Tuesday, February 3, 2009

How to record the changes in accounting estimates ?

IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors par. 32 - 40 rules the treatment of changes in accounting estimates.

As a result of the uncertainties inherent in business activities, many items in financial statements cannot be measured with precision but can only be estimated. Estimation involves judgements based on the latest available, reliable information. For example, estimates may be required of : (a) bad debts, (b) inventory obsolescence, (c) the fair value of financial assets or financial liabilities, (d) the useful lives of, or expected pattern of consumption of the future economic benefits embodied in, depreciable assets, and (e) warranty obligations.

The use of reasonable estimates is an essential part of the preparation of financial statements and does not undermine their reliability.

An estimate may need revision if changes occur in the circumstances on which the estimate was based or as a result of new information or more experience. By its nature, the revision of an estimate does not relate to prior periods and is not the correction of an error (par. 34).

A change in the measurement basis applied is a change in an accounting policy, and is not a change in an accounting estimate. 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 (par. 35).

Par. 36 of IAS 8 stated that the effect of a change in an accounting estimate, other than a change to which par. 37 applies, shall be recognized prospectively by including it in profit or loss in :

  1. the period of the change, if the change affects that period only; or
  2. the period of change and future periods, if the change affects both.

To the extent that a change in an accounting estimate gives rise to changes in assets and liabilities, or relates to an item of equity, it shall be recognized by adjusting the carrying amount of the related asset, liability or equity item in the period of change (par. 37).

Further, par. 38 stated that prospective recognition of the effect of a change in an accounting estimate means that the change is applied to transactions, other events and conditions from the date of the change in estimate. A change in an accounting estimate may effect only the current period's profit or loss, or the profit or loss of both the current period and future periods.

For example, a change in the estimate of the amount of bad debts affects only the current period's profit or loss and therefore is recognized in the current period. However, a change in the estimated useful life of, or the expected pattern of consumption of the future economic benefits embodied in, a depreciable asset affects depreciation expense for the current period and for each future period during the asset's remaining useful life.

In both cases, the effect of the change relating to the current period is recognized as income or expense in the current period. The effect, if any, on future periods is recognized as income or expense in those future periods.

Disclosure

An entity shall disclose the nature and amount of a change in an accounting estimate that has an effect in the current period or is expected to have an effect in future periods, except for the disclosure of the effect on future periods when it is impracticable to estimate that effect (par. 39).

If the amount of the effect in future periods is not disclosed because estimating it is impracticable, an entity shall disclose that fact (par. 40).

Source : IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.

2 comments:

  1. hye..i just dont get it... what actually the risk when the company revised their income statement in order to meet their target(5% increase over the last period). and how actually the changes in accounting estimates can increase the income statement?

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  2. Do you mean that the company revised their income statement in relation with the adjustment in an accounting estimate such as depreciation expenses ? I don't quite understand your question about the risk ? Do you mean the risk of misstatement ?

    How actually the changes in accounting estimates can increase the income statement ? I think to discuss this we have to see through case by case. The changes in accounting estimates not just affected to an increase in income statement but also a decrease.

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