Accounting policies and changes in accounting estimates

Question 1

What are accounting policies?

Answer 1

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

Question 2

When do we change the accounting policy?

Answer 2

Changes take place only:

• If it is required by standard or an interpretation;
• If the change results in the financial statements providing reliable and more relevant information.

Question 3

How do we account for changes in accounting policies?

Answer 3

If an entity is adopting a new standard, we follow the transitional provisions.

We use RETROSPECTIVE method when:

• If there are no transitional provisions specified in the new standard.
• If the change is voluntary.

Question 4

When there are changes in the accounting policies, what are the required disclosures? (Retrospective method)

Answer 4

Disclose the nature of the change and the effect of the change on the prior and current year.

Question 5

What are examples of changes in accounting policies?

Answer 5

1. A GAAP change. (Generally Accepted Accounting Principle)

Example:
From weighted average to First in First Out method.

2. The adoption of a new accounting standard.

Example:
Accounting for Investment Property. Accounting for Investment Property was initially done based on the financial reporting standard for Account for Investments. However, this financial reporting standards was replaced, and it was mandatory for entities to apply the new financial reporting standard on Investment Property when accounting for Investment Property.

3. A change in the measurement model of PPE from Cost to Revaluation.
   We have to ensure that all conditions for the change are met.

For this example, we need to ensure that:

1. The change will provide a reliable and a more relevant information.
2. The fair value can be measured reliable.

Question 6

What are situations not considered as changes in accounting policies?

Answer 6

1. Changes from a non-GAAP to a GAAP is treated as a ‘correction of errors’.
2. A new GAAP applied to a new transaction is treated as “no change”’.
3. A change due to a change in estimate is treated as a “change in estimate”.

Question 7

What are prior period errors?

Answer 7

This refers to omissions from, and misstatements in, the entity’s financial statements for one or more prior periods arising from failure to use, or misuse of, reliable information that was available when financial statements for those periods were authorized for issue; and could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements.

Question 8

What are examples of prior period errors?

Answer 8

• The effects of mathematical mistakes
• Mistakes in applying accounting policies
• Oversights or misinterpretations of facts
• Fraud

Example:
- Wrong computation of depreciation.

Question 9

How do we account for prior period errors?

Answer 9

Method used:
Retrospective method.

Disclosure:
- Disclose the nature of the correction and effect of the correction for the prior year only.

(BR)

For all years disclosed, financial statements are retrospectively restated to reflect the error correction.

Question 10

What are some examples of prior period errors?

Answer 10

• The use of inappropriate accounting principles
• Mistakes in applying GAAP
• Arithmetic mistakes
• Fraud or gross negligence in reporting.

Question 11

Example 1 of correction of prior period errors

Answer 11

Last in first out to first in first out correction.

Since last in first our is not permitted under the SFRS, any entities using this method need to switch to costing methods that are allowed under the financial reporting standards such as first in first out method.

This change is considered as a correction of prior period error and we will need to apply the retrospective method to account for this change.

Question 12

Example 2 of correction of prior period errors

Answer 12

Failure to include depreciation when accounting for PPE items.

Previously if an entity did not depreciate its depreciable PPE item, this will be considered as a prior period error.

A change of PPE without depreciation to PPE with depreciation will be a correction of this prior period error.

We need to apply the retrospective method to account for this change.

Question 13

What is a change in accounting estimates?

Answer 13

It is 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.

Changes in accounting estimates result from new information or new developments and, accordingly, are not correction of errors.

Question 14

How do we account for changes in accounting estimates?

Answer 14

Method used:
We use the prospective method.

Disclosure:

• Disclose the nature of the change and the effect of the change for current year and future years (if practicable)
• Disclosure is required only if change is significant.

Question 15

Examples of changes in accounting estimates.

Answer 15

• An entity changes the useful life of PPE from 10 years to 7 years.
• An entity changes the salvage value of PPE from $15,000 to $10,000
• An entity changes the provision for litigation expenses from $30,000 to $40,000.

Question 16

A change in depreciation method is classified under what type of change?

Answer 16

A change in depreciation method is not a change in accounting policy or a correction of error, but a change in the expected pattern of consumption of benefits of an asset.

This is an estimate, so we account for such a change prospectively.

Hence, it is a change in accounting estimates.

Question 16

What are the three types of changes?

Answer 16

1. Changes in accounting policies (Retrospective method)
2. Correction of prior period error (Retrospective method)
3. Change in accounting estimate (Prospective method)

Question 16

Ignore

Answer 16

Ignore

Question 17

What is the difference between retrospective method and prospective method?

Answer 17

Retrospective method:
Involves the revision of prior year’s financial statements

Prospective method:
Affects the financial statements in the current and future years only.

Question 18

Retrospective Method

Answer 18

• We restate prior year’s statements that are presented for comparative purposes to reflect the impact of the change.
• Adjust the balance in each account affected, to appear as it the newly adopted accounting policy had been applied all along/that the error had never occurred.

Possible situation:

• If retained earnings is one of the accounts whose balance must be adjusted, we adjust beginning balance of Retained Earnings for the earliest period reported in the comparative statements.
• For each year reported in the comparative statements, we revise those statements to appear as if the newly adopted accounting policy had been applied all along.

Steps for the retrospective method:

1. Calculate the prior year’s cumulative effect (CE) of the change in accounting policy or correction of prior period error.
2. Adjust the prior year’s’ cumulative effect against the relevant accounts, including the adjustment against the Beginning Retained Earnings (BRE) of the current year, if applicable.
3. Compute the current year’s effect and make corresponding year-end adjustments, if any.
4. Disclose the nature and effect of the change.

Question 19

Prospective method

Answer 19

• We implement the change in the current period, and its effects are reflected in the financial statements of the current and future years only.
• Using this method, remember that there is no cumulative effect as prior years are not affected.
• There is also no amendment to comparative figures because prior year is not involved.
• We only disclose the nature and effect if the change is significant.

Question 20

What is the definition of events after the reporting period?

Answer 20

This refers to events both favorable or unfavorable that occurs between the balance sheet data and the date when the financials statements are authorized for issue.

Question 21

When are financial statements authorized for issue?

Answer 21

• Different entities may have different authorization processes for issuing the financial statements.

Possible scenarios when financial statements are authorized for issue:

• It could be when the management authorizes them for issue to the supervisory board.
  It could be on the date of issue, not the date when the shareholders approve the financial statements.
• In some cases, an entity is required to submit its financial statements to its shareholders for approval after the financial statements have already been issued. In such cases, the financial statements are authorized for issue on the date when shareholders approve the financial statements.

(BR)

We need to disclose the date when the financial statements were authorized for issue, and who gave the authorization.

Question 22

What are the 2 types of events after the reporting period?

Answer 22

1. Adjusting events: Events that provide evidence of conditions that existed at the balance sheet date.
   - We need to adjust our financial statements for such events and disclose their effects.
2. Non-adjusting events: Those post balance sheet events that are indicative of conditions that arose subsequent to the balance sheet date.
   - No adjustment is made for such events.
   - Events may be disclosed.

Question 23

Examples of adjusting events after the reporting period.

Answer 23

An entity shall adjust the amounts recognized in its financial statements to reflect adjusting evets after the reporting period.

Examples:

• The settlement of a court case after the reporting period which confirms that the entity had a present obligation at the end of the reporting period.
• New receipt of information after the reporting period indicating that an asset was impaired at the end of the reporting period, or that the amount of a previously recognized impairment loss for that asset needs to be adjusted.

Question 23

Ignore

Answer 23

Ignore