ZeePedia buy college essays online


Advanced Financial Accounting

<<< Previous ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS 1 Next >>>
 
img
Advance Financial Accounting (FIN-611)
VU
LESSON # 29
IAS 8
ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND
ERRORS
This standard shall be applied in selecting and applying accounting policies, and
accounting for changes in accounting policies, changes in accounting estimates and
corrections of prior period errors.
DEFINITIONS:
The following terms are used in this standard with the meanings specified:
Accounting policies:
These are the specific principles, bases, conventions, rules and practices applied by an
entity in preparing and presenting financial statements.
Change in accounting estimate:
It is an adjustment of the carrying amount of an asset or a liability, or the amount of
the periodic consumption of an asset, that results from the assessment of the present
status of, and expected future benefits and obligations associated with, assets and
liabilities. Changes in accounting estimates result from new information or new
developments and, accordingly, are not corrections of errors.
Example-1:
English Limited acquired an asset. The company estimates its useful life 5 years i.e.
future economic benefits shall be drawn from the asset in next 5 years.
This is an accounting estimate.
After 2 years, the company estimates its remaining useful life 4 years. There is a
change in total useful life of the asset in third year.
This change is a change in accounting estimate.
Material:
a) Omissions or misstatements of items are material if they could, individually or
collectively; influence the economic decisions of users taken on the basis of the
financial statements.
b) Materiality depends on the size and nature of the omission or misstatement
judged in the surroundings circumstances.
151
img
Advance Financial Accounting (FIN-611)
VU
c) The size or nature of the item, or a combination of both, could be the
determining factor.
d)
Example-2:
Ihsan Sports Private Limited is in the course of finalizing its financial statement for the
year ended 30th June. 2004.
The following information is available from draft financial statements: -
Sales Rs. 200,000,000
Gross profit Rs. 50,000,000
Net profit
Rs. 20,000,000
a) Sales made during the month of June are omitted from above records
amounting to Rs. 10,000,000.
b) Purchase of stationery on 30th June amounting to Rs. 5,000 is also omitted from
above records.
Required: Which items are materials with respect to the above drafts of financial
statements?
Solution:
Sale omitted are 5% of total sales recorded, while stationery purchased is
0.0025%
Sales omitted are 50% of net profit while stationery purchased is 0.025%.
So, sales omitted are material, which could influence the economic decisions of users.
But stationery is not a material because the amount is immaterial with respect to sales
and net profit.
Prior period errors:
These are omissions from, and misstatements in, the entity's financial statements for
one or more prior periods arising from a failure to use, or misuse of, reliable
information that was available when financial statements for those periods were
authorized for issue; and could reasonably be expected to have been obtained and
taken into account in the preparation and presentation of those financial statements.
Such errors include the effects of:-
a)
Mathematical mistakes;
b)
Mistakes in applying accounting policies;
c)
Oversights; or
d)
Misinterpretations of facts; and
e)
Fraud
152
img
Advance Financial Accounting (FIN-611)
VU
Retrospective application:
This application is applying a new accounting policy to transactions, other events and
conditions as if that policy had always been applied i.e. effect of change in accounting
policy regarding previous period is to be calculated.
Retrospective restatements:
Retrospective restatements is correcting the recognitions, measurement and disclosure
of amounts of elements of financial statements as if a prior period error had never
occurred i.e. correction of error is to be made by restating the previous income
statement and opening balance of previous periods' retained earnings.
Prospective application:
It is change in accounting policy and of recognizing the effect of a change in an
accounting estimate, respectively, is:
a) Applying the new accounting policy to transactions, other events and
conditions occurring after the date as at which the policy is changed; and
b) Recognizing the effect of change in the accounting estimates in the current and
future periods affected by the change.
ACCOUNTING POLICIES:
Selection and Application of Accounting Policies:
When a Standard or an Interpretation specifically applies to a transaction, other event
or condition, the accounting policy or policies applied to that item shall be determined
by applying the Standard or Interpretation and considering any relevant
Implementation Guidance issued by the IASB for the standard or interpretation.
In the absence of a Standard or an Interpretation that specifically applies to a
transaction, other event or condition, management shall use its judgment in
developing and applying an accounting policy that results in information that is:
a) Relevant to the economic decision-making needs of users; and
b) Reliable i.e. the financial statements:
i.
Represent faithfully the financial position, financial performance and
cash flows of the entity. Reflect the economic substance of transactions,
other events and conditions, and not merely the legal form;
ii.
Are neutral, i.e. free from bias;
iii.
Are prudent; and
iv.
Are complete in all material respect.
153
img
Advance Financial Accounting (FIN-611)
VU
Accounting policies are selected and applied in accordance with a particular standard
e.g. FIFO or Weighted Average for inventory measurement. If there is no specific
policy in the standard, interpretation or any guidance issue by IASB, the policy
selected should fulfill the requirements given in the above paragraph.
In making the judgment described in above paragraph, the management shall refer to,
and consider the applicability of, the following sources in descending order:
a) The requirements and guidance in Standards and Interpretations dealing with
similar and related issues; and
b) The definitions, recognition criteria and measurement concepts for assets;
liabilities, income and expenses in the Framework.
Consistency of Accounting Policies:
a) An entity shall select and apply its accounting policies consistently for similar
transactions, other events and conditions, unless a Standard or an Interpretation
specifically requires or permits categorization of items for which different
policies may be appropriate.
b) If a Standard or an Interpretation requires or permits such categorization, an
appropriate accounting policy shall be selected and applied consistently to each
category.
CHANGES IN ACCOUNTING POLICIES:
An entity shall change an accounting policy only if the change:
a) Is required by Standard or an Interpretation; or
b) Result in the financial statements providing reliable and more relevant
information.
Example-4:
i.
Lasani Private Limited have been following LIFO (an allowed alternative
treatment of previous IAS-2) for Inventory measurement. Now the entity is
required to adopt FIFO or weighed Average method for Inventory
measurement (as per the revised IAS-2).
This is a change in accounting policy required by standard.
ii.
Pak Limited has been recognizing revenue on dispatch of goods to customers.
The company has now decided to recognize revenue on approval of goods by
the customer. This change was due to unreliable courier service. The products
delivered were not received in good condition by the customers and the
company used to take back these damaged goods.
154
img
Advance Financial Accounting (FIN-611)
VU
This is a change in accounting policy, which provides more reliable and relevant information
about the effects of the transactions.
The following are not considered as changes in accounting policies:-
a) The application of an accounting policy for transactions, other events or
conditions that differ in substance from those previously occurring; e.g. loans
were used for qualifying assets first time in current year. Previously loans were
used for purchase of vehicles and furniture etc.
b) The application of a new accounting policy for transactions; other events or
conditions that did not occur previously or were immaterial e.g. policy for
borrowing costs, loan taken in current year first time.
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 this Standard.
APPLYING CHANGES IN ACCOUNTING POLICES:
a) An entity shall account for a change in accounting policy, if the change is
required by a standard, as per transitional provision, if any, given in the
Standard.
b) An entity shall account for a change in accounting policy retrospectively if:
i.
The change is required by a Standard and where no specific transitional
provision given in Standard, or
ii.
Change in accounting policy is voluntary.
Retrospective application:
When a change in accounting policy is applied retrospectively, the entity shall adjust.
a) The opening balance of each affected component of equity for the earliest prior
period presented; and
b) The other comparative amounts disclosed for each prior period presented as if
the new accounting policy had always been applied.
Example-5:
During 2004, Aslam Engineering Ltd changed its accounting policy for the treatment
of borrowing costs that are directly attributable to the construction of commercial
building to serve as their head office power station. In previous periods, Aslam
Engineering Ltd had capitalized such costs. Aslam Engineering Ltd has now decided
to treat these costs as an expense, rather than capitalize them. Management judges that
the new policy is preferable because it results in a more transparent treatment of
155
img
Advance Financial Accounting (FIN-611)
VU
finance costs and is consistent with local industry practice, making Aslam Engineering
Ltd financial statements more comparable.
Aslam Engineering Ltd capitalized borrowing costs incurred of Rs. 2,600 during 2003
and Rs. 5,200 in periods before 2003. All borrowing costs incurred in previous years in
respect of the building under construction were capitalized.
Aslam Engineering Ltd accounting records for 2004 show profit before interest and
income taxes of Rs. 30,000, interest expense of Rs. 3,000 (which relates only to 2004);
and income taxes of Rs. 8,100.
Aslam Engineering Ltd has not yet recognized any depreciation on the building under
construction because it is not yet in use. In 2003, Aslam Engineering Ltd reported:
Rs.
Profit before interest and income taxes
18,000
Interest expense
-
Profit before income taxes
18,000
Income taxes
(5,400)
Profit
12,600
2003 opening retained earnings was Rs. 20,000.and closing retained earnings was
Rs.32, 600
Aslam Engineering Ltd tax rate was 30 percent for 2004, 2003 and prior periods.
Aslam Engineering Ltd had Rs. 10,000 of share capital throughout, and no other
components of equity except for retained earnings.
Solution:
Aslam Engineering Ltd
Extract from the Income Statement
(Restated)
2004
2003
Rs.
Rs.
Profit before interest and income taxes
30,000
18,000
Interest expense
(3,000)
(2,600)
Profit before income tax
27,000
15,400
Income tax
(8,100)
(4,620)
Profit
18,900
10,780
Aslam Engineering Limited
Statement of Retained Earnings
(Restated)
Retained
Earnings
Rs.
Balance at 31 December 2002
20,000
156
img
Advance Financial Accounting (FIN-611)
VU
Effect of change in accounting policy (Note)
(3,640)
Balance at 31 December 2002 (restated)
16,360
Profit for the year ended 31 December 2003 (restated)
10,780
Balance at 31 December 2003
27,140
Profit for the year ended 31 December 2004
18,900
Balance at 31 December 2004
46,040
Note:
Effect of change in accounting policy is the de-capitalization of interest (net of income
taxes of Rs. 1,560).
Example-6:
Servis Shoes Limited has prepared the following information for the year ended 31
March 2005.
Profit & Loss Account
2005
2004
Rs
Rs.
Sales
75,000
72,750
Cost of sales
(50,000)
(48,500)
Gross profit (1/3 of sales)
25,000
24,250
Operating expenses
(7,500)
(7,750)
17,500
16,500
(4,950)
Income tax @ 30%
(5,250)
Net Profit
12,250
11,550
Statement of Retained Earnings
2005
2004
Rs.
Rs.
Balance as at opening date
11,000
7,500
Profit for the year
12,250
11,550
23,250
19,050
Dividend
10,250
(8,050)
11,000
Balance as at closing date
13,000
The company used to account for revenue on dispatch of goods. The company
observes that the sales returns are increasing year by year. Due to a dishonest
employee, quantity received by customers was often less than quantity dispatched.
157
img
Advance Financial Accounting (FIN-611)
VU
Along-with administrative action the company also changed its policy for recognition
of revenue and decided to account for revenue after receiving acknowledgment from
customer.
Relevant amounts for the previous years; since the changed policy was adopted is Rs.
9,000 decrease in sales, resulting in a decrease of Rs. 3,000 in profit before tax.
For the current year 2005, goods dispatched by the company amounted to Rs. 1,500
which were acknowledged in next period, are included in profit & loss account
already prepared. For previous year 2004, this amount was Rs. 1,000.
Required: Account for the above change in Accounting policy.
Solution:
Service Shoes Limited
Profit & Loss Account
For the year ended 31 March 2005
(Restated)
2005
2004
Rs.
Rs.
Sales (W-1)
74,500
71,750
Cost of sales - Balancing figure
(49,667)
(47,833)
Gross profit (1/3 of sales)
24,833
23,917
Operating expenses
(7,500)
(7,750)
17,333
16,167
Income Tax @ 30%
(5,200)
(4,850)
Net profit
12,133
11,317
Service Shoes Limited
Statement of Retained Earnings (Extract)
For the year ended 31 March
(Restated)
Rs.
Balance as at 31.3.2003 (W-2)
5,400
Profit for the year 2004 (restated)
11,317
16,717
Dividend
(8,050)
Balance as at 31.3.2004
8,667
Profit for the year 2005
12,133
20,800
Dividend
(10,250)
Balance as at 31.3.2005
10,550
158
img
Advance Financial Accounting (FIN-611)
VU
Workings:
(W-1) Adjusted sales for:
2005
2004
Rs.
Rs.
Sales before change in Accounting policy
75,000
72,750
(Decrease) in sales
(1,500)
(1,000)
-
Increase in sales
1,000
Adjusted sales
74,500
71,750
(W-2) Adjustment in opening retained profits as on 31.3.2003
7,500
Profit before tax
3,000
Income Tax effect 30%
(900)
(2,100)
5,400
If retrospective application is impracticable then change in accounting policy will be
applied prospectively from the year when it is practicable to change.
159
Table of Contents:
  1. ACCOUNTING FOR INCOMPLETE RECORDS
  2. PRACTICING ACCOUNTING FOR INCOMPLETE RECORDS
  3. CONVERSION OF SINGLE ENTRY IN DOUBLE ENTRY ACCOUNTING SYSTEM
  4. SINGLE ENTRY CALCULATION OF MISSING INFORMATION
  5. SINGLE ENTRY CALCULATION OF MARKUP AND MARGIN
  6. ACCOUNTING SYSTEM IN NON-PROFIT ORGANIZATIONS
  7. NON-PROFIT ORGANIZATIONS
  8. PREPARATION OF FINANCIAL STATEMENTS OF NON-PROFIT ORGANIZATIONS FROM INCOMPLETE RECORDS
  9. DEPARTMENTAL ACCOUNTS 1
  10. DEPARTMENTAL ACCOUNTS 2
  11. BRANCH ACCOUNTING SYSTEMS
  12. BRANCH ACCOUNTING
  13. BRANCH ACCOUNTING - STOCK AND DEBTOR SYSTEM
  14. STOCK AND DEBTORS SYSTEM
  15. INDEPENDENT BRANCH
  16. BRANCH ACCOUNTING 1
  17. BRANCH ACCOUNTING 2
  18. ESSENTIALS OF PARTNERSHIP
  19. Partnership Accounts Changes in partnership firm
  20. COMPANY ACCOUNTS 1
  21. COMPANY ACCOUNTS 2
  22. Problems Solving
  23. COMPANY ACCOUNTS
  24. RETURNS ON FINANCIAL SOURCES
  25. IASBíS FRAMEWORK
  26. ELEMENTS OF FINANCIAL STATEMENTS
  27. EVENTS AFTER THE BALANCE SHEET DATE
  28. PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS
  29. ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS 1
  30. ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS 2
  31. BORROWING COST
  32. EXCESS OF THE CARRYING AMOUNT OF THE QUALIFYING ASSET OVER RECOVERABLE AMOUNT
  33. EARNINGS PER SHARE
  34. Earnings per Share
  35. DILUTED EARNINGS PER SHARE
  36. GROUP ACCOUNTS
  37. Pre-acquisition Reserves
  38. GROUP ACCOUNTS: Minority Interest
  39. GROUP ACCOUNTS: Inter Company Trading (P to S)
  40. GROUP ACCOUNTS: Fair Value Adjustments
  41. GROUP ACCOUNTS: Pre-acquistion Profits, Dividends
  42. GROUP ACCOUNTS: Profit & Loss
  43. GROUP ACCOUNTS: Minority Interest, Inter Co.
  44. GROUP ACCOUNTS: Inter Co. Trading (when there is unrealized profit)
  45. Comprehensive Workings in Group Accounts Consolidated Balance Sheet