Jethro changed its accounting policy for inventory in 2012. Prior to the change inventory had been valued using the weighted average method, but it was felt that in order to match current practice and to make the financial statements more relevant and reliable that a first-in first-out (FIFO) valuation model was more appropriate.
The impact of the change on the valuation of inventory was as follow:
31 December 2010 – increase of $12 million
31 December 2011 – increase of $19 million
31 December 2012 – increase of $28 million
Profit or loss under the weighted average valuation model are as follows:
2012 2011 $ million $ million Revenue 324 296 Cost of sales (173) (164) ____ ____ Gross profit 151 132 Expenses (83) (74) ____ ____ Profit 68 58 ____ ____
Retained earnings at 31 December 2010 were $423 million. Required:
Present the change in accounting policy in the profit or loss and produce an extract of the statement of changes in equity in accordance with IAS 8.
Worked solution 1
Profit or loss under the FIFO valuation model are as follows:
2012 2011 (restated) $ million $ million Revenue 324 296 Cost of sales (164) (157) ____ ____ Gross profit 160 139 Expenses (83) (74) ____ ____ Profit 77 65 ____ ____
Statement of changes in equity (extract) Retained Retained earnings earnings (original) $ million $ million At 1 January 2011 423 423
Change in inventory valuation policy 12
____ ____ At 1 January 2011 (restated) 435 Profit for 2011 65 58 ____ ____ At 31 December 2011 500 481 Profit for 2012 77 68 ____ ____ At 31 December 2012 577 549 ____ ____ Commentary
The cumulative impact on the retained earnings balance at 31 December 2012 is $28 million, of this amount $12 million has been adjusted against the opening retained earnings at 1 January 2011 and the 2011 cost of sales is reduced by $7 million and for 2012 it is reduced by $9 million.
Activity 1
A, an incorporated entity has previously followed a policy of capitalisation of development expenditure. It has recently decided to adopt the provisions of IAS 38
Intangible Assets, for the year ended 31 December 2012. A has been advised by their
auditors that the expenditure previously capitalised does not qualify for capitalisation under the recognition criteria set out in the standard.
The notes to the accounts for the year ended 31 December 2011 in respect of the deferred development expenditure was as follows:
$000 Balance at 1 January 2011 1,000
Additions 500
Amortisation (400)
Balance at 31 December 2011 1,100
During the year ended 31 December 2012 the company has expensed all expenditure in the period on projects, in respect of which, expenditure had previously been capitalised.
The following are extracts from the draft accounts for the year ended 31 December 2012.
Statement of profit or loss 2012 2011
(as previously published)
$000 $000
Revenue 1,200 1,100
Expenses (800) (680)
Profit for the year 400 420
Statement of changes in equity (extract) $000 $000 Balance as at 1 January 2012 3,000 2,580
Profit for the year 400 420
Balance as at 31 December 2012 3,400 3,000 Required:
Show how the statement of profit or loss and statement of changes in equity would appear in the financial statements for the year ended 31 December 2012 when the change in accounting policy is applied retrospectively.
Solution
Statement of profit or loss 2012 2011
(As restated)
$000 $000 Revenue
Expenses
Profit for the year
Statement of changes in equity (extract) $000 $000 Balance as at 1 January 2012
As previously stated
Prior period adjustment
Profit for the year
Balance as at 31 December 2012
4
Changes in accounting estimates
4.1 Definition
A change in accounting estimate is an adjustment to the carrying value of an asset (or liability) that results from a reassessment of its expected future benefits (and obligations). Commentary
A change in useful lives/residual value concerns a change in the pattern of consumption of economic benefits. This is also an estimate. A change in policy would be moving from non-depreciation of assets (which is not permitted under IFRS) to depreciating then over finite useful lives.
An estimate may have to be revised:
if changes occur regarding the circumstances on which the estimate was based;
as a result of new information, more experience or subsequent developments. Commentary
4.2 Examples
Many items recognised in the financial statements must be measured with an element of estimation attached to them.
Receivables may be measured after allowing for a general bad debt provision;
Inventory is measured at lower of cost or net realisable value but must provide for obsolescence;
A provision under IAS 37 Provisions, Contingent Liabilities and
Contingent Assets by its very nature may be an estimation of future
economic benefits to be paid out;
Non-current assets are depreciated, the expected pattern of consumption and useful life are estimates.
4.3 Accounting treatment
The effect of a change in estimate is recognised prospectively (i.e. by including in the current and future (where relevant) periods profit or loss). Commentary
A change in estimate is not an error or a change in accounting policy and therefore does not impact upon prior period statements.
A change in estimate that affects the measurement of assets or liabilities is recognised by adjusting the carrying amount of the asset or liability.
The other side of the double entry is to the statement of profit or loss and comprehensive income in the period in which the estimate is changed. Commentary
Under certain GAAPs reversals of provisions for items of expenditure are accounted for as income. Under IFRS, reversals MUST be set off against the relevant expense line item.
4.4 Disclosure
The nature and amount of a change in estimate that has an effect in the current period or is expected to have an effect in future periods.
If it is not possible to estimate the effects on future periods then that fact must be disclosed.