Changes in Accounting Policies, What to Disclose in the Financial Statements ?

Par. 28 IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors states that when initial application of an IFRS has an effect on the current period or any prior period, would have such an effect except that it is impracticable to determine the amount of the adjustment, or might have an effect on future periods, an entity shall dislose :

1. the title of the IFRS;
2. when applicable, that the change in accounting policy is made in accordance with its transitional provisions;
3. the nature of the change in accounting policy;
4. when applicable, a description of the transitional provisions;
5. when applicable, the transitional provisions that might have an effect on future periods;
6. for the current period and each prior period presented, to the extent practicable, the amount of the adjustment :
   • for each financial statement line item affected; and
   • if IAS 33 Earnings per Share applies to the entity, for basic and diluted earnings per share;
7. the amount of the adjustment relating to periods before those presented, to the extent practicable; and
8. if retrospective application required by par. 19(a) or (b) is impracticable for a particular prior period, or for periods before those presented, the circumstances that led to the existence of that condition and a description of how and from when the change in accounting policy has been applied.

Financial statements of subsequent periods need not repeat these disclosures.

Further, par. 29 states that when a voluntary change in accounting policy has an effect on the current period or any prior period, would have an effect on that period except that it is impracticable to determine the amount of the adjustment, or might have an effect on future periods, an entity shall disclose :

1. the nature of the change in accounting policy;
2. the reasons why applying the new accounting policy provides reliable and more relevant information;
3. for the current period and each prior period presented, to the extent practicable, the amount of the adjustment :
   • for each financial statement line item affected; and
   • if IAS 33 applies to the entity, for basic and diluted earnings per share
4. the amount of the adjustment relating to periods before those presented, to the extent practicable; and
5. if retrospective application is impracticable for a particular prior period, or for periods before those presented, the circumstances that led to the existence of that condition and a description of how and from when the change in accounting policy has been applied.

Financial statements of subsequent periods need not repeat these disclosures.

When an entity has not applied a new IFRS that has been issued but is not yet effective, as stated in par. 30, the entity shall disclose :

1. this fact; and
2. known or reasonably estimable information relevant to assessing the possible impact that application of the new IFRS will have on the entity's financial statements in the period of initial application.

Latest, par. 31 states that in complying with par. 30, an entity considers disclosing :

1. the title of the new IFRS;
2. the nature of the impending change or changes in accounting policy;
3. the date by which application of the IFRS is required;
4. the date as at which it plans to apply the IFRS initially; and
5. either :
   • a discussion of the impact that initial application of the IFRS is expected to have on the entity's financial statements; or
   • if that impact is not known or reasonably estimable, a statement to that effect.

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

Applying Changes in Accounting Policies

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, Changes in Accounting Estimates and Errors, paragraph 14 states that :

An entity shall change an accounting policy only if the change :

1. is required by an IFRS; or
2. results in the financial statements providing reliable and more relevant information about the effects of transactions, other events or conditions on the entity's financial position, financial performance or cash flows.

Par. 19 stated that subject to paragraph 23 :

1. an entity shall account for a change in accounting policy resulting from the initial application of an IFRS in accordance with the specific transitional provisions, if any, in that IFRS; and
2. when an entity changes an accounting policy upon initial application of an IFRS that does not include specific transitional provisions applying to that change, or changes in accounting policy voluntarily, it shall apply the change retrospectively.

For the purpose of this Standard, early application of an IFRS is not a voluntary change in accounting policy (par. 20).

In the absence of an IFRS that specifically applies to a transaction, other event or condition, management may, in accordance with par. 12, apply an accounting policy from the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework to develop accounting standards. If, following an amendment of such a pronouncement, the entity chooses to change an accounting policy, that change is accounted for and disclosed as a voluntary change in accounting policy (par. 21).

Retrospective Application

Subject to par. 23, when a change in accounting policy is applied retrospectively in accordance with par. 19(a) or (b), the entity shall adjust the opening balance of each affected component of equity for the earliest prior period presented and the other comparative amounts disclosed for each prior period presented as if the new accounting policy had always been applied (par. 22).

Limitations on Retrospective Application

When retrospective application is required by par. 19(a) or (b), a change in accounting policy shall be applied retrospectively except to the extent that it is impracticable to determine either the period-specific effects or the cumulative effect of the change (par. 23).

When it is impracticable to determine the period-specific effects of changing an accounting policy on comparative information for one or more prior periods presented, the entity shall apply the new accounting policy to the carrying amounts of assets and liabilities as at the beginning of the earliest period for which retrospective application is practicable, which may be the current period, and shall make a corresponding adjustment to the opening balance of each affected component of equity for that period (par. 24).

When it is impracticable to determine the cumulative effect, at the beginning of the current period, of applying a new accounting policy to all prior periods, the entity shall adjust the comparative information to apply the new accounting policy prospectively from the earliest date practicable (par. 25).

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

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.

Several Accounting Changes Done by IASB in response to the Global Financial Crisis

CFO.com in its article today, October 15, 2008 titled "Fair Value Tweaking on a Global Scale" said that "In response to the global credit crisis, the International Accounting Standards Board has made its third announcement in as many days about slight changes to fair value accounting rules. The proposal issued today is a tweak to IASB's financial instrument disclosure rule, which is out for public comment until December 15.

The proposal streamlines disclosure requirements related to changes in valuation techniques for financial instruments. Rather than specifying what circumstances trigger new disclosures, the proposal simply requires that any change in valuation techniques be disclosed - plus the disclosure must include the reason for making the switch. The draft rule, which is a proposed amendment to IAS 39, applies to each class of financial instruments a company holds."

Further, the article said that "Earlier in the day, accounting regulators from the European Union voted in favor of an IASB fair value rule revision issued on Monday. The revision allows companies to reclassify financial assets to avoid marking the assets to market in some limited cases. The proposal must still be approved by the EU Parliament before taking effect.

The reclassification rule, which is part of a revised IAS 39, was finalized on October 13, and mirrors an existing U.S. standard - FAS 115."

Explore more in here : Fair Value Tweaking on a Global Scale

On October 13, 2008, IASB issued amendments to IAS 39 Financial Instruments : Recognition and Measurement and IFRS 7 Financial Instruments : Disclosures that would permit the reclassification of some financial instruments.

The amendments to IAS 39 introduce the possibility of reclassification for companies applying IFRSs, which were already permitted under U.S. GAAP in rare circumstances.

Here is the link to the story : IAS amendments permit reclassification of financial instruments

Next, on October 14, 2008, IASB provided an update on its work to consider the application of fair value when markets become inactive.

In May 2008 and at the request of the Financial Stability Forum (FSF) the IASB established and Expert Advisory Panel to consider the application of fair value when markets become inactive. The Panel has since met on seven occasions, the latest of which was on Friday, 10 October.

Several issues were discussed and agreed by the Panel during the meeting.

Click here to explore : IASB provides update on applying fair value in inactive markets

Latest, on October 15, 2008, as part of the IASB's response to the credit crisis, IASB published for public comment proposals to improve the information available to investors and others about fair value measurement of financial instruments and liquidity risk.

The proposals also reflect discussions by the IASB's Expert Advisory Panel on measuring and disclosing fair values of financial instruments when markets are no longer active.

For more information, click the following link : IASB proposes improvements to financial instruments disclosures

When it is impracticable to apply a new accounting policy, how to deal with it ?

IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors replaces IAS 8 Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies and should be applied for annual periods beginning on or after 1 January 2005.

The standard retains the ‘impracticability’ criterion for exemption from changing comparative information when changes in accounting policies are applied retrospectively and prior period errors are corrected. The standard now includes a definition of ‘impracticable’ and guidance on its interpretation.

Based on this standard, applying a requirement is impracticable when the entity cannot apply it after making every reasonable effort to do so.

Paragraph 27 IAS 8 stated that when it is impracticable for an entity to apply a new accounting policy retrospectively, because it cannot determine the cumulative effect of applying the policy to all prior periods, the entity, in accordance with paragraph 25, applies the new policy prospectively from the start of the earliest period practicable.

It therefore disregards the portion of the cumulative adjustment to assets, liabilities and equity arising before the date.

Changing an accounting policy is permitted even if it is impracticable to apply the policy prospectively for any prior period.

Paragraphs 50-53 provide guidance on when it is impracticable to apply a new accounting policy to one or more prior periods.

Paragraphs 50 stated that in some circumstances, it is impracticable to adjust comparative information for one or more prior periods to achieve comparability with the current period. For example, data may not have been collected in the prior period(s) in a way that allows either retrospective application of a new accounting policy (including, for the purpose of paragraphs 51-53, its prospective application to prior periods) or retrospective restatement to correct a prior period error, and it may be impracticable to recreate the information.

It is frequently necessary to make estimates in applying an accounting policy to elements of financial statements recognized or disclosed in respect of transactions, other events or conditions. Estimation is inherently subjective, and estimates may be developed after the reporting period.

Developing estimates is potentially more difficult when retrospectively applying an accounting policy or making a retrospective restatement to correct a prior period error, because of the longer period of time that might have passed since the affected transaction, other event or condition occurred. However, the objective of estimates related to prior periods remains the same as for estimates made in the current period, namely, for the estimate to reflect the circumstances that existed when the transaction, other event or condition occurred.

Therefore, retrospectively applying a new accounting policy or correcting a prior period error requires distinguishing information that (a) provides evidence of circumstances that existed on the date(s) as at which the transaction, other event or condition occurred, and (b) would have been available when the financial statements for that prior period were authorized for issue from other information.

For some types of estimates (example, an estimate of fair value not based on an observable price or observable inputs), it is impracticable to distinguish these types of information. When retrospective application or retrospective restatement would require making a significant estimate for which it is impossible to distinguish these two types of information, it is impracticable to apply the new accounting policy or correct the prior period error retrospectively.

Hindsight should not be used when applying a new accounting policy to, or correcting amounts for, a prior period, either in making assumptions about what management’s intentions would have been in a prior period or estimating the amounts recognized, measured or disclosed in a prior period.

For example, when an entity corrects a prior period error in measuring financial assets previously classified as held-to-maturity investments in accordance with IAS 39 Financial Instruments : Recognition and Measurement, it does not change their basis of measurement for that period if management decided later not to hold them to maturity.

In addition, when an entity corrects a prior period error in calculating its liability for employees’ accumulated sick leave in accordance with IAS 19 Employee Benefits, it disregard information about an unusually severe influenza season during the next period that became available after the financial statements for the prior period were authorized for issue.

The fact that significant estimates are frequently required when amending comparative information presented for prior periods does not prevent reliable adjustment or correction of the comparative information (Hrd) ***

How IFRS deals with Changes in Accounting Policies ?

In the preparation of financial statements there is an underlying presumption that an accounting principle, once adopted, should not be changed, but rather is to be uniformly applied in accounting for events and transactions of a similar type. This consistent application of accounting principles enhances the utility of the financial statements. The presumption that an entity should not change an accounting principle may be overcome only if the reporting entity justifies the use of an alternative acceptable accounting principle on the basis that it is preferable under the circumstances.

When IFRS are revised or new standards are developed, they often are promulgated a year or more prior to the date set for mandatory application. Disclosure of future changes in accounting policies must be made when the reporting entity has yet to implement a new standard that has been issued but that has not yet come into effect.

In addition, disclosure is now required of the planned date of adoption, along with an estimate of the effect of the change on the entity’s financial position, except if making such an estimate requires undue cost or effort.

Changes in Accounting Policy

A change in an accounting policy means that a reporting entity has exchanged one accounting principles for another.

According to IAS 8, the term accounting policy includes the accounting principles, bases, conventions, rules and practices used. For example, a change in inventory costing from weighted-average to first-in, first-out would be a change in accounting policy, as would a change in accounting for borrowing costs from capitalization to immediate expensing.

Changes in accounting policy are permitted if :

1. The change is required by a standard or an interpretation, or

2. The change in accounting principle will result in a more relevant and reliable presentation of events or transactions in the financial statements of the enterprise.

IAS 8 does not regard the following as changes in accounting policies :

1. The adoption of an accounting policy for events or transactions that differ in substance from previously occurring events or transactions; and

2. The adoption of a new accounting policy to account for events or transactions that did not occur previously or that were immaterial in prior periods.

The provisions of IAS 8 are not applicable to the initial adoption of a policy to carry assets at revalued amounts, although such adoption is indeed a change in accounting policy. Rather, this is to be dealt with as a revaluation in accordance with IAS 16 or IAS 38, as appropriate under the circumstances.

Changes in accounting policy pursuant to the adoption of a standard

When a change in an accounting policy is made consequent to the enactment of a new standard, it is to be accounted for in accordance with the transitional provisions set forth in that standard.

Generally, the transitional provisions will require the restatement of comparative period information. Nonetheless, comparative information presented for a particular prior period need not be restated if doing so is impracticable.

When the comparative information for a particular prior period is not restated, the new accounting policy is to be applied to the balances of assets and liabilities as at the beginning of the period following that one, with a corresponding adjustment made to the opening balance of retained earnings for the first period restated.

The cumulative effect as of the beginning of the earliest comparative period presented (for which restatement is applied), if any, is to be reported as an adjustment to beginning retained earnings of that period.

For example, assume that a change is adopted in 2008 and comparative 2007 financial statements are to be presented with the 2008 financial statements. The change in accounting policy also affects previously reported 2005-2006 financial position and results of operations, but these are not to be presented in the current financial report.

Therefore, the cumulative effect (i.e., the cumulative amount of expense or income which would have been recognized in years prior to 2007) as of the beginning of 2007 must be reported as an adjustment to beginning retained earnings in 2007.

In certain circumstances, a new standard may be promulgated with a delayed effective date. This is done, for example, when the new requirements are complex and IASB wishes to give adequate time for preparers and auditors to master the new materials.

If, as of a financial reporting date, the reporting entity has not elected early adoption of the standard, it must disclose (1) the nature of the future change or changes in accounting policy; (2) the date by which adoption of the standard is required; (3) the date as at which it plans to adopt the standard; and (4) either (a) an estimate of the effect that change(s) will have on its financial position, or (b) if such an estimate cannot be made without undue cost or effort, a statement to that effect.

A change in an accounting policy other than one made pursuant to the promulgation of a new standard or interpretation must, under revised IAS 8, be accounted for retrospectively.

With retrospective application, the results of operations for all prior periods presented must be restated, as if the newly adopted policy has always been used. If periods before the earliest period being presented were also affected, then the opening balance of retained earnings for the earliest period being presented must be restated to reflect the net impact on all earlier periods.

(Source of this article : Wiley IFRS 2008 : Interpretation and Application of International Accounting and Financial Reporting Standards 2008)

A controversial revised of Accounting for Contingencies

CFO.com on this August 2008 published several articles regarding on controversial proposal proposed by FASB that require more company disclosure about potential lawsuit liabilities.

In its article titled "Bar Fight : Accounting for Lawsuits", CFO.com wrote that :

The proposed new standard would overhaul FAS 5, Accounting for Contingencies. Under the proposed rule, companies would have to disclose "specific quantitative and qualitative information" about loss contingencies. The new rule will also affect the contingent losses companies must disclose under FAS 141, which applies in the wake of mergers and acquisitions.

Under current accounting rules, companies are only required to take a financial charge for a contingent loss if it appears probable that the loss has occurred and its amount can be reasonably estimated. If those conditions are not met, companies must still disclose the loss contingency, but only if there is a reasonable possibility that a loss has occurred.

Under the new rule, companies would have to disclose all loss contingencies unless their likelihood is remote. And companies also would be required to disclose any contingency - no matter how remote - that is expected to be resolved within a year, and could have a severe impact on the company's financial position, financial results, or cash flow.  That's a change that would put substantially greater detail about potential lawsuit liabilities into the footnotes of corporate financial statements.

That is the part of the proposal that has many companies upset.

Here is the link to articles published by CFO.com regarding on above matter.

(1) Bar Fight : Accounting for Lawsuits (CFO.com); (2) Who Should Write the Rules ? (CFO.com); (3) Contingent Liabilities Draft Ignities Ire (CFO.com); (4) Contingent Liabilities Draft Stirs It Up

IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, the Preliminary

International Accounting Standard 8 Accounting Policies, Changes in Accounting Estimates and Errors (IAS 8 revised in December 2003) replaces IAS 8 Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies (revised in 1993) and should be applied for annual periods beginning on or after 1 January 2005.

This standard also replaces SIC-2 Consistency-Capitalization of Borrowing Costs and SIC-18 Consistency-Alternative Methods.

The main changes of IAS 8 (December 2003 revised) from the previous version are described below :

Selection of accounting policies. The requirements for the selection and application of accounting policies in IAS 1 Presentation of Financial Statements (as issued in 1997) have been transferred to the Standard.

Materiality. The Standard defines material omissions or misstatements. It stipulates that :

1. The accounting policies in IFRSs need not be applied when the effect of applying them is immaterial. This complements the statement in IAS 1 that disclosures required by IFRSs need not be made if the information is immaterial;

2. Financial statements do not comply with IFRSs if they contain material errors;

3. Material prior period errors are to be corrected retrospectively in the first set of financial statements authorized for issue after their discovery.

Retrospective restatement is correcting the recognition, measurement and disclosure of amounts of elements of financial statements as if a prior period error had never occurred.

Voluntary changes in accounting policies and corrections of prior period errors. The standard requires retrospective application of voluntary changes in accounting policies and retrospective restatement to correct prior period errors. It removes the allowed alternative in the previous version of IAS 8 i.e. (a) to include in profit or loss for the current period the adjustment resulting from changing an accounting policy or the amount of a correction of a prior period error; and (b) to present unchanged comparative information from financial statements of prior periods.

As a result of the removal of the allowed alternative, comparative information for prior periods is presented as if new accounting policies had always been applied and prior period errors had never occurred.

Impracticability. The standard retains the “impracticability” criterion for exemption from changing comparative information when changes in accounting policies are applied retrospectively and prior period errors are corrected. The standard now includes a definition of “impracticable” and guidance on its interpretation.

Applying a requirement is impracticable when the entity cannot apply it after making every reasonable effort to do so.

The Standard also states that when it is impracticable to determine the cumulative effect, at the beginning of the current period, of : (a) applying a new accounting policy to all prior periods, or (b) an error on all prior periods, the entity changes the comparative information as if the new accounting policy had been applied, or the error had been corrected, prospectively from the earliest date practicable.

Prospective application of a change in accounting policy and of recognizing the effect of a change in an accounting estimate, respectively, are : (a) applying the new accounting policy to transactions, other events and conditions occurring after the date as at which the policy is changed; and (b) recognizing the effect of the change in the accounting estimate in the current and future periods affected by the change.

Fundamental errors. The Standard eliminates the concept of a fundamental error and thus the distinction between fundamental errors and other material errors. The Standard defines prior period errors.

Disclosures. The Standard now requires, rather than encourages, disclosure of an impending change in accounting policy when an entity has yet to implement a new IFRS that has been issued but not yet come into effect. In addition, it requires disclosure of known or reasonably estimable information relevant to assessing the possible impact that application of the new IFRS will have on the entity’s financial statements in the period of initial application.

The Standard requires more detailed disclosure of the amounts of adjustments resulting from changing accounting policies or correcting prior period errors. It requires those disclosures to be made for each financial statement line item affected and, if IAS 33 Earnings per Share applies to the entity, for basic and diluted earnings per share.

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