IAS 8 and IAS 2

IAS8
Learning Outcomes
• Distinguish between an accounting policy and change in accounting estimate
• Describe how IAS 8 applies the principles of comparability where an entity changes
its accounting policies.
• Account for a change in accounting policy and change in estimate.
• Recognize and account for a prior period adjustment.
• IAS 8 shall be applied in selecting and applying accounting policies, and accounting
for changes in policies, changes in accounting estimates and corrections of prior
period errors. Accounting policies: They are the principles, bases, conventions,
rules and practices applied by an entity which specify how the effects of transactions
and other events are reflected in the Financial Statements. IAS 8 requires an entity
to select and apply appropriate accounting policies complying with IFRS.
Interpretations should ensure that the financial statements are relevant to the
decision-making needs of users and reliable (faithful representation, prudent and
complete)
• A change in accounting estimate: is an amendment 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.
• Prior Period Errors: These are omissions and misstatements in the financial
statements for one or more previous periods arising from failure to use or misuse of
reliable information that was available for use while financial statements for those
periods were authorized. Such errors include the effects of mathematical mistakes,
mistakes in applying accounting policies, misunderstandings or misinterpretations of
facts, and fraud.
• Retrospective application: is applying a new accounting policy to transactions,
other events and conditions as if that policy had always been applied.
• Retrospective restatement: is the correction of recognition, measurement and
disclosure of amounts of elements of financial statements as if a prior period error
had never occurred.
The general rule is that accounting policies are normally kept the same from period to
period to ensure comparability of financial statements.
Accounting policies should change if and only if a change is:
1. Required by IFRS
2. Required by statute
3. Will result in a more reliable and more relevant presentation of events or transactions.
Types of Events that do not constitute change in accounting policies as per IAS8.
1. Adopting an accounting policy for a new type of transaction or event not dealt with
previously by the entity.
2. Adopting a new accounting policy for a transaction or event which has not occurred
in the past or which was not material
Change in Accounting Policy
The required accounting treatment is that the change should be applied
retrospectively with an adjustment to the opening balance of retained earnings in the
statement of changes in equity. Note: Retrospective application means applying a
new accounting policy to transactions, other events and conditions as if that policy
had always been applied.
• If it is not possible to reasonably determine the change should be adjusted
prospectively i.e. applying the accounting policy to transactions, other events and
conditions occurring after the date as at which the policy is changed.
Accounting Estimates:
• An accounting estimate is a method adopted by an entity to arrive at the estimated
amounts for financial statements. Most figures in the financial statements require
some estimation such as exercise of judgement based on the latest information
available. These estimates are subject to change due to new developments and
availability of new information.
Changes in Accounting Estimates
• The requirements of IAS 8 are that the effects of a change should be included in
Statement of profit or loss and in subsequent periods. The effects of a change should
be included in the same income or expense classification as was used for the original
estimate. If the effect is material, its nature and amount must be disclosed.
Examples of changes in Accounting Policy
• The useful lives of non-current assets
• The residual values of non-current assets
• The method of depreciating non-current assets
• Warranty provisions based upon more up-to-date information about the claims
frequency.
Estimation techniques implement the measurement aspects of accounting policies
Prior Period Errors
• Prior period errors are omissions from, and misstatements in the financial statements
for one or more prior periods. These could arise from a failure to use information that
was available when financial statements for those periods were authorized for issue.
These omissions and misstatements were reasonably expected to have taken into
account in preparing these financial statements. Disclosing within the accounts a
statement of financial position at the earliest comparative period. This means that
 three statements of financial position will be presented within a set of financial
statements i.e. at end of current year and end of previous one and finally also at the
beginning of the current year.
IAS2
The objective of IAS 2 is to prescribe the accounting treatment for inventories. It
provides guidance for determining the cost of inventories and for subsequently recognizing
an expense, including any write-down to net realizable value. It also provides guidance on
the cost formulas that are used to assign costs to inventories.
Inventories are assets: Held for sale in the ordinary course of business (Finished goods) as
well as assets In the process of production for such sale (Work in Progress) and assets In
the form of materials or supplies to be consumed in the production process or in the
rendering of services (Raw Materials).
 Inventories include :
• Assets held for sale in the ordinary course of business (finished goods),
• Assets in the production process for sale in the ordinary course of business (work in
process), and
• Materials and supplies that are consumed in production (raw materials). [IAS 2.6]
 However, IAS 2 excludes certain inventories from its scope:
• Work in process arising under construction contracts (see IAS 11 Construction
Contracts)
• Financial instruments (see IAS 39 Financial Instruments: Recognition and
Measurement)
• Biological assets related to agricultural activity and agricultural produce at the point of
harvest (see IAS 41 Agriculture).
• Also, while the following are within the scope of the standard, IAS 2 does not apply to
the measurement of inventories held by: [IAS 2.3]
Valuation of Inventories:
IAS 2 states that Inventories are required to be stated at the lower of:
• Cost: Consists of purchase costs (including taxes, transport, and handling) net of
trade discounts received and conversion costs (Internal costs incurred in bringing the
inventory in the current stage, these can be direct costs such as labor and expenses)
and other costs incurred in bringing inventories to their present location and condition
• Net Realizable Value: Is the estimated selling price of the item minus all estimated
costs to make inventory ready for sale and all estimated costs necessary to make
sale
Measurement:
The standard lists types of costs which would not be included in cost of inventories.
Instead, they should be recognised as expenses in the period they are incurred. These are
as follows:
 Abnormal waste: Abnormal amounts of wasted materials, labour or other production
costs stage)
 Storage costs: Except storage costs which are necessary in the production
process before a further production
 Administrative overheads: Unrelated to production and not incurred to bring
inventories to their present location and conditions
 Foreign exchange differences arising directly on the recent acquisition of inventories
invoiced in a foreign currency
 Interest cost when inventories are purchased with delayed settlement terms.
 For inventory items that are not interchangeable, specific costs are attributed to the
specific individual items of inventory. [IAS 2.23]
 For items that are interchangeable, IAS 2 allows the FIFO or weighted average cost
formulas. [IAS 2.25] The LIFO formula, which had been allowed prior to the 2003
revision of IAS 2, is no longer allowed.
 The same cost formula should be used for all inventories with similar characteristics
as to their nature and use to the entity. For groups of inventories that have different
characteristics, different cost formulas may be justified. [IAS 2.25]
 Write-down to net realizable value
 NRV is the estimated selling price in the ordinary course of business, less the
estimated cost of completion and the estimated costs necessary to make the sale.
[IAS 2.6] Any write-down to NRV should be recognized as an expense in the period
in which the write-down occurs. Any reversal should be recognized in the income
statement in the period in which the reversal occurs. [IAS 2.34]
 Expense recognition
 IAS 18 Revenue addresses revenue recognition for the sale of goods. When
inventories are sold and revenue is recognized, the carrying amount of those
inventories is recognized as an expense (often called cost-of-goods-sold). Any
write-down to NRV and any inventory losses are also recognized as an expense
when they occur. [IAS 2.34]
Disclosure measurement:
 Accounting policy for inventories
 Carrying amount, generally classified as merchandise, supplies, materials, work in
progress, and finished goods. The classifications depend on what is appropriate for
the entity
 Carrying amount of any inventories carried at fair value less costs to sell
 Amount of any write-down of inventories recognized as an expense in the period
 Amount of any reversal of a write-down to NRV and the circumstances that led to
such reversal
 Carrying amount of inventories promised as security for liabilities
 Cost of inventories recognized as expense (cost of goods sold).
 IAS 2 acknowledges that some enterprises classify income statement expenses by
nature (materials, labour, and so on) rather than by function (cost of goods sold,
selling expense, and so on). Accordingly,
 As an alternative to disclosing cost of goods sold expense, IAS 2 allows an entity to
disclose operating costs recognized during the period by nature of the cost (raw
materials and consumables, labor costs, other operating costs) and the amount of
the net change in inventories for the period). [IAS 2.39] This is consistent with IAS 1
Presentation of Financial Statements, which allows presentation of expenses by
function or nature
Summary:
 Cost formula
(1) LIFO (Last-in, First-out) is not allowed.
(2) FIFO (First-in, First-out) is allowed.
(3) Weighted average method is allowed.
 Inventories are measured at the lower of (1) and (2)
(1) Cost
(2) Net realizable value
 Cost of inventories
(1) Costs of purchase: The cost of an item less any trade discount plus import
duties, travelling costs and other handling costs.
(2) Costs of conversion: Internal costs incurred in getting the inventory into the
current state, such as internal costs incurred during the production of finished
goods. They include both direct costs such as (labor and expenses) and share of
production overheads, where production overhead absorption are based on
normal levels of activity
(2) Other costs incurred in bringing the inventories to the current location and
condition
(3) Costs not included in the cost of inventories
(1) abnormal waste
(2) storage costs
(3) administrative overheads
(4) selling costs