As we addressed here, the IASB 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.
As the comment period has recently closed, we’ll take a look at some of the responses. First, to recap, IAS 8 in its current form 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.” It also proposes the following specific clarification:
- 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.
The comment letters will surely have provided more than enough for the IASB to chew on. Pricewaterhousecoopers for example argued that the proposed narrower definition of accounting policies still includes a term with no clear definition – that is, “practices.” PWC goes on:
- The standard could do more to describe the principle(s) behind the distinction between an accounting policy and an accounting estimate. We believe the distinction should be based on the principle that an accounting policy identifies an ‘objective reality’ (a fact, not a matter of opinion) whereas an accounting estimate reflects a ‘subjective reality’ (an uncertain position, capable of conjecture). For example, first-in, first-out (FIFO) cost and weighted average cost are each an objective reality; the selection of, say, FIFO as a method to determine inventory cost is a policy choice but determining the cost on a FIFO basis might involve making subjective estimates.
It’s an interesting way of putting the issue, although I struggle a bit with regarding an accounting policy as being a “fact.” It seems to me more like an intention or proposed methodology, the adequate implementation of which (notwithstanding its possible use of underlying estimates) can be objectively assessed, or something along those lines. Other respondents take no issue with “practices,” but argue for excluding the reference to “measurement bases.” We’ll look at that further another time. For today though, let’s focus on the choice between FIFO and weighted average cost, as a handy illustration of what the IASB has opened up here. Contrary to PWC’s identification of this as a policy choice, BDO sees it this way:
- We do not believe…that the application of FIFO or an average cost formula represents an accounting policy choice. lnstead, we consider that an entity does not have an accounting policy choice for inventory, with inventory being required to be measured at the lower of cost and net realizable value (lAS 2.9)… in our view an entity will apply either FIFO or weighted average cost, selecting the approach that it estimates will best result in it complying with the requirement to measure inventory at the tower of cost and net realizable value.
Many other respondents made the same point in different ways – but without necessarily leading to the same resulting recommendation. FEI Canada seems to agree with BDO on the underlying concept, noting that “In principle, the selection of FIFO or weighted average cost can be viewed as the selection of a method to estimate cost.” The comment letter then pivots though, to say:
- However, we think that the results of accounting for inventory cost formulas as an accounting policy are preferable to accounting for it as an estimate because: a) disclosure in accounting policies (if material) is required; and b) when there is a change between FIFO and weighted average cost, the difference should not be included in current year earnings as it would be for a change in estimate.
That last point seems to be just an assertion with no further argument behind it (that is, if the choice between the two is that of the best method to estimate cost, as stated, then any change in the current year would seem to be a refinement of that method, the effect of which should indeed be recognized in earnings). Apparently aware of this difficulty, FEI thinks this particular issue should be addressed in IAS 2 rather than in IAS 8, to “reduce the likelihood of other measurement choices being viewed as accounting policies by analogy to inventory cost formulas.”
So there you have three positions on the choice between FIFO and average cost: as an accounting policy, as an accounting estimate, and as an accounting estimate that should nevertheless be treated as an accounting policy. I could continue, because other comment letters bring additional nuances to the issue. But would you want the IASB’s new headache to become yours…?
The opinions expressed are solely those of the author