Illustration 6 – Alternative classifications
1 Reporting performance Information
The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions.
The economic decisions that are made by users of financial statements require an evaluation of the ability of an entity to generate cash and cash equivalents and of the timing and certainty of their generation.
Information about the performance of an entity, in particular its profitability, is required in order to:
assess potential changes in the economic resources that it is likely to control in the future;
predict the capacity of the entity to generate cash flows from its existing resource base; and
form judgements about the effectiveness with which the entity might employ additional resources.
Information about variability of performance is important in this respect.
1.2 Disaggregation
In order to make economic decisions, users of financial statements need to understand the make-up of figures in as much detail as possible. There is therefore a tendency in financial reporting towards providing information about the composition of figures.
Commentary
Information may be analysed in the statements or in the notes.
For example:
Disclosure of material and unusual items which are part of ordinary activities;
Information on discontinued operations;
Segment reporting. Commentary
Users can use such information to make better quality forecasts in respect of the entity.
1.3
Relevant standards on the reporting of performance
IAS 1 Presentation of Financial Statements;
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors;
IAS 7 Statement of Cash Flows (this is not examinable);
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations;
1.4
Scope of IAS 8
Criteria for selecting and applying accounting policies.
Classification of material items.
How to account for:
changes in accounting policies;
changes in accounting estimates; and
the correction of errors.
2 Accounting policies
2.1 Definition
Accounting policies are specific principles, bases, conventions, rules and practices adopted by an entity in preparing and presenting financial statements.
2.2
Selection and application
Applicable IFRSs must be applied considering any relevant implementation guidance issued by the IASB.
Commentary
Accounting policies set out in IFRSs need not be applied ONLY when the effect of applying them is immaterial.
If there is no applicable IFRS, management uses its judgement to develop and apply an accounting policy resulting in information with the qualitative characteristics of:
relevance; and
reliability;
faithful representation;
substance over form;
neutrality;
prudence; and
completeness. In making such judgements management should consider:
IFRSs dealing with similar and related transactions; then
the definitions and recognition criteria and measurement concepts set out in the Framework; also
recent pronouncements of other standard-setting bodies that use a similar conceptual framework; and
accepted industry practice.
Commentary
This may be thought of as a “GAAP hierarchy”. An accepted industry practice that conflicts with any IASB pronouncement (including the Framework) cannot be judged suitable.
Illustration 1
Kitty has recently purchased a Van Gogh painting to display in their client reception area, with the hope it will lead to more contracts and that the painting will appreciate in value.
There is no specific accounting standard that deals with this type of asset, but IAS 40
Investment Property does deal with a particular type of asset that is held for capital
appreciation.
It would therefore seem appropriate to use IAS 40 as justification to value the painting at fair value at the end of each reporting period.
2.3 Consistency of accounting policies
Accounting policies must be applied consistently for similar items unless an IFRS requires or permits categorisation of items.
When categorisation is required or permitted the most appropriate accounting policy is selected and applied consistently to each category.
Illustration 2
IAS 2 Inventories requires that inventory be valued at lower of cost and net realisable values. In identifying cost it allows alternative cost formulas; first-in first-out and weighted average. The same cost formula must be applied to similar items of inventory, but a different cost formula can be applied to a different classification of inventory.
3
Changes in accounting policy
3.1 What?
The first time application of an accounting policy to newly occurring items (or items that were previously immaterial) is not a change.
Changing the presentation of profit or loss items from the nature of expenses method to the function of expense method is a change of accounting policy.
Adopting the revaluation model of IAS 16 “Property, Plant and Equipment” where the cost model has been followed previously is a change of accounting policy. Commentary
However, it is accounted for as a revaluation under IAS 16 and not as a change in accounting policy under IAS 8.
Illustration 3
A carpet retail outlet sells and fits carpets to the general public, it recognises revenue when the carpet is fitted, which on average is six weeks after the purchase of the carpet. It then decides to sub-contract out the fitting of carpets to self-employed fitters. It now recognises revenue at the point-of-sale of the carpet.
This is not a change in accounting policy as the carpet retailer has changed the way that the carpets are fitted. Therefore there would be no need to retrospectively change prior period figures for revenue recognised.
3.2 When?
The same accounting policies must be applied within each period and from one period to the next unless a change:
is required by an IFRS; or Commentary
This is a mandatory change.
would result in the financial statements providing more relevant and reliable information.
Commentary
This is a voluntary change.
3.3 How?
3.3.1 New IFRS
If a new IFRS is issued the transitional provisions of that standard will be applied to any change of accounting policy.
Commentary
For example, when IAS 23 “Borrowing Costs” was revised in 2007 amendments were generally to be applied prospectively.
If a new IFRS does not have transitional provisions, or the change in policy is voluntary, the change is applied retrospectively.
Commentary
3.3.2 Definition
A “prior period adjustment” is an adjustment to reported income in the financial statements of an earlier reporting period.
Although retained earnings are affected, income in the current period is not affected.
Commentary
Although this term is not defined in IFRS it is widely used accounting term. The most common reasons for making prior period adjustments are changes to accounting policy (as in this section) and material errors (see later).
3.3.3
Retrospective application
Retrospective application means applying a new accounting policy to transactions, other events and conditions as though that policy had always been applied.
The opening balance of each affected component of equity is adjusted for the earliest prior period presented and the comparative amounts disclosed as if the new policy had always been applied.
If it is not practicable to apply the effects of a change in policy to prior periods IAS 8 allows the change to be made from the earliest period for which retrospective
application is practicable. Commentary
Under IAS 8 impracticable means that the entity cannot apply a requirement after making every reasonable effort to do so.
3.4 Disclosure
Nature of the change in policy.
For the current period and each prior period presented the amount of the adjustment for each line item affected within the financial statements.
The amount of the adjustment relating to periods before those presented.
If retrospective restatement is not practicable:
the circumstances that led to the existence of the condition; and
a description of how and from when the change has been applied.
Additionally
New Standard Voluntary change
Title of new Standard or Interpretation
Reasons why the new policy provides more reliable and relevant information