Change in accounting estimate

Report
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI
LANKA
POSTGRADUATE DIPLOMA IN BUSINESS AND
FINANCE - 2013/201
PRINCIPLES OF FINANCIAL AND COST
ACCOUNTING
Nadeeshani Dissanayake
B.Sc. Accounting (Sp), First Class, ACA, ACMA,
CPA (Aust)
Accounting Policies, Changes in Accounting
Estimates and Errors:
LKAS 8

Key is comparability

Objectives:
 How
to choose accounting policies
 Reporting changes in accounting policies
 Reporting changes in estimates
 Reporting the correction of errors
IAS 8 – SELECTION AND APPLICATION OF
ACCOUNTING POLICIES
For a specific transaction or event First, look to the IFRS/SLFRS that deals specifically with that situation:



International Financial Reporting Standards,
International Accounting Standards, and
Interpretations developed by IFRIC or predecessor SIC
Appendices and implementation guidance attached to these are an integral
part of each only if stated on the specific standard.
 IFRS/SLFRS standards and interpretations - top of the GAAP hierarchy

When applied – information is assumed to be relevant and reliable

What if no specific IFRS/SLFRS that applies?

If no specific IFRS/SLFRS that applies:
 Use
judgment
 Develop a policy that results in relevant and reliable
information
 Hierarchy of sources to use
 IFRS/SLFRS
Conceptual framework basics
 If not in conflict with above, use other sources:
 Pronouncements of other standard setters with similar
frameworks, accounting literature, accepted industry
practice, etc.
IAS 8 – CHANGES IN ACCOUNTING POLICIES

Accounting policies  “specific
principles, bases, conventions, rules and
practices applied by an entity in preparing and
presenting financial statements”

Source of changes in accounting policy:
 required
by a new or revised IFRS (most common)
 voluntary change to reliable and more relevant
information

Examples

If change due to:
 different
economic conditions
 new events or conditions
 previously immaterial effects

Then NOT a change in accounting policy

Initial application of an IFRS/SLFRS
–
–

Voluntary change in policy
–

if transitional accounting method provided – follow it
if no transitional method – retrospective application
retrospective application
Retrospective (retroactive) application
–
–
means apply new policy as if it had always been applied
change past amounts

Retrospective application:
 for
the earliest prior period presented
 adjust opening balance of equity affected
 adjust opening balance of other comparative
amounts disclosed

Unless
 impracticable
to determine effects on specific prior
periods or cumulative effect of change

Impracticable: not able to determine adjustments needed after
making reasonable effort, i.e.,




effects of retroactive changes not determinable
assumptions needed about management’s intentions in the prior period
cannot make estimates without knowing circumstances that existed in
the prior period; can only do using hindsight
Example: need to estimate fair value of private company three
years ago. Need to know expectations that existed then re cash
flows and risk-adjusted discount rate. Not possible in many
situations.

If impracticable to apply full retrospective treatment,
then
–

apply the change to A, L, and equity accounts at
beginning of earliest possible period for which effects are
known
If impracticable to determine cumulative effect even
on current period opening balances, then
–
apply new policy prospectively

For all changes in accounting policy, disclose




If on application of a new/revised IFRS, also report


nature of the change
amounts of adjustments to all F/S items, EPS, and to prior periods
if judged impracticable to apply retrospectively, explain why, and how
applied
name of IFRS, that transitional provisions are applied, any likely future
effects
Also disclosures about new IFRS released but not yet effective
LKAS /IAS 8 – CHANGES IN ACCOUNTING
ESTIMATES

Change in accounting estimate – adjustment to
carrying amount of an A/L or amount of asset
consumed in period resulting from its present
status and the expected future
benefits/obligations associated with it.
 Results
from new information or new developments
 If uncertain whether a change in policy or a change
in estimate, account for it as a change in estimate
Estimates are fundamental to the accounting
process
 Changes are expected and recurring
 Therefore, account for prospectively
 Prospective application – recognize effect of
change in current and future periods
 Disclose

Nature of the change
 Amount of the change, unless effect on future periods
impracticable to estimate

LKAS/IAS 8 – CORRECTIONS OF ERRORS

Prior period error – an omission or misstatement
in previously reported financial statements from
failing to use/misuse of reliable information that
Was available when F/S were authorized, and
 Could reasonably be expected to have been used in
preparing those F/S


e.g., arithmetic mistakes, mistakes in applying
accounting policies, oversights, misrepresentation
of facts, fraud

Accounting for correction of an error –
Retrospective restatement
 As if error had never been made
 If impracticable to determine period-specific
adjustments, use partial retrospective application,
or even prospective treatment (see change in
accounting policy)


Disclose
Nature of the error
 Amount of correction for each F/S item, EPS, and to
prior periods
 If judged impracticable to apply retrospectively,
explain why, how applied and date from which error
is corrected

PROVISIONS, CONTINGENT LIABILITIES
AND CONTINGENT ASSETS (LKAS 37)
DEFINITIONS
A Provision – is a liability of uncertain timing or
amount
 A Liability – is a present obligation of the entity
arising from past events, the settlement of
which is expected to result in an outflow from
the entity of resources embodying economic
benefits.
 Legal Obligation + Constructive Obligation

A Contingent Liability – is a possible obligation
that arises from past events and whose
existence will be confirmed only by the
occurrence or non- occurrence of one or more
uncertain future events not wholly within the
control of the entity ; OR
 A present obligation that arises from past
events but is not recognised because , it is not
probable that an outflow of resources
embodying economic benefits will be required
to settle the obligation or the amount of the
obligation cannot be measured with sufficient
reliability.


A contingent Assets – is a possible asset that
arises from past events and whose existence
will be confirmed only by occurrence or nonoccurrence of one ore more uncertain future
events not wholly within the control of the
company
RECOGNITION
A provision shall be recognized when :
(a) An entity has a present obligation as a result
of past event;
(b) It is probable that an outflow of resources
embodying economic benefits will be required
to settle obligation; and
(c) A reliable estimate can be made of the
amount of the obligation

Contingent Liability – Not recognised as a
liability in FS. But needs to be disclosed.
 Contingent Assets - Not recognised as a asset
in FS. But needs to be disclosed where an
inflow of economic benefit is probable.

EXAMPLE 1
Entity A is involved in a legal dispute. A customer
claims they slipped and fell at the entity premises,
sustaining a back injury. The customer is seeking
a damage of Rs. 1 mn. Despite the fact that
customers have been successful in winning
similar claims in the past, the directors of entity A
believe they will be successful in defending the
claim. Entity A’s lawyers have also advised that it
is probable that Entity A will not be found liable.
Should Entity A recognise a provision for the legal
claim ?
EXAMPLE 1 CONT….
No, a provision does not need to be recognised
in Entity A’s Financial Statements
 In this fact pattern, although the entity has a
present obligation resulting from a past event,
it is not probable that an outflow to resources
would be required to settle the obligation
 The event would likely be disclosed as
contingent liability in the FS

EXAMPLE 2
ABC is an oil exploration company. During the year, due to a
lapse in safety procedures on one of ABC’ oil rigs, there was
a major oil spill.
There is no environmental legislation that requires ABC to clean
up the contamination caused by the oil spill. However, in recent
years, ABC has widely publicised its environmental policy, which
includes an undertaking to clean up any contamination that it
causes.
ABC engineers estimate that it will cost approximately Rs. 15
mn to rectify the damage caused by the spill

Should ABC recognise a provision for the cost of rectifying the
oil spill ?
EX 2 - SOLUTION
Is there a present obligation as a result of past
event ? YES
 Is the outflow of economic resources probable
? YES
 Can the amount be reliably measured ? YES

MEASUREMENT OF PROVISIONS
A provision is measured as follows
the best estimate of expenditure required
to settle the present obligation at the end of
the reporting period
 Best estimate
The amount that an entity would rationally pay
to settle the obligation at that date or to
transfer it to a third party at that time.
Large Population of items : expected value
Single obligation : most likely amount

EX :3

Using the same facts as for Ex 2, ABC engineers
have revised their original estimates for the cost
of rectifying the damages caused by the oil spill.
The engineers now believe that there is a
15% chance of the clean-up costing Rs. 10mn
30% chance of the clean-up costing Rs. 15mn
55% chance of the clean-up costing Rs. 20mn
What is the appropriate value of the provision recognised
by ABC in its FS ?
Solution
As the oil spill is a single obligation, the individul
most likely outcome should be used to provide
the best estimate of the liability
The individual most likely outcome is Rs. 20mn
(55% likeliehood)

EX: 4
Using the same facts as for ex – 3, except now
assume that the obligation is relating to a large
population of items ( ex: warranties on cars
manufactured)
Calculate the value of the provision to be
recognised.
Provision should be estimated using the expected
value method
15% * Rs. 10mn = Rs. 1.5 mn
30% * Rs. 15mn = Rs. 4.5 mn
55% * Rs. 20mn = Rs. 11.0 mn
Total provision RS. 17mn

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