The IASB has published for public consultation proposed narrow-scope amendments to IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, open for comment until January 15, 2018.
The purpose of the proposed amendments is to help companies distinguish accounting policies from accounting estimates. The accompanying press release says: “The distinction is important because changes in accounting estimates often affect a company’s profit or loss, but changes in accounting policies generally do not. The Board welcomes feedback on its view that the amendments will make the distinction clearer.” That’s a bit of a vague description of the distinction, because of course, changes in accounting policy generally “affect a company’s profit or loss” in some way (unless they only relate to balance sheet netting or something like that). The key difference is that voluntary changes in accounting policy are usually applied retrospectively, whereas changes in accounting estimates are applied prospectively, thus increasing the relative likelihood of a material non-recurring impact on the current year’s income.
In its current form, IAS 8 defines accounting policies as “the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements.” The IASB proposes narrowing that definition, to refer only to “the specific principles, measurement bases and practices…” The change reflects, among other things, the lack of any clear definition in IFRS for the terms “conventions” and (befitting the famous principles-based nature of the standards) “rules.” Then, the IASB proposes fixing the structural peculiarity by which IAS 8 currently contains a definition of “change in accounting estimate” but lacks one for the underlying concept of “accounting estimate.” The proposed definition of accounting estimates is:
- judgments or assumptions used in applying an accounting policy when, because of estimation uncertainty, an item in financial statements cannot be measured with precision.
This is very significantly clearer than the implied description, such as it is, that falls out of the current definition of a change in accounting estimate. The exposure draft then leads into the following proposed new paragraph:
- When an item cannot be measured with precision, selecting an estimation technique or valuation technique to measure that item involves the use of judgment or assumptions in applying the accounting policy for that item. For this reason, selecting that estimation technique or valuation technique constitutes making an accounting estimate.
The surrounding language that fleshes out these concepts, such as the list of examples in IAS 8.32, is largely unchanged. However, the IASB proposes removing the illustrative example that deals with prospective application of a change in depreciation policy when retrospective application isn’t practicable, concluding that it raises too many questions as currently drafted. It also proposes addressing head-on a frequent source of confusion between policies and estimates (one that I think I remember floating around in my early days of working within Canadian GAAP;
- Selecting one of the two cost formulas prescribed by paragraphs 25–27 of IAS 2 Inventories for ordinarily interchangeable inventories does not involve the use of judgement or assumptions to determine the sequence in which those inventories are sold. For this reason, selecting that cost formula does not constitute making an accounting estimate, it constitutes selecting an accounting policy.
I assume the proposed changes will be generally positively received and ultimately implemented much as proposed. The exposure draft proposes that an issuer should apply the standard from the start of the first annual period beginning on or after whatever date is specified in the final standard, or from the start of an earlier annual period selected by the entity, and should apply it to all changes in accounting policies and all changes in accounting estimates that occur on or after that date.
The exposure draft doesn’t tinker with the other key aspect of IAS 8, relating to accounting errors. In my own experience though (which is largely in the field of regulatory compliance), this has more often been a cause of problems than the distinction between policies and accounting estimates has been. Even in the same week in which the IASB issued the exposure draft, I came across an issuer which presented a particular change as being one in accounting policy, in circumstances which seemed to me to represent the correction of an error (in that IFRS doesn’t allow a policy choice in the area in question). Within the financial statements in which such a change is implemented, the information disclosed about the change may be much the same whether it’s one or the other, although the optics of describing something as an error, and of providing an explanation for how it arose, are likely to be undesirable. Identifying something as an error correction may carry broader consequences in some jurisdictions though, including the necessity of refiling amended versions of the previously-filed statements now identified as having been erroneous, and perhaps increasing the likelihood of additional regulatory scrutiny.
Anyway, that’s not so much a problem with interpreting the standard, more one of excessive pragmatism, but I expect it will continue to be one of the main (albeit not too common) IAS 8-related headaches…
The opinions expressed are solely those of the author