The International Accounting Standards Board (“IASB”) has announced the upcoming amendments to IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. IASB expects to issue the amendments in December 2020. Well, sounds like a Christmas present that people in financial reporting should stay alert. IASB embarked into this project in 2017.
The upcoming amendments aims to help IFRS users to distinguish between accounting policies and accounting estimates. This is simply because the accounting effects of the two are different.
Let us now see what the upcoming amendments are all about.
The current requirements for accounting policies and changes in accounting estimates
Firstly, let’s understand what are the current requirements relating to accounting policies and accounting estimates.
Definition of accounting policies and changes in accounting estimates
Under the current requirements of IAS 8, the definition of accounting policies is “the specific principles, bases, conventions, rules, and practices applied by an entity in preparing and presenting financial statements.”
Interestingly, IAS 8 does not provide a specific definition of an accounting estimate. Instead, IAS 8 only defines a change in accounting estimate. IAS 8 defines a change in accounting estimate 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.”
Accounting treatment for changes in accounting policies and accounting estimates
IAS 8 requires entities to account for changes in accounting policies retrospectively. This is the case if they change the accounting policies voluntarily. To clarify, the retrospective application requires entities to adjust the opening balance and comparative amounts as if the new accounting policy had always been applied. Note that entities change their accounting policies voluntarily if such changes provide a more reliable and more relevant information.
In contrast, IAS 8 requires entities to account for changes in accounting estimates prospectively. This means entities record adjustments in the profit or loss when such changes took place (current period) and future periods.
In most situations, entities need to take up additional work and effort to gather the required information for retrospective adjustment.
The challenges of the current requirements in IAS 8
IFRS users find it a challenge to determine whether a change is a change in accounting policy or a change in accounting estimate. This is because their definition is not sufficiently clear.
For instance, the terms “conventions” and “rules” in the definition of accounting policies are not used in IFRS literature. Accordingly, users find it challenging to understand these two terms. Additionally, IFRS users also find it challenging to understand the relationship and interaction between the terms. Consequently, there are diversity in market practices.
Examples of changes in accounting policies and accounting estimates
Paragraph 32 of IAS 8 provides a list of helpful examples on accounting estimates. They are:
- Bad debts.
- Inventory obsolescence.
- The fair value of financial assets or financial liabilities.
- The useful lives of, or the expected pattern of consumption of future economic benefits embodied in, depreciable assets.
- Warranty obligations.
Some other standards may also provide some clarity on this matter. For example:
- The election of simplified approach for lease receivables is an accounting policy. [paragraph 5.5.15(b) of IFRS 9 Financial Instruments]
- 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 Property, Plant and Equipment]
- 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 Intangible Assets]
- 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 Accounting for Government Grants and Disclosure of Government Assistance]
However, there are more changes which require entities to determine their nature. Often times, the line between accounting policies and accounting estimates is not clear. Hence, entities need to apply judgement. Although IAS 8 allows an entity to treat a change as a change in accounting estimate, if it is difficult to distinguish the two, an entity is not expected to use this paragraph as the way-out.
Some of the examples that IFRS users 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 proposed amendments in the exposure draft
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:
#1: Definition of accounting policies
The proposed amendments deleted the terms “conventions” and “rules” from the definition of accounting policies.
#2: Definition of accounting estimates
Since IAS 8 does not define an accounting estimate, the exposure draft has now included a specific definition of it. The definition of a change in accounting estimate is proposed for deletion.
The proposed definition of accounting estimate in the exposure draft is “judgements or assumptions used in applying an accounting policy when, because of estimation uncertainty, an item in financial statements cannot be measured with precision”.
#3: A clarification for selecting an estimation technique or valuation technique
The exposure draft clarifies 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.
#4: A clarification on inventory cost formula
The exposure draft also includes a clarification that selecting the FIFO cost formula or the weighted average cost formula under IAS 2 constitutes selecting an accounting policy.
Further changes and decision on the exposure draft
Subsequent to the exposure period, IASB made some additional decisions at its meetings. The decisions modify some of the proposed amendments in the exposure draft 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.
Updates as at July 2021
IASB has now issued final amendments titled Definition of Accounting Estimates (Amendments to IAS 8). The definition and clarification made for accounting estimates are the same as decided by IASB in its meetings as above. Additionally, no amendments are made for accounting polices.
The amendments above is effective on 1 January 2023. Entities apply such amendments to changes in accounting estimates and changes in accounting policies that occur on or after the beginning of the first annual reporting period in which it applies the amendments.
The Malaysian Accounting Standards Board (“MASB”) had also issued the same amendments in Malaysia with the same effective date and transition.