Learning Outcomes
After reading this article, you will be able to explain how accounting policies are selected under IAS 8, state when changes in accounting policies are permitted, apply the required retrospective accounting treatment, and distinguish between changes in accounting policy, changes in estimates, and correction of prior period errors. You will be able to identify exam-standard scenarios and apply IAS 8 rules in practice.
ACCA Financial Reporting (FR) Syllabus
For ACCA Financial Reporting (FR), you are required to understand how accounting policies are chosen, when they may be changed, and how to account for such changes or for corrections of errors. In particular, revision questions may test your understanding of:
- The definition and examples of accounting policies as per IAS 8
- Criteria for selecting initial accounting policies
- Circumstances in which a change in accounting policy is permitted
- The distinction between a change in policy and a change in accounting estimate
- Accounting for retrospective changes in policy and correction of prior period errors
- Disclosures required when changes or corrections occur
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
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Which of the following constitutes a change in accounting policy?
- Switching from straight-line to reducing balance depreciation
- Measuring finished goods inventory using AVCO instead of FIFO
- Revising the useful life of a company car
- Increasing allowance for receivables from 2% to 4%
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When can an entity change an accounting policy voluntarily under IAS 8?
- At the discretion of management for any reason
- If required by a new IFRS or if the change provides more relevant and reliable information
- Only if comparability is not affected
- Any time the company reorganises its business
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True or false? When an accounting policy is changed, all previous periods' financial statements must always be restated to reflect the new policy.
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Which adjustment method applies when correcting a material error from a prior period?
Introduction
Selecting appropriate accounting policies is essential for consistent and comparable financial statements. IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors prescribes strict requirements to ensure users receive meaningful information and financial statements present a true and fair view.
Key Term: accounting policies
Specific principles, bases, conventions, rules, and practices applied by an entity in preparing and presenting financial statements.
Selecting Accounting Policies under IAS 8
Entities must use accounting policies that comply with all applicable IFRS Standards and Interpretations. Where a particular transaction is not covered by a standard, management must use judgment to develop a policy that results in relevant and reliable information for users of financial statements.
In deciding on policies, the key is compliance with IFRS, or—where guidance is lacking—best industry practice and the objectives set out in the Conceptual Framework.
Changing Accounting Policies
Accounting policies must generally be applied consistently from period to period. A change is only permitted if:
- It is required by an IFRS or an IFRS Interpretation;
- OR it results in the financial statements providing more reliable and relevant information.
Examples of a change in accounting policy:
- Switching inventory valuation from FIFO to AVCO
- Moving from cost model to revaluation model for property, plant and equipment
- Capitalising borrowing costs where previously these were expensed, due to an IFRS requirement
A change in accounting policy does not include:
- Changing methods of estimating bad debts
- Revising depreciation estimates
Key Term: change in accounting policy
A change involving the selection or application of a principle, basis, convention, rule, or practice.Key Term: change in accounting estimate
An adjustment of the carrying amount of an asset or liability resulting from new information or developments. Changes in estimates are accounted for prospectively.
Accounting Treatment for Changes in Policy
When an accounting policy is changed, IAS 8 generally requires retrospective application. This means:
- Restate prior period financial statements as if the new policy had always been applied
- Adjust opening balances of assets, liabilities, and equity for the earliest presented period
If retrospective application is impracticable (i.e. it cannot be performed after making every reasonable effort), then apply the new policy prospectively from the earliest practicable date.
Entities must disclose the nature of the change, the reason for it, the amount of the adjustment for each line item affected, and the fact if retrospective application is impracticable.
Worked Example 1.1
Bakhor Co previously valued inventory using FIFO. From this year, it switches to the weighted-average (AVCO) method. Opening inventory under AVCO is $200,000, but was reported as $180,000 under FIFO. What adjustment is needed?
Answer:
The entity restates its comparative figures by increasing opening retained earnings by $20,000 (the difference between AVCO and FIFO). Past period closing inventories and profits are restated. This is a retrospective application as required by IAS 8.
Exam Warning
Changing depreciation method (e.g., straight line to reducing balance) is seen as a change in estimate—not a policy—so is accounted for prospectively.
Distinction: Accounting Policy vs. Estimate
Correctly separating a change in policy from a change in estimate is essential. Policies relate to what and how to account for an item (e.g., choosing between FIFO and AVCO for inventory). Estimates involve judgments within that policy (e.g., estimating the useful life of equipment).
- Changes in policies are retrospective
- Changes in estimates are prospective—i.e., apply only going forward; do not restate prior periods
Worked Example 1.2
Casey Ltd has always depreciated vehicles straight-line over 5 years. It decides to switch to reducing balance, expecting this better reflects vehicle usage. What is this change?
Answer:
This is a change in estimate—not policy. The remaining net book value is depreciated over the remaining useful life on the new basis. No prior period restatement is allowed or required.
Mandatory vs. Voluntary Changes
- Mandatory: Required by adoption of a new or revised IFRS Standard or Interpretation.
- Voluntary: Permitted only if the new policy provides more reliable and relevant information.
Entities must not change accounting policy merely for improved results or comparability with other companies.
Correction of Prior Period Errors
IAS 8 also requires correction of material errors detected in prior periods. Errors include mistakes in applying accounting policies, mathematical mistakes, misinterpretations, or oversight of facts.
Corrections must be applied retrospectively:
- Restate prior period figures as if the error had never occurred
- Adjust opening retained earnings and comparative statements
Entities must disclose the nature of the error and the effect of the correction.
Worked Example 1.3
During 20X6, Rose Co finds that inventory at 31 December 20X4 was overstated by $10,000. What is the correct treatment in 20X6?
Answer:
The error is corrected by reducing opening retained earnings for the earliest period presented by $10,000 and restating affected comparative periods in the financial statements. Disclose the correction and its effect in the notes.
Disclosures
Whenever an entity changes an accounting policy or corrects a material error, full disclosure is required of:
- Nature of the change/error
- Reason for the change
- Amount of adjustment for each affected line item, for each period presented
- If retrospective restatement is impracticable, the reason why
Revision Tip
Always identify whether a scenario requires retrospective or prospective treatment. Use IAS 8’s definitions.
Summary
IAS 8 requires that accounting policies are applied consistently and only changed if required by an IFRS or if they will provide more reliable and relevant information. Policy changes are usually accounted for retrospectively, with comparative periods restated unless this is impracticable. Corrections of prior period errors also require retrospective adjustment.
Key Point Checklist
This article has covered the following key knowledge points:
- Define 'accounting policies' and give examples
- Identify circumstances when changes in policy are permitted under IAS 8
- Distinguish changes in policy from changes in accounting estimate
- Retrospective application of policy changes and prior period error corrections
- Disclosure requirements when changes or corrections occur
Key Terms and Concepts
- accounting policies
- change in accounting policy
- change in accounting estimate