Introduction
IAS 8 deals with accounting policies, the treatment of changes in accounting policies and of changes in accounting estimates, and errors.
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5: Reporting financial performance PART B SINGLE COMPANY FINANCIAL ACCOUNTS3.1 Developing accounting policies
IAS 8 defines accounting policies as follows.
ACCOUNTING POLICIES are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements. (IAS 8) Accounting policies are determined by applying the relevant IFRS or IAS.
Where there is no applicable IFRS or IAS management should use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. Management should consider IFRSs and IASs that deal with similar and related issues. They should also consider the definitions, recognition criteria and measurement concepts contained in the Framework.
An entity must select and apply its accounting policies for a period consistently for similar transactions, other events and conditions, unless an IFRS or an IAS specifically requires or permits categorisation of items for which different policies may be appropriate. If an IFRS or an IAS requires or permits
categorisation of items, an appropriate accounting policy must be selected and applied consistently to each category.
3.2 Changes in accounting policies
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The same accounting policies are usually adopted from period to period, to allow users to analyse trends over time in profit, cash flows and financial position. Changes in accounting policy will therefore be rare and should be made only if required by one of three things:
(a) A new statutory requirement (b) A new accounting standard
(c) If the change will result in a more appropriate presentation of events or transactions in the financial statements of the entity
The standard highlights two types of event which do not constitute changes in accounting policy. (a) Adopting an accounting policy for a new type of transaction or event not dealt with previously by
the entity
(b) Adopting a new accounting policy for a transaction or event which has not occurred in the past or which was not material
If a policy of revaluation of property, plant and equipment is adopted for the first time then this is treated as a revaluation under IAS 16 Property, plant and equipment, not as a change of accounting policy under IAS 8.
Examples of changes in accounting policies include:
(a) Inventory previously valued on a FIFO basis is now to be valued on a weighted average cost basis. (b) Depreciation is now classified as administrative expenses rather than cost of sales.
3.2.1 Applying a change in accounting policy
IAS 8 requires retrospective application of a change in accounting policy, unless it is impracticable to determine the cumulative amount of the adjustment.
RETROSPECTIVE APPLICATION means to apply a new accounting policy to transactions, other events and conditions as if that policy had always been applied.
Applying a requirement is IMPRACTICABLE when the entity cannot apply it after making every reasonable effort to do so. It is impracticable to apply a change in an accounting policy retrospectively or to make a retrospective restatement to correct an error if one of the following apply.
KEY TERM KEY TERM
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(a) The effects of the retrospective application or retrospective restatement are not determinable. (b) The retrospective application or retrospective restatement requires assumptions about what
management's intent would have been in that period.
(c) The retrospective application or retrospective restatement requires significant estimates of amounts and it is impossible to distinguish objectively information about those estimates that: provides evidence of circumstances that existed on the date(s) at which those amounts are to be
recognised, measured or disclosed; and would have been available when the financial statements for that prior period were authorised for issue, from other information. (IAS 8) In other words, retrospective application means that all comparative information must be restated as if the new policy had always been in force, with amounts relating to earlier periods reflected in an adjustment to opening reserves of the earliest period presented. Comparative information should be restated unless it is impracticable to do so.
Prospective application is allowed only when it is impracticable to determine the cumulative effect of the change.
PROSPECTIVE APPLICATION of a change in accounting policy means to apply the new accounting policy to transactions, other events and conditions occurring after the date as at which the policy is changed. In other words, the new accounting policy is applied from the point it is adopted to transactions occurring from that date forwards. No adjustments are made for the treatment of transactions that occurred in the past under the old policy.
3.2.2 Disclosure of a change in accounting policy
Certain disclosures are required when a change in accounting policy has a material effect on the current period or any prior period presented, or when it may have a material effect in subsequent periods. (a) Reasons for the change
(b) Nature of the change
(c) Amount of the adjustment for the current period and for each period presented
(d) Amount of the adjustment relating to periods prior to those included in the comparative information
(e) The fact that comparative information has been restated or that it is impracticable to do so If an entity has chosen to change an accounting policy, rather than this being required by statute or accounting standards, an explanation of why the new policy provides more reliable and relevant information must be given.
An entity should also disclose information relevant to assessing the impact of new IFRSs on the financial statements where these have not yet come into force.
3.3 Changes in accounting estimates
3.3.1 What are accounting estimates?
Estimates arise in relation to business activities because of the uncertainties inherent within them. Judgements are made based on the most up to date information and the use of such estimates is a necessary part of the preparation of financial statements. It does not undermine their reliability. Here are some examples of accounting estimates.
A necessary doubtful debt provision Useful lives of depreciable assets Provision for obsolescence of inventory
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5: Reporting financial performance PART B SINGLE COMPANY FINANCIAL ACCOUNTSWhere circumstances change or more information becomes available, the estimate may need to be revised.
3.3.2 Changes in accounting estimates
When an accounting estimate needs to be changed, the effect of the change should be accounted for prospectively, ie, included in the financial statements in the period it arises, and in future periods if the change affects both current and future periods.
An example of a change in accounting estimate which affects only the current period is a change in the doubtful debt estimate. However, a revision in the life over which an asset is depreciated would affect both the current and future periods, in the amount of the depreciation expense.
Reasonably enough, the effect of a change in an accounting estimate should be included in the same expense classification as was used previously for the estimate. This rule helps to ensure consistency between the financial statements of different periods.
The materiality of the change is also relevant. The nature and amount of a change in an accounting estimate that has a material effect in the current period (or which is expected to have a material effect in subsequent periods) should be disclosed. If it is not possible to quantify the amount, this impracticability should be disclosed.
3.4 Prior period errors
PRIOR PERIOD ERRORS are omissions from, and misstatements in, the entity's financial statements for one or more prior periods 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
Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud. (IAS 8)
3.4.1 Accounting treatment for prior period errors
Prior period errors should be corrected retrospectively. This involves:
(a) Either restating the comparative amounts for the prior period(s) in which the error occurred, (b) Or, when the error occurred before the earliest prior period presented, restating the opening
balances of assets, liabilities and equity for that period
so that the financial statements are presented as if the error had never occurred.
Only where it is impracticable to determine the cumulative effect of an error on prior periods can an entity correct an error prospectively.
Various disclosures are required. (a) Nature of the prior period error
(b) For each prior period, to the extent practicable, the amount of the correction (i) For each financial statement line item affected
(ii) If IAS 33 applies, for basic and diluted earnings per share
(c) The amount of the correction at the beginning of the earliest prior period presented
(d) If retrospective restatement is impracticable for a particular prior period, the circumstances that led to the existence of that condition and a description of how and from when the error has been corrected. Subsequent periods need not repeat these disclosures.
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Learning outcome C2(a)
During 20X7 Global discovered that certain items had been included in inventory at 31 December 20X6, valued at $4.2m, which had in fact been sold before the year end. The following figures for 20X6 (as reported) and 20X7 (draft) are available.
20X7 20X6 (draft)
$'000 $'000
Sales 47,400 67,200
Cost of goods sold (34,570) (55,800)
Profit before taxation 12,830 11,400
Income taxes (3,880) (3,400)
Net profit 8,950 8,000
Reserves at 1 January 20X6 were $13m. The cost of goods sold for 20X7 includes the $4.2m error in opening inventory. The income tax rate was 30% for 20X6 and 20X7.
Required
Prepare the statement of profit or loss for 20X7, with the 20X6 comparative, and a reconciliation of opening and closing retained earnings for 20X6 and 20X7.
Section summary
IAS 8 deals with the treatment of changes in accounting estimates, changes in accounting policies and errors.
Accounting policies must comply with accounting standards and be applied consistently Changes in accounting policy are applied retrospectively.
Changes in accounting estimates are not applied retrospectively.
Prior period errors will require retrospective correction if they are material.
4 IFRS 8 Operating segments
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Introduction
Large entities produce a wide range of products and services, often in several different countries. Further information on how the overall results of entities are made up from each of these product or geographical areas will help the users of the financial statements assess the past performance of the entity, better understand its risks and returns, and make more informed judgments about the entity as a whole. This is the reason for segment reporting.
Segment reporting is covered by IFRS 8 Operating segments, which replaced IAS 14 Segment reporting in November 2006.
4.1 IFRS 8 Operating segments
IFRS 8 requires an entity to adopt the 'management approach' to reporting on the financial performance of its operating segments. This ‘management approach’ has two intended advantages:
(a) It allows users of the financial statements to view operations through the eyes of management. (b) As it is based on information which is being collected anyway, it should not involve too much cost
or time to prepare.
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5: Reporting financial performance PART B SINGLE COMPANY FINANCIAL ACCOUNTSIn the words of the Standard:
‘An entity shall disclose information to enable users of its financial statements to evaluate the nature and financial effects of the business activities in which it engages and the economic environments in which it operates.’
IFRS 8 applies to listed companies only.
4.1.1 Operating segments
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An OPERATING SEGMENT is a component of an entity:
(a) that engages in business activities from which it may earn revenues and incur expenses (b) whose operating results are regularly reviewed by the entity’s chief operating decision maker to
make decisions about resources to be allocated to the segment and assess its performance, and (c) for which discrete financial information is available (IFRS 8)
4.1.2 Determining reportable segments
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An entity must report separate information about each operating segment that: (a) Has been identified as meeting the definition of an operating segment; and (b) Exceeds any of the following thresholds:
(i) Segment revenue (internal and external) is 10% or more of total revenue, or
(ii) Segment profit or loss is 10% or more of all segments in profit (or all segments in loss if greater)
(iii) Segment assets are 10% or more of total assets
At least 75% of total external revenue must be reported by operating segments. Where this is not the case, additional segments must be identified (even if they do not meet the 10% thresholds).
Two or more operating segments below the thresholds may be aggregated to produce a reportable segment if the segments have similar economic characteristics and the segments are similar in each of the following respects:
The nature of the products or services The nature of the production process
The type or class of customer for their products or services
The methods used to distribute their products or provide their services, and If applicable, the nature of the regulatory environment
Operating segments that do not meet any of the quantitative thresholds may be reported separately if management believes that information about the segment would be useful to users of the financial statements.
CTU Co has the following operating segments
Segment Internal revenue External revenue Total revenue
$’000 $’000 $’000 Car division 29 61 90 Bike division – 45 45 Truck division – 39 39 Tractor division – 23 23 Van division – 21 21 Digger division – 17 15 29 206 235