5. Accounting policies based on IFRS Flashcards
How are the changes in an 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?
The application of a new accounting policy or the correction for a material prior period error requires retrospective application. It requires the restatement of the comparative financial statements for each prior accounting period that is being presented to account for the new accounting policy and/or the material error. The details of the changes must be disclosed in the notes to the financial statements for completeness.
An example of a change in accounting policy would be a change in the
depreciation method from straight line to reducing balance.
Examples of a material prior period error include a 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 impracticable to perform the retrospective adjustment. A material change in an accounting estimate requires the prospective application. The change would also be disclosed in the notes to the financial statements. Examples of changes in accounting estimates 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 inventory. The following
are the purchases and sales made by the company during the current
year.
Disregard this question, will do it on paper.
Using FIFO method, calculate the value of inventory.
Cuba Ltd acquired a new plant in exchange for land with a book value
of £10 million (fair value amounted to £15 million), plus cash paid
upfront of £5 million.
- What will be the cost of the acquired plant in the financial
statements of Cuba Ltd? - What are the criteria set out by IAS 2 for the recognition of the
cost of an item of property, plant and equipment as an asset?
- What will be the cost of the acquired plant in the financial
statements of Cuba Ltd?
As per IAS 16, the cost of the acquired asset will be:
[fair value of asset transferred ± cash]
Therefore, the cost of the acquired plant will be:
£15 million + £5 million = £20 million - The cost of an item of property, plant and equipment should be recognised as an asset only if:
it is probable that future economic benefits associated with the item will flow to the entity; and
the cost of the item can be measured reliably.
Items such as spare parts, standby equipment and servicing equipment are also accounted for under IAS 16 when they meet the definition of property, plant and equipment. Otherwise, they are recognised as inventories. Costs of ongoing servicing of assets are not added to the carrying amount but are recorded as an expense as they are incurred.
- Precipe Ltd recorded inventories at their cost of £500,000 in
the statement of financial position as at 31 December 20X8. The
entity sold 70% of these for £300,000 on 15 January 20X9. It also
incurred a commission expense of 10% of the selling price of the
inventory. - The financial statements for the year ended 31 December 20X8
were authorised for issue on 10 January 20X9. The government
introduced tax changes on 31 March 20X9. As a result, the tax
liability recorded by the entity at 31 December 20X8 increased by
£400,000.
How will these events be reported in the books of Precipe Ltd for
the year ended 31 Dec 20X8?
- Precipe Ltd recorded inventories at their cost of £500,000 in
the statement of financial position as at 31 December 20X8. The
entity sold 70% of these for £300,000 on 15 January 20X9. It also
incurred a commission expense of 10% of the selling price of the
inventory.
The NRV of 70% inventory = £300,000 less commission expense of £30,000 =
£270,000 and it has a cost of £350,000 (£500,000 × 70%).
A sale of inventory after the reporting date reflects that the NRV of its inventory is less than its cost value. The reduction in the value will be treated as an adjusting event, as it reflects the condition of the inventories at the balance sheet date. Therefore, the entity will need to adjust down the inventory value to its NRV in the statement of financial position for the year ended 31 December
20X8.
- The financial statements for the year ended 31 December 20X8
were authorised for issue on 10 January 20X9. The government
introduced tax changes on 31 March 20X9. As a result, the tax
liability recorded by the entity at 31 December 20X8 increased by
£400,000.
How will these events be reported in the books of Precipe Ltd for
the year ended 31 Dec 20X8?
The change in the tax rate occurred after the date when the financial
statements were authorised for issue. Therefore, this will be treated as outside the scope of IAS 10. It would have been treated as a non-adjusting event if it had occurred after the reporting date but before the date of authorisation of financial statements, as the tax change arose after the reporting period.
Peter Telecom Ltd signs a mobile contract for two years with a
customer. It provides a free handset as part of the contract. It also
provides an option to insure the phone at an extra monthly cost. How
are the performance obligations assessed, revenue allocated and at
what point in time is revenue recognised as per IFRS 15?
An entity should recognise revenue to the extent that a performance obligation in a contract with a customer has been satisfied. The transaction price is the amount of consideration an entity expects from the customer in exchange for transferring goods or services.
The handset sale revenue will be recognised when the phone is delivered to the customer.
The revenue relating to the mobile monthly calls will be recognised when the customer uses the phone over the life of the contract.
Any revenue relating to the sale of mobile insurance will be treated as a
separate performance obligation and recognised on a monthly basis. For services that are performed over time, an entity transfers control of a good or service over time. It satisfies a performance obligation and recognises revenue over time.
A court case was filed against Goldwyns Ltd by its major customer for
compensation for a loss caused by the supply of poor-quality products
in the last consignment of goods.
At the reporting year end of 31 December 20X7, the case was still
pending with the value of the claim being disputed. The probability for
the settlement of the loss was unlikely.
However, based on new developments in the case, the lawyer
signalled that the entity’s liability to compensate for the loss was
probable at the year end of 31 December 20X8.
Discuss, as per the requirements of IAS 37, how the events will be
accounted for in the financial statements of Goldwyns Ltd for the year
to 31 December 20X7 and 31 December 20X8.
At 31 December 20X7
The past obligating event was the supply of poor-quality products under the contract which gives rise to a legal obligation. No present obligation was established, as the probability for the settlement of the loss was unlikely.
Therefore, provision will not be recognised. Rather it will be disclosed in the notes to the accounts as a contingent liability unless the probability for future liability is considered as remote.
At 31 December 2018
It was probable that Goldywns will be found liable to the loss settlement. As a result, it was probable that an outflow of economic resources will be required to settle the obligation Therefore, a provision will be recognised if the amount of obligation can be estimated reliably.
Chapter summary
Chapter summary
The objective of IAS 8 is to prescribe the criteria for selecting and changing accounting policies, along with the accounting treatment and disclosure of changes in accounting policies, changes in accounting estimates and corrections of errors.
International Accounting Standard 2 sets out the accounting treatment for inventories, including the determination of cost, the subsequent recognition of an expense and any write-downs to NRV. International
Accounting Standard 2 also requires inventories to be measured 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.
International Accounting Standard 16 sets out how entities should report their investment in property, plant and equipment. This standard includes guidance on:
– recognition and measurement
– determination of carrying amount
– depreciation charges
– any impairment loss
– derecognition and
– disclosure
International Accounting Standard 10 provides guidance on how an entity should adjust its financial statements for events after the reporting period:
– adjusting events: an adjustment is made to the financial statements
when the condition existed at the end of the reporting period.
– non-adjusting events: no adjustment is required for event or
conditions that arose after the reporting period.
International Financial Reporting Standard 15 sets out the principles that an
entity should apply to report the nature, amount, timing and uncertainty
of revenue and cash flows arising from a contract with a customer. This
core principle for revenue recognition is delivered in a five-step approach to
revenue recognition and measurement:
– identify the contract(s) with a customer
– identify the performance obligations in the contract
– determine the transaction price
– allocate the transaction price to the performance obligation of the
contract
– recognise revenue when (or as) the entity satisfies a performance
obligation
The objective of IAS 37 is to ensure that appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets, as well as ensuring that sufficient information is disclosed in the notes to the financial statements to enable users to understand their natures, timings and amounts.
International Financial Reporting Standard 16 prescribes accounting
policies for the recognition, measurement, presentation and disclosure of leases, providing relevant information which faithfully represents those transactions.
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 specifically with
complicated or subjective accounting practices such
as depreciation methods, recognition and
treatment of goodwill, accounting for research and
development costs, inventory valuation and the
preparation of consolidated financial statements.
Accounting policies are defined in IAS 8
(Accounting Policies, Changes in Accounting
Estimates and Errors) as ‘the specific
principles, bases, conventions, rules and
practices applied by an entity in preparing and
presenting financial statements.’
* Implicit in the definition is the need to
provide useful financial information to the
users of financial statements
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: * the opening
balance(s) in the current year’s statement of
changes in equity (usually retained earnings) - adjustment of all comparative amounts
presented in the financial statements
Accounting estimates
The use of reasonable estimates is an
essential part of the preparation of financial
statements.
It does not undermine the reliability of
financial statements.
Changes in accounting estimates result from
new developments or information and should
not be confused as corrections of errors
Reporting a change in accounting estimate
A material change in an accounting estimate requires the
prospective application. The change would also be disclosed in
the notes to the financial statements.
Examples of changes in accounting estimates 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
PPE definition
PPE are tangible assets that
- are held for use in the production or supply of goods or services for rental basis, or admin purposes and
- are expected to be used for more than one accounting period.
What does IAS 16 deal with?
It deals with the accounting treatment of PPE in:
- recognition and measurement
- determination of carrying amount
- depreciation charges
- any impairment loss
- derecognition
- disclosure
Exemptions:
- PPE held for sale (under IFRS 5)
- biological assets re agricultural activity accounted under IAS 41
- exploration of evaluation of minerals assets recognised in accordnce with IFRS 6 and minerals rights and reserves, such as oil, gas and non-generative resources
What is the initial recognition process?
PPE shall be measured at its cost or the cash price equivalent at the recognition date.
Cost includes:
- Purchase Price + duties and non-refundable purchase taxes, after deducting trade discounts
- Costs Associated with Bringing it to the location and installation
- The Estimated cost of dismantling and removing the item and restoring the site. The capitalisation of costs should cease when the asset becomes available for operating use.
Subsequent recognition
Subsequent recognition and measurement:
- recognition of the cost of replacement (if spare parts are needed) in the carrying amount of the asset
- the cost of repair and maintenance will be charged to the SPoL as an expense
- the cost of inspection (if required by law) is recognised in the carrying amount of the asset.
After recognition, an entity has 2 options for accounting for PPE at each reporting date:
- COST MODEL - after recognising PPE, it should be carried at cost less any accumulated depreciation, impairment losses (the carrying amount or net book value)
- REVALUATION MODEL: after recognition as an asset, an item of PPE whose fair value can be meausered reliably should be carried at the revalued amount (fair value at the date of the revaluation) less any subsequent accumulated depreciation/impairment losses (the carrying amount)
