INTRODUCTION

A true picture of an entity's performance only emerges after a series of financial periods' results have been reported and reviewed. The information set out in an entity's financial statements over a period of years must, accordingly, be comparable if it is to be of value to the users of those statements. Users of financial statements may want to identify trends in the entity's financial position, performance and cash flows by studying and analysing the information presented and disclosed in those statements. Thus, it is imperative that, to the maximum extent possible, the same accounting policies be applied from year to year in the preparation of financial statements, and that any necessary departures from this rule be clearly disclosed. This fundamental prerequisite is the basis for the IFRS requirement for restatement of prior periods' financial statements for corrections of accounting errors and retrospective application of new accounting policies.

Financial statements are impacted by the choices made from among different, acceptable accounting principles and methodologies. Companies select those accounting principles and methods which they believe best depict, in their financial statements, the economic reality of their financial position, results of operations and changes in financial position. While the IASB has made great progress in narrowing the range of acceptable alternative accounting for given economic events and transactions (e.g., the elimination of LIFO inventory costing), there still remain choices, which can impair the ability to compare one entity's position and results with another (e.g., first‐in, first‐out (FIFO) versus weighted‐average (WA) inventory costing; or cost versus revaluation basis of accounting for property, plant and equipment and for intangible assets).

Lack of comparability among entities and within a given entity over time can result because of changes in the assumptions and estimates underlying the application of the accounting principles and methods, from changes in the details of acceptable principles made by a promulgating authority, such as an accounting standard‐setting body, and for numerous other reasons. While there is no preventing these various factors from causing changes to occur, it is important that changes be made only when they result in improved financial reporting, or when necessitated by the imposition of new financial reporting requirements. Whatever the reason for introducing change, and hence the risk of non‐comparability, to the financial reporting process, adequate disclosures must be made to achieve transparency in financial reporting so that users of the financial statements are able to comprehend the effects and compensate for them in performing financial analysis.

IAS 8 deals with accounting changes (i.e., changes in accounting estimates and changes in accounting policies) and also addresses the accounting for the correction of errors. A principal objective of IAS 8 is to prescribe accounting treatments and financial statement disclosures which will enhance comparability, both within an entity over successive years and with the financial statements of other entities.

Even though the correction of an error in financial statements issued previously is not considered an accounting change, it is discussed by IAS 8 and is therefore covered in this chapter.

In the preparation of financial statements there is an underlying presumption that an accounting policy, once adopted, should not be changed, but rather be uniformly applied in accounting for events and transactions of a similar type. This consistent application of accounting policies enhances the decision usefulness of the financial statements. The presumption that an entity should not change an accounting policy may be overcome only if the reporting entity can justify the use of an alternative acceptable accounting policy on the basis that it is preferable under the circumstances.

The IASB's Improvements Project resulted in significant changes being made to IAS 8. It now requires retrospective application of voluntary changes in accounting policies and retrospective restatement to correct prior period errors with the earliest reported retained earnings balance being adjusted for any effects of a voluntary change in an accounting policy or of a correction of an error on earlier years. The only exception to this rule occurs when retrospective application or restatement would be impracticable to accomplish, and this has intentionally been made a difficult criterion to satisfy. The revised standard removed the permitted alternative in the previous version of IAS 8 (1) to include in profit or loss for the current period the adjustment resulting from changing an accounting policy or correcting a prior period error, and (2) to present unchanged comparative information from financial statements of prior periods.

The Improvements Project also resulted in some reorganisation of materials in the standards, specifically relocating certain guidance between IAS 1 and IAS 8. As revised, certain presentational issues were moved to IAS 1, while guidance on accounting policies, previously found in IAS 1, was moved to IAS 8. In addition, included in revised IAS 8 is a hierarchy of criteria to be applied in the selection of accounting policies.

As amended, IAS 8 incorporates the material formerly found in SIC 18, Consistency—Alternative Methods, which requires that an entity select and apply its accounting policies for a period consistently for similar transactions, other events and conditions, unless a standard or an interpretation specifically requires or permits categorisation of items for which different policies may be appropriate, in which case an appropriate accounting policy shall be selected and applied consistently to each category. Simply stated, the expectation is that, in the absence of changes in promulgated standards, or changes in the character of the transactions being accounted for, the reporting entity will continue to use accounting policies from one period to the next without change and use them for all transactions and events within a given class or category without exception.

When IFRS are revised or new standards are developed, they are often issued a year or more prior to the date set for mandatory application. Disclosure of future changes in accounting policies must be made when the reporting entity has yet to implement a new standard that has been issued but that has not yet come into effect. In addition, disclosure of the planned date of adoption is now required, along with an estimate of the effect of the change on the entity's financial position, except if making such an estimate would incur undue cost or effort.

SCOPE

IAS 8 is applied in the selection of accounting policies and in accounting for changes in accounting policies, changes in estimates and corrections of prior year errors. This chapter addresses the criteria for selecting and changing accounting policies, together with the accounting treatment and disclosure of changes in accounting policies, changes in accounting estimates and corrections of errors in accordance with IAS 8.

DEFINITIONS OF TERMS

Accounting policies. Specific principles, bases, conventions, rules and practices adopted by an entity in preparing and presenting financial statements. Management is required to adopt accounting policies that result in a fair, full and complete presentation of the financial position, performance and cash flows of the reporting entity.

Change in accounting estimate. An adjustment of the carrying amount of an asset or liability, or related expense, resulting from reassessing the present status of, and expected future benefits and obligations associated with, that asset or liability. Prospective application applies to changes in estimates resulting from new information or new developments (which, therefore, are not corrections of errors). The use of reasonable estimates is an essential part of the financial statement preparation process and does not undermine their reliability.

Change in accounting policy. A change in accounting policy that either (1) is required by an IFRS, or (2) is a change that results in the financial statements providing faithfully represented and more relevant information about the effects of transactions, other events or conditions on the entity's financial position, financial performance or cash flows.

Impracticable. Applying a requirement is impracticable when the entity cannot apply it after making every reasonable effort to do so. For management to assert that it is impracticable to apply a change in an accounting policy retrospectively or to make a retrospective restatement to correct an error, one or more of the following conditions must be present: (1) after making every reasonable effort the effect of the retrospective application or restatement is not determinable; (2) the retrospective application or restatement requires assumptions regarding what management's intent would have been in that period; or (3) the retrospective application or retrospective restatement requires significant estimates of amounts and it is impossible to develop objective information that would have been available at the time the original financial statements for the prior period (or periods) were authorised for issue to provide evidence of circumstances which existed at that time regarding the amounts to be measured, recognised and/or disclosed by retrospective application.

International Financial Reporting Standards (IFRS). Standards and Interpretations adopted by the International Accounting Standards Board (IASB). They comprise International Financial Reporting Standards (IFRS), International Accounting Standards (IAS), and Interpretations developed by the International Financial Reporting Interpretations Committee (IFRIC) or the former Standing Interpretations Committee (SIC).

Material. Omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions that users make on the basis of the financial statements. Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances.

Prior period errors. Omissions from, and misstatements in, the entity's financial statements for one or more prior periods arising from a failure to use, or misuse of, reliable information that (1) was available when financial statements for those periods were authorised for issue, and (2) could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements. Such errors include the effects of mathematical mistakes, mistakes in applying accounting principles, oversight or misuse of available facts, use of unacceptable GAAP and fraud.

Prospective application. The method of reporting a change in accounting policy and of recognising the effect of a change in an accounting estimate, respectively, by: (1) applying the new accounting policy to transactions, other events and conditions occurring after the date as at which the policy is changed, and (2) recognising and disclosing the effect of the change in the accounting estimate in the current and future periods affected by the change.

Retrospective application. Applying a new accounting policy to past transactions, other events and conditions as if that policy has always been applied.

Retrospective restatement. Correcting the recognition, measurement and disclosure of amounts of elements of financial statements as if a prior period error had never occurred.

IMPORTANCE OF COMPARABILITY AND CONSISTENCY IN FINANCIAL REPORTING

Accounting principles—whether various IFRS or national GAAP—have long held that an important objective of financial reporting is to encourage comparability among financial statements produced by essentially similar entities. This is necessary to facilitate informed economic decision making by investors, creditors, regulatory agencies, vendors, customers, prospective employees, joint venturers and others. While full comparability will not be achieved as long as alternative principles of accounting and reporting for like transactions and events remain available, a driving force in developing new accounting standards has been to enhance comparability. The IASB strives to remove alternatives within IFRS.

An important implication of comparability is that users be informed about the accounting policies that were employed in the preparation of the financial statements, any changes in those policies and the effects of such changes. While historically some accountants opposed the focus on comparability, on the grounds that uniformity of accounting removes the element of judgement needed to produce the most faithful representation of an individual entity's financial position and performance, others have expressed concern that overemphasis on comparability might be an impediment to the development of improved accounting methods. Increasingly, however, the paramount importance of comparability is being recognised, to which the ongoing convergence efforts strongly attest.

The Conceptual Framework for Financial Reporting 2018 lists comparability as one of the enhancing qualitative characteristics of accounting information (also included as such characteristics are verifiability, timeliness and understandability), which are complementary to the fundamental qualitative characteristics: relevance and faithful representation. Comparability is explained as follows:

Comparability enables users to identify and understand similarities in, and differences among, items.

In addition, comparability should not be confused with uniformity; for information to be comparable, similar elements must look alike and dissimilar elements must look different. The quality of consistency enhances the decision usefulness of financial statements to users by facilitating analysis and the understanding of comparative accounting data.

Strict adherence to IFRS or any other set of standards obviously helps in achieving comparability, since a common accounting language is employed by all reporting parties. According to IAS 1:

The presentation and classification of items in the financial statements should be retained from one period to the next unless it is apparent that, following a significant change in the nature of the entity's operations or a review of its financial statements, another presentation or classification would be more appropriate with regard to the criteria for the selection and application of accounting policies in IAS 8; or an IFRS requires a change in presentation.

It is, however, inappropriate for an entity to continue accounting for transactions in the same manner if the policies adopted lack the qualitative characteristics of relevance and faithful representation. Thus, if more relevant and/or faithfully representational accounting policy alternatives exist, it is better for the entity to change its methods of accounting for defined classes of transactions with, of course, adequate disclosure of both the nature of the change and of its effects.

ACCOUNTING POLICY

In accordance with IAS 1, the reporting entity's management is responsible for selecting and applying accounting policies which:

1. Present fairly financial position, results of operations and cash flows of an entity, as required by IFRS;
2. Present information in a manner that provides relevant, reliable, comparable and understandable information;
3. Provide additional disclosures where necessary to enable users to understand the impact of particular transactions, other events and conditions on the entity's financial position and performance.

Under IFRS, management is required to disclose, in the notes to the financial statements, a description of all significant accounting policies of the reporting entity. In theory, if only one method of accounting for a type of transaction is acceptable, it is not necessary to cite it explicitly in the accounting policies note, although many entities do routinely identify all accounting policies affecting the major financial statement captions.

The “summary of significant accounting policies” is customarily, but not necessarily, the first note disclosure included in the financial statements.

SELECTING ACCOUNTING POLICIES

IAS 8 has established a hierarchy of accounting guidance for selecting accounting policies in accordance with IFRS. This is comparable to the “hierarchy of GAAP” established under US auditing standards many years ago (which was superseded by guidance in the FASB Accounting Standards Codification) and provides a logical ordering of authority for those instances when competing and possibly conflicting guidance exists. Given the relative paucity of authoritative guidance under IFRS (which is a “principles‐based” standard, vs. “rules‐based” standards found in US GAAP), heavy reliance is placed on reasoning by analogy from the existing standards and from materials found in various non‐authoritative sources.

According to IAS 8, when selecting accounting policies with regard to an item in the financial statements, authoritative sources of such policies are included only in IFRS, comprising International Financial Reporting Standards, International Accounting Standards (IAS) and Interpretations developed by the International Financial Reporting Standards Interpretations Committee (IFRIC) or the former Standing Interpretations Committee (SIC). IFRS also provide guidance to assist management in applying their requirements. Improvements to IFRS, published in May 2008, clarified that only guidance which is an integral part of IFRS is mandatory. Guidance which is not an integral part of IFRS does not provide requirements for financial statements.

When there is not any IFRS standard or Interpretation which specifically applies to an item in the financial statements, transaction, other event or condition, management must use judgement in developing and applying an accounting policy. This should result in information which is both:

1. Relevant to the decision‐making needs of users; and
2. Reliable in the sense that the resulting financial statements:
   1. Will represent faithfully the financial position, performance and cash flows of the entity;
   2. Will reflect the economic substance of transactions, other events and conditions, and not merely their legal form;
   3. Are neutral (i.e., free from bias);
   4. Are prudent; and
   5. Are complete in all material respects.

In making this judgement, management must give consideration to the following sources, listed in descending order of significance:

1. The requirements in IFRS and in Interpretations dealing with similar and related issues; and
2. The definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses set out in the Conceptual Framework.

Note that when developing a policy where IFRS does not provide guidance, IAS 8 also states that an entity may consider the most recent pronouncements of other standard‐setting bodies that use a similar conceptual framework to develop accounting standards, other accounting literature and accepted industry practices, to the extent that these do not conflict with the sources detailed in the preceding paragraph. In practice, this means that many IFRS reporters will look to US GAAP guidance where IFRS does not provide guidance.

CHANGES IN ACCOUNTING POLICIES

A change in an accounting policy means that a reporting entity has exchanged one accounting principle for another. According to IAS 8, the term accounting policy includes the accounting principles, bases, conventions, rules and practices used. For example, a change in inventory costing from “WA” to “FIFO” would be a change in accounting policy. Other examples of accounting policy options in IFRS include cost versus revaluation basis of accounting for property, plant and equipment and for intangible assets (IAS 16, IAS 38); cost versus fair value basis of accounting for investment property (IAS 40); and fair value versus proportionate share of the value of net assets acquired for valuing a non‐controlling interest in business combinations (IFRS 3). Changes in accounting policy are permitted if:

1. The change is required by a standard or an interpretation; or
2. The change will result in a more relevant and reliable presentation of events or transactions in the financial statements of the entity.

IAS 8 does not regard the following as changes in accounting policies:

1. The adoption of an accounting policy for events or transactions that differ in substance from previously occurring events or transactions; and
2. The adoption of a new accounting policy to account for events or transactions that did not occur previously or that were immaterial in prior periods.

The provisions of IAS 8 are not applicable to the initial adoption of a policy to carry assets at revalued amounts, although such adoption is indeed a change in accounting policy. Rather, this is to be dealt with as a revaluation in accordance with IAS 16 or IAS 38, as appropriate under the circumstances.

CHANGES IN ACCOUNTING ESTIMATES

The preparation of financial statements requires frequent use of estimates—for such items as asset service lives, residual values, fair values of financial assets or financial liabilities, likely collectability of accounts receivable, inventory obsolescence, accrual of warranty costs, provision for pension costs and so on. These future conditions and events and their effects cannot be identified with certainty; therefore, changes in estimates will be highly likely to occur as new information and more experience is obtained. IAS 8 requires that changes in estimates be recognised prospectively by including them in profit or loss in:

1. The period of change if the change affects that period only; or
2. The period of change and future periods if the change affects both.

For example, on January 1, 202X, a machine purchased for €10,000 was originally estimated to have a 10‐year useful life and a salvage value of €1,000. On January 1, 202X+5 (five years later), the asset is expected to last another 10 years and have a salvage value of €800. As a result, both the current period (the year ending December 31, 202X+5) and subsequent periods are affected by the change. Annual depreciation expense over the estimated remaining useful life is computed as follows:

The annual depreciation charge over the remaining life would be computed as follows:

An impairment affecting the cost recovery of an asset should not be handled as a change in accounting estimate but instead should be treated as a loss of the period.

In some situations, it may be difficult to distinguish between changes in accounting policy and changes in accounting estimates. For example, a company may change from deferring and amortising a cost to recording it as an expense as incurred because the future benefits of the cost have become doubtful. In this instance, the company is changing its accounting principle (from deferral to immediate recognition) because of its change in the estimate of the future utility of a particular cost incurred currently.

According to IAS 8, when it is difficult to distinguish a change in an accounting policy from a change in an accounting estimate, the change is treated as a change in an accounting estimate.

CORRECTION OF ERRORS

Although good internal control and the exercise of due care should serve to minimise the number of financial reporting errors that occur, these safeguards cannot be expected to eliminate errors in the financial statements completely. As a result, it was necessary for the accounting profession to develop standards which would ensure uniform treatment of accounting for error corrections.

IAS 8 deals with accounting for error corrections. Under earlier versions of the standard, so‐called “fundamental errors” could be accounted for in accordance with either benchmark or allowed alternative approaches to effecting corrections. The IASB's Improvements Project resulted in the elimination of the concept of fundamental errors, and also the elimination of what had formerly been the allowed alternative treatment. Under revised IAS 8, therefore, the only permitted treatment is “retrospective restatement” as a prior period adjustment (subject to an exception when doing so is impracticable, as described below). Prior periods must be restated to report financial position and financial performance as they would have been reported had the error never arisen.

There is a clear distinction between errors and changes in accounting estimates. Estimates by their nature are approximations which may need revision as additional information becomes known. For example, when a gain or loss is ultimately recognised on the outcome of a contingency which previously could not be estimated reliably, this does not constitute the correction of an error and cannot be dealt with by restatement. However, if the estimated amount of the contingency had been miscomputed from data available when the financial statements were prepared, at least some portion of the variance between the accrual and the ultimate outcome might reasonably be deemed an error. An error arises only where information available, which should have been taken into account, was ignored or misinterpreted.

Errors are defined by revised IAS 8 as omissions from and other misstatements of the entity's financial statements for one or more prior periods which are discovered in the current period and relate to reliable information which: (1) was available when those prior period financial statements were prepared, and (2) could reasonably be expected to have been obtained and taken into account in the original preparation and presentation of those financial statements. Errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts and the effects of financial reporting fraud.

IAS 8 specifies that, when correcting an error in prior period financial statements, the term “restatement” is to be used. That term is exclusively reserved for this purpose so as to effectively communicate to users of the financial statements the reason for a particular change in previously issued financial statements.

An entity should correct material prior period errors retrospectively in the first set of financial statements authorised for issue after their discovery by: (1) “restating the comparative amounts for the prior periods presented in which the error occurred, or (2) if the error occurred before the earliest prior period presented (beginning of the preceding period), restating the opening balances of assets, liabilities and equity for the earliest prior period presented.”

Restatement consists of the following steps:

• Step 1—Adjust the carrying amounts of assets and liabilities at the beginning of the first period presented (beginning of the preceding period) in the financial statements for the amount of the correction on periods prior to those presented in the financial statements.
• Step 2—Offset the amount of the adjustment in Step 1 (if any) by adjusting the opening balance of retained earnings (or other components of equity or net assets, as applicable to the reporting entity) for that period.
• Step 3—Adjust the financial statements of each individual prior period presented for the effects of correcting the error on that specific period (referred to as the period‐specific effects of the error).

When restating previously issued financial statements, management is to disclose:

1. The fact that the financial statements have been restated;
2. The nature of the error;
3. The effect of the restatement on each line item in the financial statements; and
4. The cumulative effect of the restatement on retained earnings (or other applicable components of equity or net assets).

These disclosures need not be repeated in subsequent periods.

The correction of an error in the financial statements of a prior period discovered subsequent to their issuance is reported as a prior period adjustment in the financial statements of the subsequent period. In some cases, however, this situation necessitates the recall or withdrawal of the previously issued financial statements and their revision and reissuance.

FUTURE DEVELOPMENTS

The IASB has responded to difficulties entities faced in distinguishing changes in accounting policies from changes in accounting estimates. Such difficulties arose because the previous definition of a change in accounting estimate in IA 8 Accounting Policies, Changes in Accounting Estimates and Errors was not sufficiently clear. Consequential amendments introduce a definition of ‘accounting estimates' and included other amendments to IAS 8 to help entities distinguish changes in accounting policies from changes in accounting estimates. The IASB issued the amendments in 2021, which are effective for annual reporting periods beginning on or after 1 January 2023. Earlier application is permitted.

US GAAP COMPARISON

Under US GAAP, the FASB Accounting Standards Codification (ASC) is the single source of authoritative literature; nevertheless, there is no single standard that addresses accounting policies in US GAAP similar to IAS 8. However, similar to IFRS, accounting policies must be in accordance with existing US GAAP and be applied consistently. Changes in accounting policy must be based on either a change required by an Accounting Standards Update, or a substantive argument that the new policy is superior to the current due to improved representational faithfulness as found in ASC 250, Accounting Changes and Error Corrections (ASC 250).

As noted in ASC 250 errors and changes in accounting policies are applied retrospectively for all the periods presented in a set of financial statements. The effect of errors and changes that occurred prior to the earliest period presented is included in the opening balances of equity for the earliest period presented. The description of the change or error would also be disclosed, and the financial statement line item effected.

ASC 250‐10‐45‐9 states that if it is impracticable to determine the financial effects of changes in accounting principles in prior periods, the effect is presented for the most recent period that is practicable. Reasons why it is impracticable are disclosed. Retrospective application of a new accounting policy, however, includes only direct effects and associated tax effects. Indirect effects (e.g., change in incentive pay accrual as a result of the application) are not included in prior periods, but in the current period, if and when those effects are realised.

Similar to IFRS, policies need not be applied to items that are immaterial. Materiality is defined in US GAAP very similarly to IFRS, which is the inclusion or omission of information from financial statements that would affect the decisions of users. The concept includes changes in the trend of earnings or other measures that otherwise would be considered material. The threshold for materiality for errors for interim financial statements is made on the relevant measure (i.e., income) for the year. However, errors that are material to the quarter must be disclosed.

One significant difference from IFRS is that the FASB Concepts Statements, the equivalent of the IFRS Framework, do not establish accounting standards or disclosure practices for particular items.

Under US GAAP, the accounting policies for subsidiaries do not need to be uniform; however, such variation in accounting policies should be appropriately disclosed in consolidated financial statements.

LIFO inventory is allowed under US GAAP and changes from LIFO to FIFO and FIFO to LIFO are addressed in ASC 250.