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IAS 8 ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS

CHANGES IN ACCOUNTING ESTIMATES:

As a result of the uncertainties inherent in business activities, many items in financial statements cannot be measured with accuracy but can only be estimated. Estimation involves judgments based on the latest available and reliable information. For example, estimates may be required for:

a) Doubtful debts,

b) Inventory obsolescence;

c) The fair value of financial assets or financial liabilities;

d) The useful lives of, and expected pattern of consumption of the future economic

benefits embodied in depreciable asset, and

e) Warranty obligations.

The effect of a change in an accounting estimate, other than a change to which following paragraph applies, shall be recognized prospectively by including it in profit or loss in:

a) The period of the change, if the change affects that period only; or

b) The period of the change and future period, if the change affects both.

To the extent that a change in an accounting estimate gives rise to changes in assets and liabilities, or relates to an item of equity it shall be recognized by adjusting the carrying amount of the related asset, liability or equity item in the period of the change.

a) Prospective recognition of the effect of a change in an accounting estimate means that the change is applied to transactions, other events and conditions from the date of the change in estimate.

b) A change in an accounting estimate may affect only the current period’s profit or loss, or the profit or loss of both the current period and future periods.

For example, a change in the estimate of the amount of bad debts affects only the current period’s profit or loss and therefore is recognized in the current period only. However, a change in the estimated useful life of, or the expected pattern of future economic benefits embodied in a depreciable asset affects depreciation expense for the current period and future periods during the asset’s remaining useful life. In both cases, the effect of the change relating to the current period is recognized as income or expense in the current period. The effect, if any, on future periods is, recognized as income or expense in those future periods.

Example-8:

Idrees Sports Private Limited purchased an asset with followings details:

Cost Price = Rs. 2,500,000 Estimated useful life = 10 years

Estimated residual value = Rs. 100,000

In third year, the company estimates the useful life of its asset at 6 years with residual value of Rs. 220,000. The company depreciates its asset on straight line method.

Required: Account for the above Accounting Estimates in the Financial Statements of Idrees Sports Private limited, in the third year.

Solution:

Idress Sports Private Limited Extract from cost of goods sold statement

Rs Rs

Manufacturing Expenses Depreciation (W-2) 300,000

Note: This change in Accounting Estimate has been accounted for prospectively.

Working:

(W-1)

Year Cost Depreciable Depreciation Depreciation Book

Amount Rate (W-3) Amount Value

(Rs) (Rs) % (Rs) (Rs) 1 2,500,000 2,400,000 10% 240,000 2,260,000

2. 2,400,000 10% 240,000 2,020,000

(W-2)

Year Carrying Depreciable DepreciableDepreciation Book Amount Amount Rate Value

Rs Rs % Rs Rs

(2,020,000 – 220,000) 3 2,020,000 1,800,000 16.67% 300,000 1,720,000 4 16.67% 300,000 1,420,000 5 16.67% 300,000 1,120,000

1. 16.67% 300,000 820,000
2. 16.67% 300,000 520,000 8 16.67% 300,000 220,000

(W-3) Depreciation rate in first two years

Depreciation Rate = ¹x100 Estimated useful life

Depreciation Rate = ¹x100 10

Depreciation Rate = 10%

(W-4) Depreciation rate from third year

Depreciation Rate = ¹x100 Estimated useful life

Depreciation Rate = ¹x100 6

Depreciation Rate = 16.67%

Disclosure:

An entity shall disclose the nature and amount of change in an accounting estimate that has an effect in the current period or is expected to have an effect in future periods, except for the disclosure of the effect on future periods when it is impracticable to estimate that effect.

If the amount of the effect in future periods is not disclosed because it is impracticable, an entity shall disclose that fact.

Errors:

a) Errors can arise in respect of the recognition, measurement, presentation or disclosure of elements of financial statements.

b) Financial statements do not comply with IFRSs if they contain either material errors or immaterial errors made intentionally to achieve a particular presentation of an entity’s financial position, financial performance or cash flow.

c) Potential current period errors discovered in that period are corrected before the financial statements are authorized for issue. However, material errors are sometimes not discovered until a subsequent period, and these prior period errors are corrected in the comparative information presented in the financial statements for that subsequent period.

If it is not impracticable, an entity shall correct prior period errors retrospectively in the first set of financial statements authorized for issue after their discovery by:

a) Restating the comparative amounts for the prior period(s) presented in which the error occurred; or

b) If the error occurred before the earliest prior period presented, and then restating the opening balances of assets, liabilities and equity for the earliest prior period presented.

Example-9:

During 2008, Saleem Co discovered that some products that had been sold during 2007 were incorrectly included in inventory at 31 December 2007 at Rs. 6,500.

Saleem Co’s accounting records for 2008 show sales of Rs. 104,000, cost of goods sold of Rs.86,500 (including Rs. 6,500) for the error in opening inventory), and income taxes of Rs. 5,250.

In 2007, Saleem Co’s reported:

2007 Rs.

Sales 73,500 Cost of goods sold (53,500)

Profit before income taxes 20,000 Income taxes (6,000) Profit 14,000

2007 opening retained earnings was Rs. 20,000 and closing retained earning was Rs.34,

000.

Saleem Company’s income tax rate was 30 percent for 2008 and 2007. It had no other income or expenses

Saleem Company’s had Rs. 50,000 of share capital throughout and no other components of equity except for retained earnings.

Solution:

Saleem Co’s

Extract from the Income Statement

Saleem Co’s Statement of Changes in Equity