Question

Question One IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors is applied in selecting and applying accounting policies, accounting for changes in estimates and reflecting corrections of prior period errors. Required: a) Explain the basis on which the management of an entity must select its accounting policies and (02 marks) b) Distinguish, with an example, between changes in accounting policies and changes in accounting estimates. (03 marks)

Answer 1

Answer 1

The basis of selection of accounting policies by the management are;-

a. Prudence

In view of the uncertainty attached to future events, profits are not anticipated but recognised only when realised though not necessarily in cash. Provision is made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information.

b. Substance over Form

The accounting treatment and presentation in financial statements of transactions and events should be governed by their substance and not merely by the legal form.

c. Materiality

Financial statements should disclose all “material” items, i.e. items the knowledge of which might influence the decisions of the user of the financial statements

Answer 2

• A change in accounting principle is a change in how financial information is calculated, while a change in accounting estimate is a change in the actual financial information.
• Changes in accounting principles can include inventory valuation or revenue recognition changes, while estimate changes are related to depreciation or bad-debt allowances.
• Principle changes are done retroactively, where financial statements have to be restated, while estimate changes are not applied retroactively.

For example  commonly changed estimates include bad-debt allowance, warranty liability, and depreciation while example of change in accounting policy is a change in inventory valuation; for example, a company might switch from a first in, first out (FIFO) method to a specific-identification method. According to the FASB, an entity should only change an accounting principle when it is justifiably preferable to an existing method or when it is a necessary reaction to a change in the accounting framework.