Chapter 5 - Interpreting Accounting Policies Based On IFRS Flashcards
How are changes in new accounting policy, the correction of material prior year errors and changes in accounting estimates applied in the financial statements in order to comply with IAS 8?
Requires retrospective action - restatement of the comparative FS for each prior accounting period that is being presented to account for the new accounting policy and/or material error(s). The details of the changes must be disclosed in the notes to the FS for completeness.
Examples:
Change in accounting policy = change in depreciation method (straight line to reducing balance).
Material error = material over/understatement of sales or inventory or other expenses due to mathematical mistakes. Mistakes in applying accounting policies, oversights or misinterpretations of facts and fraud.
IAS 8 only allows for the prospective application of both a change in accounting policy and material prior period errors if it is impractical to perform the retrospective adjustment. A material change in accounting estimate requires the prospective application. Examples include a change in the estimated lifespan of a fixed asset or a change in the estimate used in the calculation of the provision of doubtful debtors.
Konyak Plc imports goods from Nepal and sells them in the local market. It uses the FIFO method to value its goods. The following are the purchases and sales made by the company during the current year.
Purchases:
Jan - 10,000 units @ £15 each
Mar - 15,000 units @ £20 each
July - 10,000 units @ £45 each
Sales:
May - 15,000 units
Nov - 15,000 units
Based on FIFO method, calculate the value of inventory at the end of May, September and December.
May - (£250,000)
Sept - £650,000
Dec - £225,000
What is the purpose of IAS 8?
Prescribes 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.
It aims to enhance relevant and reliability of financial statements to improve comparability. 2 major concerns governing the application of accounting policies are: (1) Selection and application and (2) consistency.
When should changes in accounting policy be made and how should they be made?
Only if the change is required by IFRS or if it results in FS being more relevant + reliable.
Must be applied retrospectively in the FS and adjustments would need to be made for all comparative amounts presented and opening balances in current year’s accounts.
Full disclosure is required at the end of the first accounting period in which the change was introduced (standard, nature, transitional provisions, current and prior year adjustments, any explanations).
What are changes in accounting estimates and how should they be made?
Changes in accounting estimates are applied prospectively by including it in the profit or loss, as shown:
- If change affects that period only, the effect is recognised in the period of the change; or
- If change affects both the period of change and future periods, the effect is recognised in both periods.
Only disclosure required is the nature and amount of change that has an effect in the current period (or is expected to have in the future).
How does IAS 8 define prior period errors and how should errors be corrected?
“omissions from, and misstatements in, the entity’s FS for one or more prior periods arising from a failure to use, or misuse of, reliable information that:
- Was available when the FS for those periods were authorised for issue; and
- Could have been reasonably expected to be taken into account in the preparation and presentation of those FS”
Should be corrected retrospectively in the first set of FS after their discovery by:
- Restating the comparative amounts for the prior years presented in which the error occurred; or
- If the error occurred before the earliest prior period presented, the opening balance of assets, liabilities and equity for the earliest period presented should be restated.
Full disclosure should be made at the end of the first accounting period error was discovered (nature, correction line item/EPS, correction amount).
How should entities recognise inventories?
IAS 2 sets out the accounting treatment for inventories, including the determination of cost, the subsequent recognition of an expense and any write-downs to net realisable value.
Inventories within the scope of IAS 2 are assets:
- held for sale in the ordinary course of business (finished goods)
- in the process of production in the ordinary course of business (work in progress)
- in the form of materials and supplies that are consumed in production (raw materials) or in the rendering of services.
Assets that are excluded within the scope of IAS 2 include:
- work in progress arising under construction contracts
- financial instruments
- biological assets related to agricultural activity and agricultural produce at the point of harvest.
How should inventories be measured?
IAS 2 - at the lower of cost and NRV. The cost of inventories comprises all costs of purchase, costs of
conversion and other costs incurred in bringing the inventories to their present location and condition.
What is included/excluded from the cost of inventories?
The cost of inventories comprises all 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.
Inventory cost does not include:
- 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.
What are the methods of accounting for inventory?
1) Standard costing method: usually associated with a manufacturing company, 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 overheads etc.) to maintain productivity.
2) Retail method: usually used by retailers that resell merchandise, used to estimate the value of ending inventory using the cost to retail price ratio. 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. Where inventory costs are not interchangeable, specific costs are attributed to the specific individual items of inventory. For interchangeable items, IAS 2 allows the First in First Out (FIFO) or weighted average cost formulas. Last in First Out (LIFO) is now prohibited under IAS 2.
(WAC uses the average cost of goods – divide the cost of goods available for sale by the number of units available for sale).
What is NRV and how should you recognise a write-down to it?
NRV = 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 it occurs. Any reversals should be recognised in the income in the period in which the reversal occurs.
Assets should not be carried in excess of amounts expected to be realised from their sale or use.
What disclosures are required under IAS 2?
- accounting policy for inventories;
- amount of any write-down of inventories recognised as an expense in the reporting period;
- cost of inventories recognised as expense (cost of goods sold);
- amount of any reversal of a write-down to NRV and the circumstances that led to such reversal; and
- separate disclosure of inventories carried as assets at the period end, including:
–– carrying amount, generally classified as merchandise, supplies, materials, work in progress, and finished goods;
–– carrying amount of any inventories carried at fair value less costs to sell; and
–– carrying amount of inventories pledged as security for liabilities.
What is the scope and objective of IAS 16?
The objective of this standard is to deal with the accounting treatment of property, plant and equipment (PPE).
PPE are tangible items that:
- are held for use in the production or supply of goods or services, for rental basis, or for administrative purposes; and
- are expected to be used for more than one accounting period.
IAS 16 does not apply to:
- PPE held for sale under IFRS 5;
- Biological assets related to agricultural activity accounted for under IAS 41 (Agriculture); and
- Exploration and evaluation of mineral assets recognised in accordance with IFRS 6; and mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative resources.
How should PPE be initially recognised and measured under IAS 16?
Should be recognised as an asset if it meets the definition of an asset and the cost can be measured reliably.
Measured at its cost or the cash price equivalent at recognition date. Cost includes:
1) Purchase price, including duties and non-refundable purchase taxes, after deducting trade discounts;
2) Costs directly attributable to bringing the asset to the location and condition necessary for it to operate in the manner intended by management; and
3) The estimated costs of dismantling and removing the item and restoring the site on which it is located.
How should PPE be subsequently recognised and measured?
Recognition:
- Assets needing replacement of some component parts during the useful life will recognise the cost of replacement in the carrying value of the relevant asset if it satisfies the recognition criteria
- Cost of day-to-day or ongoing repair/maintenance will be charged to the statement of profit or loss as an expense
- An asset requiring an inspection after a specified interval as per industry laws will recognise the cost of such inspection in the carrying value of the related asset, if its economic benefits are for more than one reporting period.
Measurement:
After recognition, the entity has two options to choose from in terms of measurement:
1) Cost model – cost less any accumulated depreciation / accumulated impairment losses
2) Revaluation model – where fair value can be measured reliably = fair value at the date of revaluation less any subsequent accumulated depreciation / accumulated impairment losses.
Revaluation increases = reval surplus in other comprehensive income and accumulated in equity. If the increase reverses a revaluation decrease, it should be recognised in PandL
Revaluation decreases = PandL unless they reverse a previous revaluation increase.
