The IASB has announced the upcoming amendments to IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors which is expected to be issued in December 2020 (well, sounds like a Christmas present that people in financial reporting should stay alert). The IASB embarked into this project in 2017 with the upcoming amendments is expected to help users of IFRSs to be able to distinguish between accounting policies and accounting estimates, simply because the accounting effects of the two are different.
Under the current requirements of IAS 8, accounting policies are defined as “the specific principles, bases, conventions, rules, and practices applied by an entity in preparing and presenting financial statements.” Accounting estimates, on the other hand, is defined as “an adjustment of the carrying amount of an asset or a liability, or the amount of the periodic consumption of an asset, that results from the assessment of the present status of, and expected future benefits and obligations associated with, assets and liabilities.” Whenever an entity changes its accounting policy voluntarily to provide more reliable and more relevant information, such change will be accounted for retrospectively – i.e., the opening balance and comparative amounts are adjusted as if the new accounting policy had always been applied. However, a change in accounting estimates is a prospective adjustment – adjustment is included in the profit or loss when such change took place (current period) and future periods (if applicable). In most situations, additional work and effort are required to gather the required information for retrospective adjustment.
Challenges of the current requirements
Many people find it challenging to determine whether a change is an accounting policy change or a change in accounting estimate mainly because the definition of the two is not sufficiently clear. For example, the terms conventions and rules in the definition of accounting policies are not used in IFRS literature, and hence, people find it challenging to understand these two concepts. Besides, users also find it challenging to understand the relationship and interaction between these two concepts. Because of this, there is diversity in market practice. Examples provided in paragraph 32 of IAS 8 on accounting estimates – specifically bad debts, inventory obsolescence, the fair value of financial assets or financial liabilities, useful lives of the expected pattern of consumption of depreciable assets, and warranty obligations – are helpful. Certain specific standards may also provide some guidance in this matter and to quote some as examples are:
- Election of simplified approach for lease receivables is an accounting policy [paragraph 5.5.15(b) of IFRS 9]
- A change in residual values and/or the estimated costs of dismantling and removing items of property, plant and equipment is an accounting estimate [paragraph 76 of IAS 16]
- A choice between cost model or revaluation model for property, plant and equipment or intangible asset is an accounting policy [paragraph 29 of IAS 16 or paragraph 72 of IAS 38]
- Method of presentation of grants related to assets and presentation of grants related to income is an accounting policy [paragraph 39(a) of IAS 20]
However, in practice, there are more accounting changes that require an entity to determine whether such change is an accounting policy change or otherwise. Often time, the line between the two is blurred, and hence, judgement is needed. Although IAS 8 allows an entity to treat a change as a change in accounting estimate if it is difficult to distinguish between the two, an entity is not expected to use this paragraph as a way-out. Example of questions that people may find challenging are:
- Should a change from first-in, first-out (FIFO) to weighted average cost formula for inventories under IAS 2 Inventories constitute an accounting policy change?
- Should a change from output method to input method in measuring progress towards satisfaction of performance obligation under IFRS 15 Revenue from Contracts with Customers constitute a change in accounting estimates?
The upcoming amendments
Now let’s see what to expect in the upcoming amendments. In the Exposure Draft on Accounting Policies and Accounting Estimates Proposed amendments to IAS 8 for public comments issued by the IASB in September 2017, the IASB had proposed the following amendments:
- Accounting policies definition – the proposed amendments deleted the terms conventions and rules in accounting policies definition.
- A newly revised definition of accounting estimates – judgements or assumptions used in applying an accounting policy when, because of estimation uncertainty, an item in financial statements cannot be measured with precision (this proposed definition is most likely to be changed based on the tentative decision of the IASB as explained below).
- A clarification that selecting an estimation technique, or valuation technique, used when an item in the financial statements cannot be measured with precision, constitutes making an accounting estimate.
- A clarification that selecting the FIFO cost formula or the weighted average cost formula under IAS 2 constitutes selecting an accounting policy.
However, additional decisions have also been made by the IASB at its meetings which modify some of the proposed amendments included in the exposure draft following public comments as follows:
- A revision to the definition of accounting estimates to specify that:
- accounting estimates are monetary amounts in financial statements that are subject to measurement uncertainty;
- such monetary amounts are outputs of measurement techniques used in applying accounting policies; and
- an entity uses judgements and/or assumptions in developing an accounting estimate.
- Clarification that (i) effects of a change in an input and/or measurement technique used to develop an accounting estimate are changes in accounting estimates; (ii) a change in accounting estimates arising from new information or new developments is not a correction of an error.
- Estimation techniques and valuation techniques are examples of measurement techniques an entity uses to develop accounting estimates.
- To retain the current definition of accounting policies in IAS 8. This possibly to avoid the unintended consequence of the perception of narrowing the scope of what constitutes an accounting policy. At the same time, the IASB also did not decide to define those terms used in the definition of accounting policies.
- To clarify that if a change is a change in accounting estimate, it cannot also be a change in accounting policy. This is to avoid a perceived overlap between the definition of accounting policies and accounting estimates.
- Not to add the proposed paragraph in the exposure draft on whether selecting an inventory cost formula constitutes selecting an accounting policy. This is mainly because entities do not often change the cost formula and the existing requirement in paragraph 36(a) of IAS 2 has made it sufficiently clear that it is an accounting policy.
The IASB has decided to finalise the amendments based on the above modification and not to re-expose them. How the final wordings will look like will only be known once the final amendments are issued. It is also not clear at this juncture on the transitional provision as well as the effective date as these will only be discussed in the IASB future meetings. We will update you and keep you posted once a clearer direction is provided. Stay tuned!