International Accounting Standard 8 – Accounting Policies, Changes in Accounting Estimates and Errors
What are accounting policies and what do they cover?
An entity’s accounting policies reflect the set of principles, bases, conventions, rules, and practices by which its financial statements are prepared and presented. Accounting policies may relate to the measurement bases of each of the reporting entity’s assets and liabilities, for example, financial assets and financial liabilities, inventory, property, plant and equipment, investment property and intangible assets. Accounting policies also address recognition and derecognition principles, for instance, revenue recognition policies or the derecognition of financial assets from the statement of financial position. In addition, accounting policies may pertain to presentation matters.
What qualitative characteristics and consistency requirements apply to accounting policies?
The Conceptual Framework for Financial Reporting sets out four qualitative characteristics of financial information in financial statements: relevance, reliability, comparability, and understandability. Accordingly, accounting policies should be as reliable and relevant as possible to users of the financial statements. They must also be applied consistently to similar transactions and events. The fundamental requirement of consistency applies not only across similar transactions, but also across reporting periods, to enable comparability over time. A change in accounting policy is exceptional and permitted only when it results in financial statement information that is more relevant and sufficiently reliable.
Why are accounting policies critical to the preparation of financial statements?
The application of appropriate accounting policies is a primary and essential component and serves as the starting point in the preparation of financial statements. Accounting policies may have a profound effect on financial statements. For example, the financial statements of a real estate investment company measuring investment property at fair value under International Accounting Standard (IAS) 40, Investment Property, may be entirely different from those prepared under the alternative cost model.
How are accounting policies selected when IFRS guidance is limited or allows choice?
IFRS Accounting Standards often provide guidance for determining an entity’s accounting policies. However, there may be circumstances not addressed by existing standards or interpretations, in which case the reporting entity must apply judgment to develop appropriate accounting policies. Furthermore, in some cases a particular IFRS Accounting Standard allows the reporting entity to choose between more than one accounting policy. In such situations, the entity must select a specific policy and apply it consistently.
What role do accounting estimates play in financial statement preparation?
Another essential element in the preparation of financial statements is the use of estimates. The use of reasonable estimates is an integral part of financial statement preparation and does not undermine their reliability. Estimates are necessary due to the inherent uncertainty of business activity. As a result, many items in the financial statements cannot be measured precisely but only estimated. Estimates requiring significant judgment may relate, for example, to doubtful debts, inventory obsolescence, the fair value of financial assets and financial liabilities, useful lives of depreciable assets, warranty provisions, and forecasts of future taxable income for the recognition of deferred tax assets.
How are changes in accounting estimates treated?
By nature, estimates may change from period to period. A change in accounting estimate is an adjustment of the carrying amount of an asset or liability, or of the periodic consumption of an asset, resulting from reassessment of their present condition and the expected future benefits and obligations associated with them. Consequently, estimates must be updated when changes in circumstances occur, or as a result of new information or accumulated experience.
What issues are addressed by IAS 8?
IAS 8 sets the criteria for the selection and modification of accounting policies based on the Conceptual Framework for Financial Reporting, and establishes the accounting treatment and disclosure requirements for changes in accounting policies. It also addresses the treatment of changes in accounting estimates and the correction of errors.
How does IAS 8 distinguish between policy changes, estimate changes, and errors?
The Standard distinguishes between a change in accounting policy, a change in estimate, and the correction of an error. While the guiding principle for accounting policy changes is retrospective application to achieve comparability, the guiding principle for changes in accounting estimates is not to attribute them to prior periods. Similarly, the guiding principle for correcting material prior-period errors is the restatement of comparative amounts. Unlike changes in accounting policy, the rationale for restatement in the case of an error is not comparability but the need to correct the error once identified, in order to present comparative information.
Which related standards complement IAS 8?
The Standard does not address first-time adoption of IFRS, which is covered by IFRS 1, First-time Adoption of International Financial Reporting Standards.
While IAS 8 details disclosure requirements regarding changes in accounting policies, disclosure requirements regarding the accounting policies themselves are set out in IFRS 18, Presentation of Financial Statements.
The accounting treatment and disclosure of the tax effects of error corrections and retrospective adjustments arising from changes in accounting policies are prescribed by IAS 12, Income Taxes.