IAS 8: Policies, estimates and errors
Telling a change of policy from a change of estimate or an error, and whether to fix it looking back or looking forward.
ACCA exams this helps with: FR Financial Reporting SBR Strategic Business Reporting See the ACCA map
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What it is: IAS 8 tells you what to do when something about the accounts changes: the rules the company follows, its estimates, or a mistake found in an earlier year.
The key idea: changes of policy and errors are fixed looking back (restate last year’s figures). Changes of estimate are fixed looking forward (only this year and later).
Example. A machine was expected to last 10 years, but now looks like it will last 8. That’s a new estimate, so depreciation changes from this year on. Last year’s accounts are not changed.
Key words
- Accounting policy
- The rules and methods a company uses to prepare its accounts.Example: Valuing inventory using FIFO, or measuring property using the cost model.
- Accounting estimate
- A figure that needs judgement because the true amount isn’t known yet.Example: Useful lives of assets, allowances for bad debts, warranty provisions.
- Retrospective
- Applied as if the new treatment had always been used: last year’s figures and opening retained earnings are restated.Example: A policy change from FIFO to weighted average is shown in the comparatives too.
- Prospective
- Applied only from now on. Past figures are left alone.Example: A change in useful life affects this year’s and future depreciation only.
- Prior period error
- A mistake in earlier accounts, such as a miscount, a misapplied policy or fraud.Example: Last year’s closing inventory was counted twice.
Learn
IAS 8 covers three kinds of change. The treatment depends on which one it is.
| What changed | Examples | Treatment |
|---|---|---|
| Accounting policy | Change of inventory cost formula; a new IFRS applied for the first time | Retrospective: restate comparatives and opening retained earnings |
| Accounting estimate | Useful life, residual value, depreciation method, bad debt allowance | Prospective: this year and future years only |
| Prior period error | Arithmetic mistakes, misapplied policies, oversights, fraud | Retrospective: restate as if the error had never happened |
When can a company change a policy?
Only if a new or amended standard requires it, or if the new policy gives more reliable and relevant information. Companies can’t switch policies just to improve their profit.
Policy or estimate?
If you can’t tell, treat it as a change in estimate. A change in depreciation method (for example straight line to reducing balance) is a change in estimate, because it reflects a new view of how the asset is used up.
How to correct a prior period error
- Restate the comparative figures for the earlier year as if the error had never happened.
- If the error is from before the earliest year shown, adjust opening retained earnings.
- Disclose the nature of the error and the amount of each correction.
More from the workshop
- No standard applies? Management uses judgement, looking first at standards on similar issues, then at the Conceptual Framework, and may also consider other standard-setters with a similar framework and industry practice.
- Not a change of policy: applying a policy to a kind of transaction that didn’t happen before, or was immaterial.
- Consistency: use the same policy for similar items, unless a standard allows different policies for different categories.
- Impracticable? If you can’t work out the effect on earlier years, apply the change (or correct the error) from the earliest period you can, which may be the current period.
Watch it explained
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Videos from YouTube tutors
These videos are made by independent tutors on YouTube, not by Trial Balance. Some use US terms or older exam names (for example F7 for FR), but the principles are the same.
Worked example
A machine cost £100,000 and was depreciated straight line over 10 years with no residual value. At the start of year 5, the company decides its total useful life will be 8 years, not 10.
| Working | £ |
|---|---|
| Cost | 100,000 |
| Depreciation for years 1–4 (4 × 10,000) | (40,000) |
| Carrying amount at the start of year 5 | 60,000 |
| Remaining life: 8 − 4 = 4 years | |
| New annual depreciation: 60,000 ÷ 4 | 15,000 |
This is a change in estimate, so it is prospective: years 5 to 8 are charged £15,000 each. Years 1 to 4 are not restated.
Workshop example: Beta Co (correcting an error)
In 20X2 Beta Co finds that goods sold in 20X1 were wrongly included in closing inventory at 31 December 20X1 at 6,500. Tax rate 30%. Share capital 5,000; retained earnings at 31 December 20X0 were 20,000. Before correction, 20X1 showed sales 73,500, cost of sales 53,500, tax 6,000; 20X2 shows sales 104,000, cost of sales 86,500 (including the 6,500 from the wrong opening inventory) and tax 5,250.
| Restated | 20X2 | 20X1 |
|---|---|---|
| Sales | 104,000 | 73,500 |
| Cost of goods sold | (80,000) | (60,000) |
| Profit before tax | 24,000 | 13,500 |
| Income tax | (7,200) | (4,050) |
| Profit | 16,800 | 9,450 |
| Statement of changes in equity | Share capital | Retained earnings | Total |
|---|---|---|---|
| 31 December 20X0 | 5,000 | 20,000 | 25,000 |
| Profit 20X1 (restated) | — | 9,450 | 9,450 |
| 31 December 20X1 | 5,000 | 29,450 | 34,450 |
| Profit 20X2 | — | 16,800 | 16,800 |
| 31 December 20X2 | 5,000 | 46,250 | 51,250 |
Effect on 20X1: cost of sales up 6,500; tax down 1,950; profit down 4,550; inventory down 6,500; tax payable down 1,950; equity down 4,550. In 20X2 the 6,500 is removed from cost of sales, because it belonged to 20X1.
Practice questions
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