In this topic 7 sections
Ask why the number changed
| Category | What changed? | General approach |
|---|---|---|
| Accounting policy | The principle, basis or practice used to account for a transaction | Apply required transition provisions; otherwise retrospective application, subject to impracticability |
| Accounting estimate | A measurement is revised using new information or developments | Recognise prospectively in the relevant current/future periods |
| Prior-period error | Available reliable information was omitted or misused | Correct material errors retrospectively, subject to impracticability |
An estimate can later prove inaccurate without having been an error when made. The question is what reliable information was available, and could reasonably have been obtained and used, at the earlier authorisation date. Hindsight must not be used to rewrite a reasonable historical estimate.
- Identify the reason for change
- check the governing standard and transition rules
- distinguish new information from an earlier mistake
- determine the affected dates
- calculate the adjustment and tax effects
- reconcile and disclose.
Start with the standard that specifically applies. If none applies directly, IAS 8 sets a hierarchy for developing a reliable and relevant policy. First consider requirements dealing with similar or related matters, then the Framework's definitions and recognition and measurement concepts. Guidance from standard-setters using a similar framework, accounting literature and accepted industry practice may also help, but cannot override those higher sources. Consistency means using the policy for similar transactions unless an applicable requirement permits or requires a justified distinction. A different treatment for a genuinely different transaction is not automatically a policy change.
Changing a policy requires a reason and a time map
A new standard may contain its own transition provisions. Follow them rather than automatically reopening every comparative period. A voluntary policy change must produce reliable and more relevant information. A preferred profit outcome is not a sufficient reason.
Retrospective application normally presents the information as though the new policy had always been used. Adjust the opening balance of each affected equity component for the earliest period presented and the comparative figures for each affected prior period. Determine whether an additional opening balance sheet is necessary. An IAS 16 change to a revaluation policy follows that standard's special rules rather than the ordinary retrospective policy-change treatment.
Impracticability is a demanding condition, not a convenient synonym for expensive. Consider whether reasonable efforts can establish the effects without reconstructing past management intentions or using impermissible hindsight. Where effects cannot be determined for particular periods, apply the new policy from the earliest practicable date and explain the limitation.
Original policy-change roll-forward
| Date | Inventory increase | Deferred tax liability increase | Cumulative retained earnings increase |
|---|---|---|---|
| Opening Year 3 | 12,000 | 3,000 | 9,000 |
| Closing Year 3 | 20,000 | 5,000 | 15,000 |
| Closing Year 4 | 17,000 | 4,250 | 12,750 |
The opening Year 3 restatement debits inventory $12,000, credits deferred tax liability $3,000 and credits opening retained earnings $9,000. It is not Year 4 income. For Year 3, the inventory uplift grows by $8,000: cost of sales falls $8,000, tax expense rises $2,000 and comparative profit rises $6,000.
In Year 4 the uplift falls from $20,000 to $17,000. Cost of sales therefore rises $3,000; the deferred tax expense effect is a $750 credit; current profit falls $2,250. Check the bridge: $15,000 opening retained-earnings uplift less $2,250 equals the $12,750 closing uplift.
Do not confuse the closing inventory adjustment with the current-year profit adjustment. Profit reflects the change between opening and closing effects. These are restatement workings, not instructions to post every cumulative amount again into an already adjusted ledger. Tax assumptions here illustrate the connection; Module 4 develops tax-base analysis.
Revised estimates use the remaining carrying amount
| Step | Calculation | Amount |
|---|---|---|
| Original annual depreciation | (96,000 − 6,000) / 6 | 15,000 |
| Carrying amount after two years | 96,000 − 30,000 | 66,000 |
| Revised depreciable amount | 66,000 − 3,000 | 63,000 |
| Depreciation for each remaining year | 63,000 / 3 | 21,000 |
The next year's entry is debit depreciation expense $21,000 and credit accumulated depreciation $21,000. Do not restate the two earlier $15,000 charges merely because a later estimate is different. Where an estimate change affects an asset, liability or equity carrying amount, adjust the relevant item as required; estimate changes do not invariably affect only profit or loss.
A change in depreciation method resulting from a changed expected consumption pattern is treated as a change in estimate under IAS 16. Calling straight-line a method does not make every method revision a policy change. A genuine change in measurement basis is a different matter. If the distinction between policy and estimate is difficult, IAS 8 treats the change as an estimate change.
Errors: correct the affected reporting period
Restate Year 4 utilities expense upwards and Year 4 profit downwards by $9,000. Increase the comparative accrual liability $9,000. The Year 5 opening retained-earnings correction is a $9,000 debit with a $9,000 credit to the accrued liability. Payment in Year 5 debits that liability and credits cash. It does not create another Year 5 utilities expense.
If a material error predates the earliest comparative period, correct the opening amounts of that earliest period, subject to impracticability. A current-period error discovered before authorisation is corrected before those statements are issued. The accounting response should reflect when the underlying activity occurred, rather than when someone happened to find the invoice.
Disclosures and self-check
Explain the nature of a policy change, estimate change or material error and the required amounts. Policy changes and prior-period corrections may require effects by financial-statement line item, opening-period adjustments and effects on earnings per share where IAS 33 applies. Where retrospective effects or future estimate effects cannot be established, explain the applicable limitation rather than inventing a number.
| New information | Best classification | Reason |
|---|---|---|
| New engineering evidence shortens an asset's remaining useful life | Estimate | The measurement expectation has changed |
| An arithmetic formula omitted a material group of invoices available last year | Error | Reliable historical information was incorrectly processed |
| A justified change from one permitted inventory cost formula to another | Policy | The accounting basis has changed |
| A standard specifies a particular transition method | Follow that transition | General retrospective guidance does not override it |
Self-check: In Cedar's example, can Year 4 profit increase by the full $17,000 inventory uplift?
Answer: No. The opening uplift was already $20,000. The $3,000 decrease in the uplift raises current cost of sales and reduces current pre-tax profit. The cumulative closing equity uplift and the current-year profit movement are different quantities.
Sources and further reading
Study guide: Module 2, accounting policies, estimates and errors in Part A, printed pages 69–76. All cases and amounts above are original. Download the policy, estimate and error decision guide.
Concept sources: AASB 108, March 2020 compilation, paragraphs 7–53; AASB 116, December 2021 compilation, paragraphs 51 and 61; AASB 101, December 2021 compilation, paragraphs 40A–40D; AASB's 2021 policy/estimate amendment announcement.