Accounting policies

Question 1

What are the key accounting policies?

Answer 1

What are the key accounting policies?

• accounting policies (IAS 8)
• accounting for inventories (IAS 2)
• accounting for property, plant and equipment (IAS 16)
• accounting for events after the reporting period (IAS 10)
• revenue from contracts with customers (IFRS 15)
• provisions, contingent liabilities and contingent assets (IAS 37)
• accounting for leases (IFRS 16)

Question 2

What are accounting policies?

Answer 2

What are accounting policies?

Accounting policies are the specific principles, rules and procedures applied by an entity to ensure that transactions are recorded properly and financial statements are prepared and presented correctly.

These policies are used to deal with complicated or subjective accounting practices such as:

• Depreciation methods,
• Recognition and treatment of goodwill,
• Accounting for research and development costs,
• Inventory valuation and
• Preparation of consolidated financial statements

Question 3

How does IAS 8 prescribes the criteria for selecting and changing accounting policies ?

Answer 3

How does IAS 8 prescribes the criteria for selecting and changing accounting policies ?

IAS 8 prescribes 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.

The standard is intended to enhance the relevance and reliability of an entity’s financial statements. It also aims to improve the
comparability of those financial statements both over time and with the financial statements of other entities.

Question 4

What are the two major concerns governing the application of account policies?

Answer 4

What are the two major concerns governing the application of account policies?

1. selection and application
2. consistency

Selection and application

IAS 8 prescribes the criteria for the selection and application of the appropriate accounting policies. Across all IFRS there is guidance to assist entities in applying their requirements.

In the absence of an IFRS , IAS 8 requires the entity’s management to use its judgement in selecting accounting policies that are:

• relevant to the economic decision-making needs of the users
• reliable

When making their judgements, management should first refer to the requirements and guidance in IFRS dealing with
similar issues; then take consideration of the definitions, recognition criteria and measurement concepts for assets,
liabilities, income and expenses in the IASB’s Conceptual Framework

Consistency

An entity should select and apply its accounting policies consistently to promote comparability between financial statements of different accounting periods and for similar transactions, other events and conditions.

Question 5

When is Changes in accounting policy allowed?

Answer 5

Changes in accounting policy

An entity should change an accounting policy only if the change is required by IFRS or if it results in the financial statements providing reliable and more relevant information.

As a general rule, a change in an accounting policy must be applied retrospectively in the financial statements – in other words, it should be applied to prior periods as though that policy had always been in place.

This will require adjustment of:

1. the opening balance(s) in the current year’s statement of changes in equity (usually retained earnings)
2. adjustment of all comparative amounts presented in the financial statements

IAS 8 also requires full disclosure of the above.

Question 6

What must be included in full disclosures when changes in accounting policy is applied?

Answer 6

International Accounting Standard 8 requires full disclosure of the following items at the end of the first accounting period in which the change was introduced:

1. the IFRS that was responsible for the change;
2. the nature of the change in policy;
3. transitional provisions;
4. for the current and each prior period presented, the amount of the adjustment to:

– each line item affected
– earnings per share

5. the amount of the adjustment relating to prior periods not presented; and
6. an explanation outlining how the change in policy was applied, if retrospective application is impracticable

Question 7

What is accounting estimate and give an example?

Answer 7

Changes in accounting estimates result from new developments or information and should not be confused as corrections of errors.

A common example of an accounting estimate is the allowance for receivables (doubtful debts). This is an estimated amount deducted from trade receivables, representing those who may be unable to meet their debt obligations.

It is estimated based upon a combination of factors including professional judgement, historical behaviour and current analysis. Revising the allowance upwards or downwards is an example of a change in accounting estimate, not a change in accounting policy.

Question 8

How are changes in accounting estimates recognised?

Answer 8

The effect of a change in an accounting estimate is recognised prospectively by including it in the statement of profit or loss and OCI.

1. If the change affects that period only, the effect is recognised in the period of the change.
2. If the change affects both the period of the change and future periods, the effect is recognised in the current and future periods.

The disclosure requirements are less onerous than for a change in accounting policy. The only disclosure required is the nature and amount of change that has an effect in the current period (or is expected to have in future).

Question 9

Prior period errors. What is this and how is it applied?

Answer 9

IAS 8 defines prior period errors as omissions from and misstatements in the entity’s financial statements for one or more prior periods arising from a failure to use, or misuse of, reliable information that:

1. was available when the financial statements for those periods were authorised for issue; and
2. could have been reasonably expected to be taken into account in the preparation and presentation of those financial statements.

Question 10

Example of prior period error?

Answer 10

Examples of a material prior period error include:

1. a material over/understatement of revenue, inventory or other expenses due to mathematical mistakes;
2. mistakes in applying accounting policies;
3. oversights or misinterpretations of facts; and
4. fraud.

Errors should be corrected retrospectively in the first set of financial statements after their discovery by:

1. restating the comparative amounts for the prior period(s) presented in which the error occurred; or
2. if the error occurred before the earliest prior period presented, the opening balances of assets, liabilities and equity for the earliest period presented should be restated

Question 11

How should prior period error be presented in the notes?

Answer 11

In this set of financial statements, full disclosure of the following should be made at the end of the first accounting period in which a material prior period error was discovered:

1. the nature of the prior period error;
2. for each prior period presented, if practicable, disclose the correction to each line item affected and EPS; and
3. the amount of the correction at the beginning of earliest period presented

Question 12

Methods of costing inventories?

Answer 12

There are a number of methods of accounting for inventory cost. The standard cost and retail methods may be used for the measurement of cost, provided that the results approximate to actual cost.

Standard costing

usually associated with a manufacturing company, is the practice of assigning an expected or standard cost for an actual cost and periodically analysing variances between the expected and actual costs into various components (direct labour, direct material and overhead) to maintain productivity.

The retail method

used by retailers that resell merchandise, is a technique used to estimate the value of ending inventory using the cost-to-retail price ratio. The retail inventory method works when there is a clear relationship between the price purchased from a wholesaler and the price sold to customers and the mark-up is consistent across all products sold – such as if a retailer marks up every item by 80% of the wholesale price.

Question 13

What do we mean by Write-down to net realisable value?

Answer 13

What do we mean by Write-down to net realisable value?

Net realisable value 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. 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 statement of profit or loss and OCI in the period in which the reversal occur.

Question 14

What do we mean by What do we mean by Write-down to net realisable value?

Answer 14

The matching principle and expense recognition

When inventories are sold, the carrying amount of those inventories should be recognised as an expense in the period
in which the related revenue is recognised, as per IFRS 15 (Revenue from Contracts with Customers).

The amount of any write-down of inventories to NRV and all losses of inventories should be recognised as an expense in the period the
write-down or loss occurs.

Inventories are usually written down to NRV item by item. However, it may be appropriate to group similar or related items in some circumstances.

Question 15

What does FIFO stand for?

Answer 15

first in, first out! this is for For items that are interchangeable, as per IAS 2. See page 86 of book for calculation.

Question 16

What do we mean by adjusting event and when is it used?

Answer 16

Adjusting events

An adjustment is made to the financial statements when the condition existed at the end of the reporting period.

Settlement of litigation in respect of events that occurred before the end of reporting period may be recorded as liability in
the financial statements or adjusted in accordance with IAS 37 (Provisions, Contingent Liabilities and Contingent Assets).

Discovery of errors in the financial statements may be adjusted in accordance with IAS 8 (Accounting Policies, Changes in Accounting Estimates and Errors.

Question 17

What do we mean by non adjusting events?

Answer 17

Non-adjusting events

No adjustment is required for event or conditions that arose after the reporting period.

For example:

1. A dividend declared after the reporting period does not indicate a liability (there is no obligation until the dividend has been approved by the shareholders in a general meeting) at the reporting date and so is not recognised as a liability at the end of the reporting period.
2. Any litigation charges against the company arising out of events that occurred after the reporting period do not indicate a liability at the reporting date and do not trigger the recognition of a liability.

If these events are material and could influence the financial decisions of users, the following disclosures are required for
each material category of non-adjusting event after the reporting period:

a) the nature of the event; and
b)an estimate of its financial effect, or a statement that such an estimate cannot be made.

If events after the reporting period indicate that the going concern assumption is not appropriate, then an entity should not prepare its financial statements on a going-concern basis. An example of this would be if management intends to liquidate the entity or to cease trading, or that it has no realistic alternative but to do so.

Question 18

Revenue from contracts with customers. What is this?

Answer 18

Recognition and measurement

The core principle of IFRS for revenue recognition is delivered in the five-step approach:

Step 1: identify the contract with the customer, name, T&Cs, the rights of each party etc.

Step 2: identify the performance obligations in the contract -

separate the contract into parts or separate performance obligations when the promised good or service is distinct: for
example, if each part has a distinct function and a distinct profit margin and can be sold separately.

A distinct good or service is ‘separately identifiable’ from other promises in the contract. Examples include:

• a contract to supply, as a package, a ‘free’ mobile phone handset with a call package and insurance cover (the supply of the mobile phone, the call charges and the insurance premiums are separate performance obligations)

Step 3: determine the transaction price - The transaction price is the amount of consideration an entity expects from the customer in exchange for transferring goods or services. The consideration may include fixed amounts, variable amounts or both, in addition to the effects of the customer’s credit risk and the time value of money (if material).

Step 4: allocate the transaction price -An entity must allocate the transaction price to each separate performance obligation (with distinct goods or services) in proportion to the standalone selling price of the good or service underlying each performance obligation.

Step 5: recognise revenue as obligations are performed - For example, handing over a car to a customer determines the timing of revenue recognition. For more complex contracts, such as those for construction assets (buildings, ships or roads), the performance obligation is satisfied when:

• the entity has the present right to payment for the asset;
• the customer has legal title to the asset;
• the entity has transferred physical possession of the asset;
• the customer has the significant risks and rewards of ownership of the asset; and
• the customer has accepted the asset

Question 19

What do we mean by contingent liability?

Answer 19

Contingent liability

A contingent liability is defined as:

1. a possible obligation that arises from past events and whose existence depends upon the occurrence (or non-occurrence) of one or more uncertain future events which are not in the control of the entity; or
2. a present obligation that arises from past events but is not recognised because either:

– it is not probable that an outflow of economic benefits will be required to settle the obligation; or
– a present obligation which arises from past events cannot be measured with sufficient reliability.

Examples include court cases where it is not clear whether the entity has a liability at the reporting date.

A contingent liability is not recognised in the financial statements (as an expense or a liability). It is disclosed as a contingent liability in the notes to financial statements unless the possibility of an outflow of economic benefits or resources is remote.

Question 20

Contingent asset

Answer 20

Contingent asset

A contingent asset is a possible asset that arises from a past transaction or event and whose existence depends upon the occurrence (or non-occurrence) of some uncertain future events not wholly within the entity’s control. For example, compensation (an inflow of economic benefits) expected from the settlement of a court case where the outcome is not certain.

A contingent asset should not be recognised in the financial statements unless it is almost certain that the entity will be entitled to the inflow of economic benefits. However, if there is no certainty, the entity will disclose such a probable contingent asset in the notes to the financial statement.