Changing policies, estimates and classifications and...

The views expressed in this presentation are those of the presenter,

not necessarily those of the IASB or IFRS Foundation.

International Financial Reporting Standards

Changing policies, estimates and

classifications and correcting errors

September 2015

©IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Michael Wells, Director of Education, IASB

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© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

The requirements are set out in International Financial Reporting Standards (IFRS), as issued by the IASB at 1 January 2015, including those with an effective date after 1 January 2015, but not the IFRSs they will replace.

Disclaimer: The IFRS Foundation, the authors, the presenters and the workshop organisers do not accept responsibility for any loss caused by acting or refraining from acting in reliance on the material in this PowerPoint presentation, whether such loss is caused by negligence or otherwise and this presentation is not a form of advice or opinion.

Recent regulatory issues why this is relevant to you


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• In July 2013, the IFRS Interpretations Committee received a request from the European Securities and Markets Authority (ESMA) to clarify the criteria to distinguish between a change in an accounting policy and a change in an accounting estimate, in relation to the application of IAS 8. (see Appendix A to Agenda Paper 11A Review of IAS 8 - Distinction between changes in accounting policies and changes in accounting estimates May 2015 IASB meeting http://www.ifrs.org/Meetings/MeetingDocs/IASB/2015/May/AP11A-Disclosure-Initiative.pdf)

• The following table lists the issues raised by ESMA.

http://www.ifrs.org/Meetings/MeetingDocs/IASB/2015/May/AP11A-Disclosure-Initiative.pdf








Recent regulatory issues why this is relevant to you (1 of 3 slides)


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Issue IAS 8 and

A change in the basket of high quality corporate bonds

(HQCB) used to determine the discount rate for a defined

benefit obligation, eg from AA-rated bonds to A-rated bonds

IAS 19

A change in the assessment of own credit risk for

measurement of financial liabilities at fair value; eg from

using a credit default swap curve to using the spread of the

most recent debt issuance.

IFRS 13

A change of credit value adjustment (CVA) calculation to

determine the probability of default.

IFRS 13

A change in the cost formula used for inventories: from FIFO

to weighted average cost.

IAS 2



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Issue IAS 8 and

A change in the ‘significant or prolonged’ criteria for

impairment of financial assets.

IAS 39

A change in the depreciation method: from straight-line to the

units-of-production method when the expected pattern of

consumption has changed.

IAS 16

A change from the cost model to the revaluation model for

measuring a class of property, plant and equipment.

IAS 16

A change in the valuation technique to measure fair value,

eg from a market approach to an income approach (Level 3).

IFRS 13

A change in the option pricing model for share options from

Black and Scholes to Monte Carlo.

IFRS 2



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(see Appendix A to Agenda Paper 11A Review of IAS 8 - Distinction between changes in accounting policies and changes in accounting estimates, May 2015 IASB meeting http://www.ifrs.org/Meetings/MeetingDocs/IASB/2015/May/AP11A-Disclosure-Initiative.pdf)

Issue IAS 8 and

A change in the expenditures included in the initial

measurement of exploration and evaluation assets.

IFRS 6

Inventory has been measured at cost but it has become

obsolete and its net realisable value (NRV) is lower than

cost.

IAS 2







Framework-based approach for applying IFRS


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• What are the economics of the phenomenon (eg transaction or event)?

• What information about the phenomenon is relevant for informing resource allocation decisions by existing and potential investors and lenders who cannot require information directly and that can be faithfully represented etc?

• Then consider IFRS requirements

• Make judgements to develop accounting policy

• Make judgements and estimates to apply the requirements with rigour and consistency


The views expressed in this presentation are those of the

presenter,

not necessarily those of the IASB or IFRS Foundation

The concepts: objective and

qualitative characteristics

©IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK | www.ifrs.org

Provide financial information about the reporting entity that is useful to primary users—existing and potential investors, lenders and other creditors who cannot require reporting entities to provide information directly to them—in making decisions about providing resources to the entity (buy, sell, hold, provide loan/settle (paragraphs OB 2 and OB 5 Conceptual Framework)

…Investors’, lenders’ and other creditors’ expectations about returns depend on their assessment of the amount, timing and uncertainty of (the prospects for) future net cash inflows to the entity.

Objective of IFRS financial reporting 9


• To assess an entity’s prospects for future net cash inflows, existing and potential investors, lenders and other creditors need information about: – the resources of the entity; – claims against the entity; and – stewardship—how efficiently and effectively the

entity’s management and governing board have discharged their responsibilities to use the entity’s resources – eg protecting the entity's resources from

unfavourable effects of economic factors such as price and technological changes

Objective of IFRS financial reporting continued 10


• If financial information is to be useful, it must be relevant and faithfully represent what it purports to represent (ie fundamental qualities).

– Financial information without both relevance and faithful representation is not useful, and it cannot be made useful by being more comparable, verifiable, timely or understandable.

• The usefulness of financial information is enhanced if it is comparable, verifiable, timely and understandable (ie enhancing qualities—less critical but still highly desirable) – Financial information that is relevant and faithfully represented

may still be useful even if it does not have any of the enhancing qualitative characteristics.

Qualitative characteristics 11


• Relevance: capable of making a difference in users’ decisions – predictive value (input to process to predict future cash flows) – confirmatory value (confirm/disconfirm prior cash flow

expectations)

– materiality (entity-specific—could affect a user’s decision) • Faithful representation: faithfully represents the

phenomena it purports to represent – completeness (depiction including numbers and words) – neutrality (unbiased) – free from error (ideally) Note: faithful representation replaces reliability

Fundamental qualitative characteristics 12




presenter,


Changing accounting policies, estimates and

classifications and correcting errors


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Accounting policies are specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements (paragraph 5 of IAS 8).

Accounting policies are designed to provide information capable of making a difference in the decisions made by users (ie relevant) that can be faithfully represented—complete, neutral and free from error—etc (see paragraphs 8 and 10 of IAS 8)

Consequently, an entity can voluntarily change an accounting policy only if the change results in the financial statements providing reliable and more relevant information (see paragraph 14 of IAS 8)

Accounting policies the concept


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Which measurement basis provides the most relevant

information that can be faithfully represented about an

entity’s investment property?

Choose 1 of:

(a) Historical cost (no depreciation; no impairment);

(b) Cost model (historical cost-depreciation-impairment);

(c) Revaluation model (fair value-depreciation-impairment);

(d) Fair value model;

(e) Fair value less costs to sell; or

(f) Entity specific current value measure (value in use).

Accounting policy relevant information: investment property


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information that can be faithfully represented about a

manufacturing entity’s plant?

Choose 1 of:







Accounting policy relevant information: plant


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information that can be faithfully represented about a

palm-oil grower’s bearer plants?

Choose 1 of:







Accounting policy relevant information: bearer plants


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As a result of the uncertainties inherent in business activities, many items in financial statements cannot be measured with precision but can only be estimated. Estimation involves judgements based on the latest available, reliable information (see paragraph 32 of IAS 8).

The use of reasonable estimates is an essential part of the preparation of relevant financial information and does not undermine the ‘reliability’ of financial statements (see paragraph 4.41 of the Conceptual Framework and paragraph 33 of IAS 8).

Accounting estimates the concept


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

Financial statements do not comply with IFRS if they contain either:

• material errors (errors that could affect a user’s decision made on the basis of the financial info); or

• immaterial errors made intentionally to achieve a particular presentation of an entity’s financial position, financial performance or cash flows.

(paragraph 41 of IAS 8).

Errors the concept


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Prior period errors are omissions from, and

misstatements in, the entity’s financial statements for

one or more prior periods arising from failure to, or

misuse of, reliable information that:

(i) was available when financial statements for those

periods were authorised for issue; and

(ii) could reasonably be expected to have been

obtained and taken into account in the preparation

and presentation of those financial statements.

(paragraph 5 of IAS 8).

Prior period errors the concept


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An entity need not apply its accounting policies when the

effect of applying them is immaterial. (see paragraph 8

of IAS 8).

It is not a change in accounting policy to apply for the

first time a new or previously undisclosed accounting

policy to transactions, other events or conditions that:

• did not previously occur (or occurred but were

immaterial); or

• that differ in substance from those previously

occurring. (paragraph 16 of IAS 8).

Guidance—policies, estimates and errors (slide 1 of 3 slides)


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A change in measurement basis applied is:

• a change in accounting policy;

• not a change in accounting estimate.

When it is difficult to distinguish a change in

accounting policy from a change in accounting estimate,

the change is treated as a change in accounting

estimate. (paragraph 35 of IAS 8).



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An estimate may need revision if:

• changes occur in the circumstances on which the

estimate was based; or

• as a result of new information or more experience.

By its nature, the revision of an estimate:

• does not relate to prior periods; and

• is not the correction of an error

(paragraph 34 of IAS 8)



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• Correction of an error—retrospective restatement

• Change in accounting policy—retrospective application

• Change in accounting estimate—prospective

application

• Change in classification arising from change in use—

transfer

• Change in classification arising from change of

circumstance—transfer

IFRS principles


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Correcting prior period errors example: the principle


You are deciding whether to buy shares in Entity A or Entity B.

The companies are identical—same transactions with the same

counterparties; same jurisdiction; both formed on 1/1/20x4.

Which of the following presentations of B’s profit in its 20x5

accounts would best inform your decision to invest in A or B?

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Profit for year 20x5 20x4 20x5 + 20x4

Entity A 50 50 100

In error Entity B reports 40 profit in its 20x4 accounts ? ? 100

Explanation 20x5 20x4 20x5 + 20x4

(a) Restate comparative figures (20x4) to correct error 50 50 100

(b) Overstate 20x5 profits—compensating error 60 40 100

(c) Ignore the prior period error—leave it uncorrected 50 40 90

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Assume Entities A and B are identical in all respects.

On 1/1/20x1 both buy identical land for CU100.

A reports the land (investment property) at its fair value of CU150

at 31/12/20x3; CU160 at 31/12/20x4; and CU190 at 31/12/20x5.

In 20x5 B changes from cost model to fair value model.

Which of the following ‘fixes’ in B’s 20x5 financial statements best

enables potential investors to decide whether to invest in A or B?

B reports additional income of (choose 1 of):

(a) CU30 (20x5) and CU10 (restated 20x4);

(b) CU30 (20x5) and CU60 (restated 20x4); or

(c) CU90 (20x5) and nil (20x4).

Change in accounting policy example: the principle


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Assume Entities A and B are identical in all respects. On 1/1/20x4 both buy plant for CU100. Both intending keeping the plant in production for its entire economic life. At 31/12/20x4 A and B report plant at CU90 (estimated useful life = 10 years; nil residual value).

In late 20x5 new technology is discovered that doubles the economic life of such plant from 10 years to 20 years (measured from 1/1/20x4).

Which of the following ‘fixes’ in A and B’s 20x5 financial statements is the most faithfully representation? Report depreciation of (choose 1 of): (a) CU5 (20x5) and CU5 (restated 20x4);

(b) CU5 (20x5) and CU10 (20x4);

(c) CU4.74 (ie CU90÷19 yrs) (20x5) and CU10 (20x4); or

(d) nil (20x5) and CU10 (20x4).

Change in accounting estimate example: the principle


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• Impracticability exception (paragraphs 5 & 50–53 of

IAS 8)

– a practical expedient (rule)

– anti-abuse—prohibits the use of hindsight when

applying a new accounting policy to, or correcting

amounts for, a prior period

• Transitional provisions when applying for the first time

new and amended Standards and Interpretations

– the IASB’s application of the cost constraint

IFRS application guidance (1 of 2 slides)


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• Accounting policies need not be applied when the effect of

applying them is immaterial (paragraph 8 of IAS 8)

– entity specific application of the materiality aspect of

relevance

• The initial application of a policy to revalue assets in

accordance with IAS 16 Property, Plant and Equipment or

IAS 38 Intangible Assets is a change in an accounting

policy to be dealt with as a revaluation in accordance with

IAS 16 or IAS 38, rather than in accordance with IAS 8.

(paragraph 17 of IAS 8)

IFRS application guidance (2 of 2 slides)


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Assume Entities A and B are identical in all respects. On 1/1/20x1 both buy identical land for CU100. A reports the land (PPE) at its fair value (revaluation model) of CU150 at 31/12/20x3; CU160 at 31/12/20x4; and CU190 at 31/12/20x5. In 20x5 B changes from cost model to the revaluation model.

In B’s 20x5 financial statements how must it report the change in accounting policy?

B reports additional income of (choose 1 of):

(a) CU30 in profit or loss in 20x5 and CU10 (restated 20x4);

(b) CU30 in profit or loss in 20x5 and CU60 (restated 20x4);

(c) CU90 in profit or loss in 20x5 and nil (20x4); or

(d) CU90 in other comprehensive income in 20x5 and nil (20x4).

Change in accounting policy example: a rule


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• Why does IFRS provide the rule (an exception from the

retrospective application principle) specified in paragraph

17 of IAS 8 for accounting a change in accounting policy

for PPE from the cost model to the revaluation model?

• Is the rule consistent with the Conceptual Framework?

– In other words, does the rule result in decision-useful

information?

• Why did IASB not specify a similar rule for a change in

accounting policy for investment property from the cost

model to the fair value model?

What do you think?


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On 1/1/20x1 Entity A buys farmland for CU100 and rents the land to a another. In late December 20x5 the lease agreement expires and A occupies the land and begins farming on it. A measures investment property at fair value and PPE at historical cost. The fair value of its land is CU150 at 31/12/20x3; CU160 at 31/12/20x4; and CU190 at 31/12/20x5.

In A’s 20x5 statement of comprehensive income how, if at all, must it report the change in the fair value of the land?

A reports income (expense) of (choose 1 of):

(a) CU30 (20x5) and CU10 (20x4);

(b) nil (20x5) and CU10 (20x4);

(c) nil (20x5) and nil (20x4 restated); or

(d) nil 20x5 and CU-60 (20x4 restated).

Change use => new classification example: a principle


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On 1/1/20x1 Entity A buys farmland for CU100. In late December 20x5 A ceases farming and rents the land to a another. A measures PPE at historical cost and investment property at fair value. The fair value of its land is CU150 at 31/12/20x3; CU160 at 31/12/20x4; and CU190 at 31/12/20x5.

In A’s 20x5 statement of comprehensive income how must it report the change in the fair value of the land?

A reports additional income of (choose 1 of):

(a) CU30 in profit or loss in 20x5 and CU10 (restated 20x4);

(b) CU30 in profit or loss in 20x5 and CU60 (restated 20x4);

(c) CU90 in profit or loss in 20x5 and nil (20x4); or

(d) CU90 in other comprehensive income in 20x5 and nil (20x4).

Change use => new classification example: a rule


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• Why does IFRS provide the rule—basically recognise the cumulative change in fair value up to the date of the change in use in OCI, like a revaluation (see paragraph 61 of IAS 40)—for accounting a change in classification (from PPE using the cost model to investment property using the fair value model) arising from the change in use of the investment property?

• Is the rule consistent with the Conceptual Framework?

– In other words, does the rule result in decision-useful

information?

• Why do you think IAS 40 Investment Property (and other Standards) provides so many rules to specify accounting for the change in classification of assets?

What do you think?


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presenter,


The BigChange case study


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For each ‘item’ below choose 1 of:

(a) change of accounting policy; (b) change in accounting

estimate; (c) change in classification; or (d) correction of a

prior period error.

• Reporting imaginary teak planation—asset (fair value) and

income (increase in fair value in each period)

• Management fraudulently inflating their performance

bonuses

• Inadvertently claiming reimbursement of non-refundable

purchase taxes

BigChange—policies v estimates v errors What do you think (1 of 4 slides)


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prior period error.

• Reassessment of building’s useful life following

earthquake

• Change in the rate of income tax to which BigChange is

subject

• Change from accounting for property in accordance with

IAS 40 to IAS 16 when property that was being rented to a

tennant becomes owner occupied

BigChange—policies v estimates v errors. What do you think? (2 of 4 slides)


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For each ‘item’ below choose 1 of: (a) change of accounting policy; (b) change in accounting estimate; (c) change in classification; or (d) correction of a prior period error.

• Change from fair value less costs to sell to the cost model for measuring bearer plants

– (would your answer be different if using the IFRS for SMEs?)

• Change from cost model to fair value model for measuring investment property

– (would your answer be different if using the IFRS for SMEs?)

• Change from cost model to revaluation model for measuring plant (PPE)

BigChange—policies v estimates v errors What do you think (3 of 4 slides)


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prior period error.

• Change formula for assigning cost to inventories from the

FIFO formula to the weighted average cost formula

• Change from classifying dividends received from operating

activities cash flows to investing activity cash flows.

BigChange—policies v estimates v errors What do you think? (4 of 4 slides)


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In accordance with IAS 8 the fraud prior period error

would be corrected in BigChange’s 20x6 financial

statements as follows:

• 20x5 (ie restated comparative figures): ↓profit and loss

36 mill (ie reversing 50 mill fair value income, CU5 mill

bonus expense and 9 mill income tax expense);

• accumulated profits at 01/01/20x5: ↓108 mill (ie 36 mill

x 3 years); and

• 31/12/20x5 (restate comparative figures): ↓200

biological assets (teak plantation), ↑20 receivable

asset and ↓36 deferred tax liability.

BigChange IFRS accounting for the fraud


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In which order must BigChange account for the changes relating to its plant. Choose 1 of: (a) 1st change of accounting policy, 2nd change in

accounting estimate, and 3rd correction of a prior period error;

(b) 1st change in accounting estimate, 2nd change of accounting policy, and 3rd correction of a prior period error; or

(c) 1st correction of a prior period error, 2nd change of accounting policy, and 3rd change in accounting estimate.

Why is only one order correct?

Accounting for changes in policies and estimates and errors


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In BigChange’s 20x6 financial statements: • (1st) correction of prior period error—restated 20x5: ↑1 mill

depreciation expense; ↓4 mill accumulated profits at

01/01/20x5; and at 31/12/20x5 ↑25 mill asset (buildings)

and ↑30 mill liability (refund purchase taxes claim in error).

Retrospective restatement purchase taxes (IAS 8)

• (2nd) change in accounting policy—restated 20x5: ↑65 mill

(↓5 depreciation expense and ↑60 mill fair value); ↑65 mill

accumulated profits at 01/01/20x5; and at 31/12/20x5

↑130 mill asset (land and building).

Retrospective application of fair value model policy (IAS

8)

IFRS financial statements investment property (ignoring tax)


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In BigChange’s 20x6 financial statements: • (1st) correction of prior period error—restated 20x5: ↑1 mill

depreciation expense; ↓4 mill accumulated profits at 01/01/20x5; and at 31/12/20x5 ↑25 mill asset (buildings) and ↑30 mill liability (refund purchase taxes claim in error).

Retrospective restatement purchase taxes (IAS 8)

• (2nd) change in accounting policy (cost to revaluation model)—in early 20x6: ↑130 mill income (present in OCI); and ↑130 mill asset (land and building).

The initial application of a policy to revalue PPE is dealt with as a revaluation rather than retrospective application (see IAS 8¶17).

IFRS financial statements PPE (ignoring tax) (1 of 2 slides)


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In BigChange’s 20x6 financial statements (note

disclosure): • Change in accounting estimate—from 20x7 onwards

depreciation expense will be ↑1.208 mill higher per year

because the remaining estimate of useful life of the factory

building changed from 24 to 20 years due to the presence

of seismic activity in the area

Prospective ‘correction’ for change in accounting

estimate—useful life (IAS 8)

IFRS financial statements PPE (ignoring tax) (2 of 2 slides)


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In BigChange’s 20x7 financial statements: • 20x7: ↑155 mill asset (PPE—land and buildings); and

↓155 mill asset (investment property—land and buildings)

Transfer land and buildings from investment property to

PPE when property is occupied by the owner-entity.

IFRS financial statements IAS 40 to IAS 16 (ignoring tax)


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• If BigChange was also a dealer in property, could it elect, as its

accounting policy, to account for property inventory using the

fair value model?

– If not, could BigChange nevertheless voluntarily disclose the

fair value of such property inventory?

• In a future period, could BigChange revert to the cost model for

its properties (land and buildings) classified as investment

property and as property, plant and equipment?

• Had BigChange’s 31 December 20x5 annual financial

statements been approved for issue on 31 March 20x6 (rather

than on 31 January 20x6), would you answer to any of the

questions above change?

What do you think?


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Thank you


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