and fell at the entity premises,
sustaining a back injury. The customer is seeking a
damage of Rs. 1 mn. Despite the fact that customers
have been successful in winning similar claims in the
past, the directors of entity A believe they will be
successful in defending the claim. Entity A’s lawyers
have also advised that it is probable that Entity A will
not be found liable.
Should Entity A recognise a provision for the legal
claim ?
EXAMPLE 1 CONT….
 No, a provision does not need to be recognised in
Entity A’s Financial Statements
 In this fact pattern, although the entity has a
present obligation resulting from a past event, it
is not probable that an outflow to resources
would be required to settle the obligation
 The event would likely be disclosed as contingent
liability in the FS
EXAMPLE 2
 ABC is an oil exploration company. During the year, due to a lapse
in safety procedures on one of ABC’ oil rigs, there was a major oil
spill.
There is no environmental legislation that requires ABC to clean up
the contamination caused by the oil spill. However, in recent years,
ABC has widely publicised its environmental policy, which includes
an undertaking to clean up any contamination that it causes.
ABC engineers estimate that it will cost approximately Rs. 15 mn to
rectify the damage caused by the spill

Should ABC recognise a provision for the cost of rectifying the oil
spill ?
EX 2 - SOLUTION
 Is there a present obligation as a result of past
event ? YES
 Is the outflow of economic resources probable ?
YES
 Can the amount be reliably measured ? YES
MEASUREMENT OF PROVISIONS
 A provision is measured as follows
the best estimate of expenditure required to
settle the present obligation at the end of the
reporting period
 Best estimate

The amount that an entity would rationally pay

to settle the obligation at that date or to transfer
it to a third party at that time.
Large Population of items : expected value
Single obligation : most likely amount
EX :3
 Using the same facts as for Ex 2, ABC engineers
have revised their original estimates for the cost
of rectifying the damages caused by the oil spill.
The engineers now believe that there is a
15% chance of the clean-up costing Rs. 10mn
30% chance of the clean-up costing Rs. 15mn
55% chance of the clean-up costing Rs. 20mn
What is the appropriate value of the provision recognised
by ABC in its FS ?
 Solution
As the oil spill is a single obligation, the individul
most likely outcome should be used to provide the
best estimate of the liability
The individual most likely outcome is Rs. 20mn
(55% likeliehood)
EX: 4

Using the same facts as for ex – 3, except now

assume that the obligation is relating to a large
population of items ( ex: warranties on cars
manufactured)
Calculate the value of the provision to be
recognised.
Provision should be estimated using the expected
value method
15% * Rs. 10mn = Rs. 1.5 mn
30% * Rs. 15mn = Rs. 4.5 mn
55% * Rs. 20mn = Rs. 11.0 mn
Total provision RS. 17mn