IAS 8 covers:
- selecting and applying accounting policies and accounting for changes in accounting policies,
- changes in accounting estimates,
- corrections of prior period errors.
In addition to IAS 8, the IASB has issued Guide to Selecting and Applying Accounting Policies.
Definition of accounting policies
Accounting policies are defined as the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements (IAS 8.5). An entity reporting under IFRS should obviously apply IFRS when developing its accounting policies.
Events not covered by IFRS
There are transactions or events that are not covered by IFRS (e.g. business combinations under common control). Paragraphs IAS 8.10-12 set out the criteria for developing accounting policies in such cases. In short, in the absence of specific provisions in IFRS, developed accounting policies should be relevant and reliable. When developing such policies, entities should look into:
- IFRS dealing with similar cases,
- The Framework,
- Other GAAP and accounting practice.
Note that referencing to other GAAP and accounting practice is voluntary. However local law sometimes requires entities to apply local GAAP to transactions or events not covered by IFRS.
Requirements for changes in accounting policies
An entity should apply accounting policies consistently for similar transactions or events unless IFRS specify otherwise (IAS 8.13). Paragraphs IAS 8.14-31 cover changes in accounting policies and related disclosure requirements. As a rule, new accounting policy should be applied retrospectively unless it results from adoption of a new IFRS with different transitional provisions. For example, IFRS 15 and IFRS 16 allowed so-called ‘modified retrospective application‘.
IAS 8 takes into account the fact that a retrospective application can be impracticable (make sure to read carefully the definition of impracticable in IAS 8) and prescribes what to do in such a case (paragraphs IAS 8.23-27 and IAS 8.50-53). In practice, genuine instances of impracticability of retrospective application are rare.
Note that the application of a new accounting policy for transactions that did not occur previously or were immaterial is not a change in accounting policy (IAS 8.16b).
Immaterial impact of changes in accounting policies
Sometimes the impact of a change in accounting policy is immaterial. Such instances are not covered in IAS 8 as IFRS generally do not deal with immaterial items. If the impact is immaterial, entities don’t need to follow retrospective application. If the new accounting policy impacts the measurement or recognition of assets or liabilities, the question then arises what to do with assets/liabilities that existed (or would exist) as at the opening balance of current year. There are two approaches adopted in practice:
1/ Assets/liabilities as per opening balance of current year are remeasured/recognised/derecognised in line with the new accounting policy.
Under this approach, the corresponding impact is included in current year P/L in line with the nature of these assets (e.g. operating income, finance costs etc.). In order for this change in accounting policy to be immaterial, the cumulative impact on current period P/L must also be immaterial. Interestingly, this approach is officially allowed (unlike 2/ below) under US GAAP [ASC 250-10-S99-3 SAB Topic 5.F Accounting Changes Not Retroactively Applied Due to Immateriality].
2/ Assets/liabilities as per opening balance are not remeasured/recognised/derecognised in line with the new accounting policy.
Under this approach, no one-off P/L impact is recognised. The drawback of this solution is that the new accounting policy is not fully followed until assets/liabilities as per opening balance would have been derecognised anyway. In such a case, the materiality should be assessed based on a what-if approach, i.e. what would be the impact of remeasuring/ recognising/ derecognising all assets and liabilities under the new accounting policy (in other words: what is the materiality of what is missing).
Disclosure of changes in accounting policies
IAS 8.28-31 set out the requirements for disclosure requirements concerning changes in accounting policies.
Note that IAS 8.30 requires disclosure about IFRS that have been issued but are not yet effective. There are two dominant approaches here: some companies disclose a full set of all IFRS and amendments to them, while the other focus only on entity-specific material matters. Another thing to consider is how entities disclose ‘information relevant to assessing the possible impact that application of the new IFRS will have on the entity’s financial statements’. The disclosure should be entity-specific and explain how this new IFRS (or an amendment) will impact accounting for transactions carried out by the entity, even if the quantified impact is not known yet.
Changes in accounting estimates
A change in accounting estimate is an adjustment to the carrying amount of an asset or a liability, or the amount of the periodic consumption of an asset, that results from the assessment of the present status of, and expected future benefits and obligations associated with, assets and liabilities. Changes in accounting estimates result from new information or new developments and, accordingly, are not corrections of errors (IAS 8.5). Changes in accounting estimates are covered in IAS 8.32-40. Estimates are an inherent part of financial reporting and they don’t undermine the reliability of financial statements. Estimates, by their nature, change from period to period and are accounted for prospectively, i.e. in the period of change. Changes in estimates may result from new information, more experience or changes in facts or circumstances.
Changes in accounting estimates vs. changes in accounting policies
In practice, the difference between accounting estimate and accounting policy is often blurred. It is also true that entities try to minimise the frequency of changes in accounting policies to avoid changing the comparative data. IAS 8.35 reads ‘When it is difficult to distinguish a change in an accounting policy from a change in an accounting estimate, the change is treated as a change in an accounting estimate.’ An example of such a situation is a change of depreciation method which results from changes in estimates of the pattern in which an asset’s future economic benefits are expected to be consumed. In this case, all impact of the change is treated as a change in accounting estimate (IAS 16.BC33).
The same paragraph (IAS 8.35) states also that ‘a change in the measurement basis applied is a change in an accounting policy, and is not a change in an accounting estimate.’ It is not clarified what is meant by ‘measurement basis’ but it probably refers to paragraphs IAS 1.117-118 where examples of measurement bases are historical cost, current cost, net realisable value, fair value or recoverable amount. Therefore, a change of a measurement basis for an asset from e.g. historical cost to fair value is a change in accounting policy and should be applied retrospectively. An exception to this rule relates to the initial application of a policy to revalue items of PP&E and intangible assets, which should not be applied retrospectively (IAS 8.17).
A specific provision is included also in paragraph IFRS 13.66 which states that a change in the valuation technique should be accounted for as a change in accounting estimate. Entities can therefore infer that all changes in valuation technique, provided that the measurement basis remains unchanged (e.g. fair value), are changes in accounting estimates.
See also the section on correction of errors vs. changes in accounting policies or estimates below.
Requirements for correction of errors
Paragraphs IAS 8.41-49 set out requirements for correction of errors. The definition of an error in set out in paragraph IAS 8.5. In short, errors are misstatements in financial statements resulting from various kinds of mistakes, adopting accounting policies that are against IFRS requirements or fraud.
Material prior period errors should be corrected retrospectively with disclosures as set out in IAS 8.49. The discussion on materiality is crucial here, so check out this page on materiality. Interestingly, IAS 8 does not include a requirement to explicitly state that an error was made.
Similarly to changes in accounting policies, IAS 8 takes into account impracticability of retrospective restatement. In such a case, paragraphs IAS 8.43-48 and IAS 8.50-53 apply.
Correcting errors may trigger additional obligations resulting from local law.
Correction of errors vs. changes in accounting policies or estimates
Consider the following examples of errors:
- change in an estimated amount resulting from previous omission or misinterpretation of facts or circumstances,
- change in an accounting policy where the previous accounting policy was not in line with IFRS requirements,
- reclassification where the previous classification was not in line with IFRS requirements.
As we can see, some changes in estimates may be in fact errors. It is important to consider whether (and to what extent) the previous estimate was impacted by omission or misinterpretation of facts or circumstances that could reasonably be expected to have been obtained and taken into account when the previous estimate was made. If so, the change in estimated amount is a correction of error that requires retrospective restatement and related disclosure.
Similarly, when changing an accounting policy or making a reclassification, it is important to consider whether previous policy was in line with IFRS. If not – this is in fact a correction of error.
Correction of immaterial errors
Immaterial errors can be corrected in current year without restating comparative amounts. It is generally accepted that immaterial errors should be corrected via the same financial statement lines through which the error originated. For example, overstated revenue from previous years should decrease current year revenue so that total cumulative revenue is correct. If such a correction in current year would influence users of financial statements analysing current year results, then this error is material for current year results and should be corrected retrospectively.
Some argue that immaterial errors can be corrected through equity as a current year change/movement. It is not a valid approach in my opinion, as under IAS 1 all changes in equity during a period, other than those resulting from transactions with owners in their capacity as owners, should be included in total comprehensive income (IAS 1.7 definition of total comprehensive income, IAS 1.IN13a, IAS 1.109).