IAS 8 ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS

Key Definitions [IAS 8.5]

Accounting policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements.

A change in accounting estimate is an adjustment of the carrying amount of an asset or liability, or related expense, resulting from reassessing the expected future benefits and obligations associated with that asset or liability.

International Financial Reporting Standards are standards and interpretations adopted by the International Accounting Standards Board (IASB). They comprise:
International Financial Reporting Standards (IFRSs);
International Accounting Standards (IASs); and
Interpretations developed by the International Financial Reporting Interpretations Committee (IFRIC) or the former Standing Interpretations Committee (SIC) and approved by the IASB.

Materiality. Omissions or misstatements of items are material if they could, by their size or nature, individually or collectively, influence the economic decisions of users taken on the basis of the financial statements.

Prior period errors are omissions from, and misstatements in, an entity's financial statements for one or more prior periods arising from a failure to use, or misuse of, reliable information that was available and could reasonably be expected to have been obtained and taken into account in preparing those statements. Such errors result from mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud.

Selection and Application of Accounting Policies

When a Standard or an Interpretation specifically applies to a transaction, other event or condition, the accounting policy or policies applied to that item must be determined by applying the Standard or Interpretation and considering any relevant Implementation Guidance issued by the IASB for the Standard or Interpretation. [IAS 8.7]

In the absence of a Standard or an Interpretation that specifically applies to a transaction, other event or condition, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. [IAS 8.10]. In making that judgement, management must refer to, and consider the applicability of, the following sources in descending order:
the requirements and guidance in IASB standards and interpretations dealing with similar and related issues; and
the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework. [IAS 8.11]

Management may also consider the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework to develop accounting standards, other accounting literature and accepted industry practices, to the extent that these do not conflict with the sources in paragraph 11. [IAS 8.12]

Consistency of Accounting Policies

An entity shall select and apply its accounting policies consistently for similar transactions, other events and conditions, unless a Standard or an Interpretation specifically requires or permits categorisation of items for which different policies may be appropriate. If a Standard or an Interpretation requires or permits such categorisation, an appropriate accounting policy shall be selected and applied consistently to each category. [IAS 8.13]

Changes in Accounting Policies

An entity is permitted to change an accounting policy only if the change:
is required by a standard or interpretation; or
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. [IAS 8.14]
Note that changes in accounting policies do not include applying an accounting policy to a kind of transaction or event that did not occur previously or were immaterial. [IAS 8.16]

If a change in accounting policy is required by a new IASB standard or interpretation, the change is accounted for as required by that new pronouncement or, if the new pronouncement does not include specific transition provisions, then the change in accounting policy is applied retrospectively. [IAS 8.19]

Retrospective application means adjusting 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. [IAS 8.22]

However, if it is impracticable to determine either the period-specific effects or the cumulative effect of the change 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. [IAS 8.24]

Also, if 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. [IAS 8.25]

Disclosures Relating to Changes in Accounting Policies

Disclosures relating to changes in accounting policy caused by a new standard or interpretation include: [IAS 8.28]
the title of the standard or interpretation causing the change
the nature of the change in accounting policy
a description of the transitional provisions, including those that might have an effect on future periods
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
for basic and diluted earnings per share (only if the entity is applying IAS 33)
the amount of the adjustment relating to periods before those presented, to the extent practicable
if retrospective application is impracticable, an explanation and description of how the change in accounting policy was applied.

Financial statements of subsequent periods need not repeat these disclosures.

Disclosures relating to voluntary changes in accounting policy include: [IAS 8.29]
the nature of the change in accounting policy
the reasons why applying the new accounting policy provides reliable and more relevant information
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
for basic and diluted earnings per share (only if the entity is applying IAS 33)
the amount of the adjustment relating to periods before those presented, to the extent practicable
if retrospective application is impracticable, an explanation and description of how the change in accounting policy was applied.
Financial statements of subsequent periods need not repeat these disclosures.

If an entity has not applied a new standard or interpretation that has been issued but is not yet effective, the entity must disclose that fact and any and known or reasonably estimable information relevant to assessing the possible impact that the new pronouncement will have in the year it is applied. [IAS 8.30]

Changes in Accounting Estimate

The effect of a change in an accounting estimate shall be recognised prospectively by including it in profit or loss in: [IAS 8.36]
the period of the change, if the change affects that period only, or
the period of the change and future periods, if the change affects both.

However, 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 is recognised by adjusting the carrying amount of the related asset, liability, or equity item in the period of the change. [IAS 8.37]

Disclosures Relating to Changes in Accounting Estimate

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
if the amount of the effect in future periods is not disclosed because estimating it is impracticable, an entity shall disclose that fact. [IAS 8.39-40]

Errors

The general principle in IAS 8 is that an entity must correct all material prior period errors retrospectively in the first set of financial statements authorised for issue after their discovery by: [IAS 8.42]
restating the comparative amounts for the prior period(s) presented in which the error occurred; or
if the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented.

However, if it is impracticable to determine the period-specific effects of an error on comparative information for one or more prior periods presented, the entity must restate the opening balances of assets, liabilities, and equity for the earliest period for which retrospective restatement is practicable (which may be the current period). [IAS 8.44]

Further, if it is impracticable to determine the cumulative effect, at the beginning of the current period, of an error on all prior periods, the entity must restate the comparative information to correct the error prospectively from the earliest date practicable. [IAS 8.45]

Disclosures Relating to Prior Period Errors

Disclosures relating to prior period errors include: [IAS 8.49]
the nature of the prior period error
for each prior period presented, to the extent practicable, the amount of the correction:
for each financial statement line item affected, and
for basic and diluted earnings per share (only if the entity is applying IAS 33)
the amount of the correction at the beginning of the earliest prior period presented
if retrospective restatement is impracticable, an explanation and description of how the error has been corrected.

Financial statements of subsequent periods need not repeat these disclosures.

IAS 2 INVENTORIES

Objective of IAS 2

The objective of IAS 2 is to prescribe the accounting treatment for inventories. It provides guidance for determining the cost of inventories and for subsequently recognising an expense, including any write-down to net realisable value. It also provides guidance on the cost formulas that are used to assign costs to inventories.

Scope

Inventories include assets held for sale in the ordinary course of business (finished goods), assets in the production process for sale in the ordinary course of business (work in process), and materials and supplies that are consumed in production (raw materials). [IAS 2.6]

However, IAS 2 excludes certain inventories from its scope: [IAS 2.2]
work in process arising under construction contracts (see IAS 11 Construction Contracts
financial instruments (see IAS 39 Financial Instruments: Recognition and Measurement)
biological assets related to agricultural activity and agricultural produce at the point of harvest (see IAS 41 Agriculture).

Also, while the following are within the scope of the standard, IAS 2 does not apply to the measurement of inventories held by: [IAS 2.3]
producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products, to the extent that they are measured at net realisable value (above or below cost) in accordance with well-established practices in those industries. When such inventories are measured at net realisable value, changes in that value are recognised in profit or loss in the period of the change.
commodity brokers and dealers who measure their inventories at fair value less costs to sell. When such inventories are measured at fair value less costs to sell, changes in fair value less costs to sell are recognised in profit or loss in the period of the change.

Fundamental Principle of IAS 2

Inventories are required to be stated at the lower of cost and net realisable value (NRV). [IAS 2.9]

Measurement of Inventories

Cost should include all: [IAS 2.10]
costs of purchase (including taxes, transport, and handling) net of trade discounts received
costs of conversion (including fixed and variable manufacturing overheads) and
other costs incurred in bringing the inventories to their present location and condition

IAS 23 Borrowing Costs identifies some limited circumstances where borrowing costs (interest) can be included in cost of inventories that meet the definition of a qualifying asset. [IAS 2.17 and IAS 23.4]

Inventory cost should not include: [IAS 2.16 and 2.18]
abnormal waste
storage costs
administrative overheads unrelated to production
selling costs
foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a foreign currency
interest cost when inventories are purchased with deferred settlement terms.

The standard cost and retail methods may be used for the measurement of cost, provided that the results approximate actual cost. [IAS 2.21-22]

For inventory items that are not interchangeable, specific costs are attributed to the specific individual items of inventory. [IAS 2.23]

For items that are interchangeable, IAS 2 allows the FIFO or weighted average cost formulas. [IAS 2.25] The LIFO formula, which had been allowed prior to the 2003 revision of IAS 2, is no longer allowed.

The same cost formula should be used for all inventories with similar characteristics as to their nature and use to the entity. For groups of inventories that have different characteristics, different cost formulas may be justified. [IAS 2.25]

Write-Down to Net Realisable Value

NRV is the estimated selling price in the ordinary course of business, less the estimated cost of completion and the estimated costs necessary to make the sale. [IAS 2.6] Any write-down to NRV should be recognised as an expense in the period in which the write-down occurs. Any reversal should be recognised in the income statement in the period in which the reversal occurs. [IAS 2.34]

Expense Recognition

IAS 18 Revenue, addresses revenue recognition for the sale of goods. When inventories are sold and revenue is recognised, the carrying amount of those inventories is recognised as an expense (often called cost-of-goods-sold). Any write-down to NRV and any inventory losses are also recognised as an expense when they occur. [IAS 2.34]

Disclosure Required disclosures: [IAS 2.36]
accounting policy for inventories
carrying amount, generally classified as merchandise, supplies, materials, work in progress, and finished goods. The classifications depend on what is appropriate for the entity
carrying amount of any inventories carried at fair value less costs to sell
amount of any write-down of inventories recognised as an expense in the period
amount of any reversal of a writedown to NRV and the circumstances that led to such reversal
carrying amount of inventories pledged as security for liabilities
cost of inventories recognised as expense (cost of goods sold). IAS 2 acknowledges that some enterprises classify income statement expenses by nature (materials, labour, and so on) rather than by function (cost of goods sold, selling expense, and so on). Accordingly, as an alternative to disclosing cost of goods sold expense, IAS 2 allows an entity to disclose operating costs recognised during the period by nature of the cost (raw materials and consumables, labour costs, other operating costs) and the amount of the net change in inventories for the period). [IAS 2.39] This is consistent with IAS 1 Presentation of Financial Statements, which allows presentation of expenses by function or nature.