1. Connolly – International Financial Accounting and Reporting – 4 th Edition CHAPTER 21 ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS

2. Connolly – International Financial Accounting and Reporting – 4 th Edition 21.1 INTRODUCTION Conceptual Framework for Financial Reporting 2010 (See Chapter 1, Section 1.3) IAS 1 Presentation of Financial Statements (See Chapter 2)

3. Connolly – International Financial Accounting and Reporting – 4 th Edition 21.2 IAS 8 ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS Objective: To prescribe the criteria for selecting and changing accounting policies, together with the accounting treatment and disclosure of changes in accounting policies, changes in accounting estimates and correction of errors Scope: All financial statements prepared in accordance with IASs/IFRSs

4. Connolly – International Financial Accounting and Reporting – 4 th Edition Key definitions Accounting Polices The specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting FS Prior Period Errors Omissions from, and misstatements in, the entity’s FS for one or more prior periods arising from a failure to use, or misuse of, reliable information that:  was available when FS for those periods were authorised for issue; and  could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those FS. Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud.

5. Connolly – International Financial Accounting and Reporting – 4 th Edition Accounting policies Select in accordance with IAS/IFRS or interpretation, or judgement if none available APs normally kept the same to ensure comparability of FS over time. Change when  Required by an IFRS – therefore follow transitional arrangements if provided, otherwise apply change retrospectively  Voluntarily, i.e. results in better quality financial statements – therefore apply change retrospectively

6. Connolly – International Financial Accounting and Reporting – 4 th Edition Retrospective changes in accounting policies  Adjust the opening balance of each effected component and any other relevant comparative amounts as if the new accounting policy had always been applied. This means that there will be a PPA to the balance of retained earnings b/f in the statement of changes in equity  Comparative information should be restated unless impracticable to do so  When a change in AP has a material effect on the current period or any prior period presented, or may have a material effect in subsequent periods, the following disclosures should be made: o Reasons for change; o Amount of adjustment recognised in the current period; o Amount of adjustment included in each period prior to those included in the FS.

7. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 21.1: Retrospective change in accounting policy Raven Limited has traditionally valued its inventory using the weighted average method of valuation. During the year ended 31 December 2012, the directors of Raven Limitd decided to change the method of inventory valuation to the FIFO method in order to give a fairer presentation of the company’s results and financial position. The reported retained earnings of Raven Limited at 31 December 2010 were €/€2,500,000 and extracts from the company’s financial statements for each of the last three year, on the basis of inventory being valued on a weighted average basis, are provided below are: Year End2010 (€)2011 (€)2012 (€) Cost of sales830,000904,000968,000 Profit after tax50,00080,000105,000 Inventory valuation: Weighted Average275,000257,000304,000 FIFO296,000294,000365,000

8. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 21.1: Retrospective change in accounting policy Cont’d Requirement Based on the information provided, show how the change in inventory valuation method will be reflected in the financial statements of Raven Limited for the year ended 31 December 2012.

9. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 21.1: Retrospective change in accounting policy Solution: Statement of Profit or Loss and Other Comprehensive Income Statement of Financial Position 2012 (€)2011 (€) Cost of Sales944,000888,000 Profit after Tax129,00096,000 2012 (€)2011 (€) Current Assets Inventory365,000294,000

10. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 21.1: Retrospective change in accounting policy Solution (Cont’d): Statement of Changes in Equity (Extract) Retained Earnings € At start of period2,580,000 Change in accounting policy 37,000 Restated2,617,000 Profit for year 129,000 At end of period2,746,000

11. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 21.3: Change in presentation The directors of Texas have decided to include the depreciation charge for the year ended 31 December 2012 in cost of sales rather than administrative expenses, as was previously the policy. Requirement Outline the impact of this change, if any on the presentation of the financial statements for the year ended 31 December 2012. Solution: In the 2012 FS, while no changes are required to the figures, additional disclosures are required. For example, comparative information (2011) should be re-stated (unless it is impractical to do so), together with an explanation as to why the new policy will provide reliable and more relevant information

12. Connolly – International Financial Accounting and Reporting – 4 th Edition Accounting estimates Estimates may be required for:  bad debts;  warranty obligations;  inventory obsolescence; and  useful lives of depreciable assets etc. Changes in estimates result from new information or new developments relating to assets and liabilities. Accordingly, they are not corrections of errors. i.e. if changes occur in the circumstances on which the estimate was based or as a result of new information. This does not relate to prior periods and is not the correction of an error. The effect of a change in estimate should be recognised prospectively in the SPLOCI in the period of the change and/or future periods (e.g. bad debts, RUEL of PPE). If the effect of the change is material, its nature and amount must be disclosed. See Chapter 21, Examples 21.4-21.6

13. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 21.4: Change in accounting estimate (1) Previously, Blackbird Limited depreciated plant and equipment using the reducing balance method at 20% per annum. The company is proposing to depreciate plant and equipment using the straight line method over five years. Requirement Explain the appropriate accounting treatment in accordance with IAS 8 and IAS 16. Solution: This decision involves a change in estimate (not accounting policy) as the policy is still to write off the cost of the plant and equipment over its EUEL. The change is made prospectively.

14. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 21.5: Change in accounting estimate (2) Apple Limited reviews its depreciation policy annually. At the most recent review for the year ended 31 December 2012, the directors decided that the remaining useful life of the machine at 1 January 2012 was three years. Additional information in relation to machinery is as follows: Machinery - cost at the date of acquisition 1-1-09 €3,600,000 Estimated useful life at 1-1-09 10 years Estimated residual value as at 1-1-09Nil Requirement Explain how to account for this change in the useful economic life of machinery in the financial statements of Apple Limited for the year ended 31 December 2012.

15. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 21.5: Change in accounting estimate (2) Solution: € Cost at 1 January 2009 3,600,000 Depreciation year ended 31 December 2009 ( 360,000) Depreciation year ended 31 December 2010 ( 360,000) Depreciation year ended 31 December 2011 ( 360,000) Carrying Amount as at 31 December 2011 2,520,000 Revised remaining useful life 3 years Depreciation for year ended 31 December 2012 840,000 The change in the useful economic life of machinery is a change in accounting estimate and should be applied prospectively.

16. Connolly – International Financial Accounting and Reporting – 4 th Edition Correction of prior period errors Errors are material omissions from or misstatements in FS e.g. mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretation of facts and fraud Current period errors are corrected before the FS are issued Sometimes material errors are not discovered until a later period. These should be corrected retrospectively in the first set of FS issued after their discovery by:  restating the opening balance of assets, liabilities and equity as if the error had never occurred, and presenting the necessary adjustment, to the opening balance of accumulated profits in the statement of changes in equity; and  restating the comparative figures, as if the error had never occurred. Disclosure:  nature of the PPE;  amount of correction to each FS line item presented for the prior periods; and  amount of correction at the beginning of the earliest prior period presented.

17. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 1 Honda Limited made a provision for corporation tax of €500,000 for the year ended 31 December 2013. In March 2014 this provision was agreed by the Revenue and paid at €540,000. Requirement Explain how this should be accounted for in Honda Limited’s financial statements. Solution This is the correction of an accounting estimate and not an error. The correction will be made by increasing the tax charge for the year ended 31 December 2014 by €40,000. The effect of the correction on the 2014 profits needs to be disclosed.

18. Connolly – International Financial Accounting and Reporting – 4 th Edition Angel plc has a retained profit of €32,781 for the year ended 31 December 2012 and its balance on retained earnings stood at €709,311 on 1 January 2012. It has been discovered, while producing the 2012 financial statements, that the closing inventory figure as at 31 December 2011 was overstated by €48,099, thus overstating the profit for the year ended 31 December 2011 by €48,099 (the retained profit figure for the year ended 31 December 2012 has been determined by using the correct inventory figure as at 1 January 2012). The retained profit for the year ended 31 December 2011 was originally stated at €90,342, using the incorrect closing inventory figure. In the statement of changes in equity, under movements on reserves, this adjustment would be shown as follows: Angel plc – SCE (Extract) Balance at 31 December 2011€ As previously reported709,311 Prior period adjustment (note x)(48,099) Restated661,212 Retained profit for year32,781 Balance at 31 December 2012693,993 Example 21.7: Prior period error

19. Connolly – International Financial Accounting and Reporting – 4 th Edition 21.3 DISCLOSURES 1.Changes in Accounting Policies (see Example 21.1 and Example 21.2) (a)reason for change; (b)amount of the adjustment on the current period and for each period presented; and (c)the fact that comparative figures have been restated or that it was not practicable to do so. 2.Correction of Errors (see Example 21.7) (a)the nature of the prior period error; (b)the amount of the correction for each period presented; (c)the amount of the correction at the start of the earlier prior period presented; and (d)if retrospective correction is not practicable, a description of how and when the error was corrected. 3.Changes in Accounting Estimates (see Example 21.4 and Example 21.5) (a)the nature of the change; (b)the effect on the current periods financial statements; and (c)the effect in future periods if this is practicable.

20. Connolly – International Financial Accounting and Reporting – 4 th Edition SUMMARY Change in accounting policy Correction of material errors Change in accounting estimate Prior Period Adjustment Current Period Adjustment