useful life of, or the expected pattern of consumption of the future economic benefits
embodied in, a depreciable asset. [IAS 8.38].
The standard also notes that corrections of errors should be distinguished from changes
in accounting estimates. Accounting estimates by their nature are approximations that
may need revision as additional information becomes known. For example, the gain or
loss recognised on the outcome of a contingency is not the correction of an error.
[IAS 8.48].
The distinction between an accounting policy and an accounting estimate is particularly
important because a very different treatment is required when there are changes in
accounting policies or accounting estimates (discussed at 4.4 and 4.5 below). When it is
difficult to distinguish a change in an accounting policy from a change in an accounting
estimate, IAS 8 requires the change to be treated as a change in an accounting estimate.
[IAS 8.35].
4.3
The selection and application of accounting policies
Entities complying with IFRS (which is a defined term, discussed at 1.1 above) do not
have a free hand in selecting accounting policies; indeed the very purpose of a body of
accounting literature is to confine such choices.
IFRSs set out accounting policies that the IASB has concluded result in financial
statements containing relevant and reliable information about the transactions, other
events and conditions to which they apply. [IAS 8.8].
To this end, IAS 8’s starting point is that when an IFRS specifically applies to a
transaction, other event or condition, the accounting policy or policies applied to that
item should be determined by applying the IFRS and considering any relevant
implementation guidance issued by the IASB for the IFRS. [IAS 8.7]. This draws out the
distinction that IFRS must be applied whereas implementation guidance (which, as
discussed at 1.1 above, is not part of IFRS) must be considered. As noted earlier, though,
we would generally be surprised at entities not following such guidance.
Those policies need not be applied when the effect of applying them is immaterial.
However, it is inappropriate to make, or leave uncorrected, immaterial departures from
IFRS to achieve a particular presentation of an entity’s financial position, financial
performance or cash flows (see 4.6 below). [IAS 8.8]. The concept of materiality is
discussed at 4.1.5 above.
There will be circumstances where a particular event, transaction or other condition is
not specifically addressed by IFRS. When this is the case, IAS 8 sets out a hierarchy of
guidance to be considered in the selection of an accounting policy.
Presentation of financial statements and accounting policies 159
The primary requirement of the standard is that management should use its judgement
in developing and applying an accounting policy that results in information that is:
(a) relevant to the economic decision-making needs of users; and
(b) reliable, in that the financial statements:
(i) represent faithfully the financial position, financial performance and cash
flows of the entity;
(ii) reflect the economic substance of transactions, other events and conditions,
and not merely the legal form;
(iii) are neutral, that is, free from bias;
(iv) are
prudent;
and
(v) are complete in all material respects. [IAS 8.10].
There is, in our view, clearly a tension between (b) (iii) and (b) (iv) above – at least based
on what many would consider the natural meaning of the words ‘neutral’ and ‘prudent’.
Prudence and neutrality are not defined or otherwise discussed by IAS 8. They are,
however, discussed in the IASB’s Conceptual Framework) as follows (see Chapter 2 for a
discussion of the Framework and specifically at 5.1.2 regarding faithful representation).
A neutral depiction is one without bias in the selection or presentation of financial
information. A neutral depiction is not slanted, weighted, emphasised, de-emphasised or
otherwise manipulated to increase the probability that financial information will be
received favourably or unfavourably by users. That is not to imply that neutral information
has no purpose or no influence on behaviour. On the contrary, relevant financial
information is, by definition, capable of making a difference in users’ decisions. [CF 2.15].
The Conceptual Framework has a discussion of the word ‘prudence’, the exercise of
which is considered by the Board to support neutrality. The IASB considers prudence
to be the exercise of caution when making judgements under conditions of uncertainty.
This is said to mean that:
• assets and income are not overstated and liabilities and expenses are not
understated; but also that
• the exercise of prudence does not allow for the understatement of assets or income
or the overstatement of liabilities or expenses. Such misstatements can lead to the
overstatement or understatement of income or expenses in future periods. [CF 2.16].
The standard gives guidance regarding the primary requirement for exercising
judgement in developing and applying an accounting policy. This guidance comes in
two ‘strengths’ – certain things which management is required to consider, and others
which it ‘may’ consider, as follows.
In making its judgement, management shall refer to, and consider the applicability of,
the following sources in descending order:
(a) the requirements and guidance in IFRSs dealing with similar and related issues; and
(b) the definitions, recognition criteria and measurement concepts for assets,
liabilities, income and expenses in the Framework;2 [IAS 8.11] and
in making this judgement, management may also consider the most recent pronouncements
of other standard-setting bodies that use a similar conceptual framework to develop
160 Chapter
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accounting standards, other accounting literature and accepted industry practices, to the
extent that these do not conflict with the sources in (a) and (b) above. [IAS 8.12]. If an entity
considers pronouncements of other standard-setting bodies in making its judgement in
developing and applying an accounting policy, it should, in our view, consider all the
contents of the pronouncements that are relevant to the issue. In other words, it should not
adopt a selective or ‘cherry-picking’ approach.
In an agenda decision of March 2011, the Interpretations Committee noted the
following. ‘The Committee observed that when management develops an accounting
policy through analogy to an IFRS dealing with similar and related matters, it needs to
use its judgement in applying all aspects of the IFRS that are applicable to the particular
issue.’ The committee concluded that the issue of developing accounting policies by
analogy requires no further clarification, so did not add the matter to its agenda.
4.4
Changes in accounting policies
As discussed at 4.1.4 above, consistency of accounting policies and presentation is a
basic principle in both IAS 1 and IAS 8. Accordingly, IAS 8 only permits a change in
accounting policies if the change:
(a) is required by an IFRS; or
&n
bsp; (b) results in the financial statements providing reliable and more relevant information
about the effects of transactions, other events or conditions on the entity’s financial
position, financial performance or cash flows. [IAS 8.14].
IAS 8 addresses changes of accounting policy arising from three sources:
(a) the initial application (including early application) of an IFRS containing specific
transitional provisions;
(b) the initial application of an IFRS which does not contain specific transitional
provisions; and
(c) voluntary changes in accounting policy.
Policy changes under (a) should be accounted for in accordance with the specific
transitional provisions of that IFRS.
A change of accounting policy under (b) or (c) should be applied retrospectively, that is
applied to transactions, other events and conditions as if it had always been applied.
[IAS 8.5, 19-20]. The standard goes on to explain that retrospective application requires
adjustment of the opening balance of each affected component of equity for the earliest
prior period presented and the other comparative amounts disclosed for each prior
period presented as if the new accounting policy had always been applied. [IAS 8.22]. The
standard observes that the amount of the resulting adjustment relating to periods before
those presented in the financial statements (which is made to the opening balance of
each affected component of equity of the earliest prior period presented) will usually
be made to retained earnings. However, it goes on to note that the adjustment may be
made to another component of equity (for example, to comply with an IFRS). IAS 8 also
makes clear that any other information about prior periods, such as historical summaries
of financial data, should be also adjusted. [IAS 8.26].
Presentation of financial statements and accounting policies 161
Frequently it will be straightforward to apply a change in accounting policy retrospectively.
However, the standard accepts that sometimes it may be impractical to do so. Accordingly,
retrospective application of a change in accounting policy is not required to the extent that
it is impracticable to determine either the period-specific effects or the cumulative effect
of the change. [IAS 8.23]. This is discussed further at 4.7 below. As noted at 4.3 above, in the
absence of a specifically applicable IFRS an entity may apply an accounting policy from
the most recent pronouncements of another standard-setting body that use a similar
conceptual framework. The standard makes clear that a change in accounting policy
reflecting a change in such a pronouncement is a voluntary change in accounting policy
which should be accounted for and disclosed as such. [IAS 8.21].
The standard clarifies that the following are not changes in accounting policy:
• the application of an accounting policy for transactions, other events or conditions
that differ in substance from those previously occurring; and
• the application of a new accounting policy for transactions, other events or
conditions that did not occur previously or were immaterial. [IAS 8.16].
More importantly, the standard requires that a change to a policy of revaluing intangible
assets or property plant and equipment in accordance with IAS 38 and IAS 16 respectively
is not to be accounted for under IAS 8 as a change in accounting policy. Rather, such a
change should be dealt with as a revaluation in accordance with the relevant standards
(discussed in Chapters 17 at 8.2 and 18 at 6). [IAS 8.17-18]. What this means is that it is not
permissible to restate prior periods for the carrying value and depreciation charge of the
assets concerned. Aside of this particular exception, the standard makes clear that a
change in measurement basis is a change in an accounting policy, and not a change in an
accounting estimate. However, when it is difficult to distinguish a change in an accounting
policy from a change in an accounting estimate, the standard requires it to be treated as a
change in an accounting estimate, discussed at 4.5 below. [IAS 8.35].
4.5
Changes in accounting estimates
The making of estimates is a fundamental feature of financial reporting reflecting the
uncertainties inherent in business activities. IAS 8 notes that the use of reasonable
estimates is an essential part of the preparation of financial statements and it does not
undermine their reliability. Examples of estimates given by the standard are:
• bad debts;
• inventory obsolescence;
• the fair value of financial assets or financial liabilities;
• the useful lives of, or expected pattern of consumption of the future economic
benefits embodied in, depreciable assets; and
• warranty obligations. [IAS 8.32-33].
Of course there are many others, some of the more subjective relating to share-based
payments and post-retirement benefits.
Estimates will need revision as changes occur in the circumstances on which they are
based or as a result of new information or more experience. The standard observes that,
by its nature, the revision of an estimate does not relate to prior periods and is not the
162 Chapter
3
correction of an error. [IAS 8.34]. Accordingly, IAS 8 requires that changes in estimate be
accounted for prospectively; defined as recognising the effect of the change in the
accounting estimate in the current and future periods affected by the change. [IAS 8.5, 36].
The standard goes on to explain that this will mean (as appropriate):
• adjusting the carrying amount of an asset, liability or item of equity in the statement
of financial position in the period of change; and
• recognising the change by including it in profit and loss in:
• the period of change, if it affects that period only (for example, a change in
estimate of bad debts); or
• the period of change and future periods, if it affects both (for example, a
change in estimated useful life of a depreciable asset or the expected pattern
of consumption of the economic benefits embodied in it). [IAS 8.36-38].
4.6
Correction of errors
As with all things, financial reporting is not immune to error and sometimes financial
statements can be published which, whether by accident or design, contain errors. IAS 8
defines prior period errors as omissions from, and misstatements in, an entity’s financial
statements for one or more prior periods (including the effects of mathematical
mistakes, mistakes in applying accounting policies, oversights or misinterpretations of
facts, and fraud) arising from a failure to use, or misuse of, reliable information that:
(a) was available when financial statements for those periods were authorised for
issue; and
(b) could reasonably be expected to have been obtained and taken into account in the
preparation and presentation of those financial statements. [IAS 8.5].
Errors can arise in respect of the recognition, measurement, presentation or disclosure
of elements of financial statements. IAS 8 states that financial statements do not comply
with IFRS if they contain errors that are:
(a) material;
or
(b) immaterial but are made intentionally to a
chieve a particular presentation of an
entity’s financial position, financial performance or cash flows. [IAS 8.41].
The concept in (b) is a little curious. As discussed at 4.1.5.A above, an error is material if it
could influence the economic decisions of users taken on the basis of the financial
statements. We find it difficult to imagine a scenario where an entity would deliberately
seek to misstate its financial statements to achieve a particular presentation of its financial
position, performance or cash flows but only in such a way that did not influence the
decisions of users. In any event, and perhaps somewhat unnecessarily, IAS 8 notes that
potential current period errors detected before the financial statements are authorised for
issue should be corrected in those financial statements. This requirement is phrased so as
to apply to all potential errors, not just material ones. [IAS 8.41]. The standard notes that
corrections of errors are distinguished from changes in accounting estimates. Accounting
estimates by their nature are approximations that may need revision as additional
information becomes known. For example, the gain or loss recognised on the outcome of
a contingency is not the correction of an error. [IAS 8.48].
Presentation of financial statements and accounting policies 163
When it is discovered that material prior period errors have occurred, IAS 8 requires
that they be corrected in the first set of financial statements prepared after their
discovery. [IAS 8.42]. The correction should be excluded from profit or loss for the period
in which the error is discovered. Rather, any information presented about prior periods
(including any historical summaries of financial data) should be restated as far back as
practicable. [IAS 8.46]. This should be done by:
(a) restating the comparative amounts for the prior period(s) presented in which the
error occurred; or
(b) if the error occurred before the earliest prior period presented, restating the
opening balances of assets, liabilities and equity for the earliest prior period
presented. [IAS 8.42].
This process is described by the standard as retrospective restatement, which it also
defines as correcting the recognition, measurement and disclosure of amounts of
elements of financial statements as if a prior period error had never occurred. [IAS 8.5].
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 33
