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Accounting policy (definition in IAS 8)

Apart from accounting policies, IAS 8 is devoted to errors and accounting estimates

For example, interim report of Infosys Ltd (form 10-K) is 214 pages long

7 pages (124-131) are focused on accounting policy 2

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Determines the way of how the assets, liabilities, equity, income and expenses have to be:

measured

recognized

presented

in accordance with the choice made by a company

E.g. machinery in ACME company have to be depreciated in accordance with the straight-line method, residual value is assumed to be equal to 10 % of their costs and those costs are capitalized into the cost of the production 4

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Impact of respective method of depreciation on net income

Year Residual

value Capitalized / Expensed

Straight-line

SYD SYD

1 10% C 0 0 0

1 10% E -18 000 -6 000 -30 000

1 20% C 0 0 0

1 20% E -16 000 -5 333 -26 667

Total cost: 100 000 Estimated life: 5

If only one way of measurement, recognition and / or presentation would have been possible, there wouldn´t been any need for disclosure of accounting policy in financial statements (i.e. in notes)

However, there are many instances, in which the IFRS allows alternative accounting policies, e.g.:

various methods of depreciation (amortization) are permitted; e.g. IAS 16 states:

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there are various methods of presentation of interests and dividends permitted in accordance with IAS 7.31-33:

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government grant provided for the acquisition of assets could recognized in accordance with IAS 20.24

if the cost of asset has been 200, grant has been provided at 120 and useful life of the asset are 5 years, then

a) asset shall be recognized at 80 only; dep. charge is 16

b) asset shall be recognized at 200, and liability (deffered income, measured at 120), should be recognized through profit or loss during the expected life of the asset; depreciation charge is 40 (=200 / 5), income is recognized at 24 (=120 / 5); net impact on profit or loss is thus 16

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interest in companies are accounted for in accordance with the to amount of such share:

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> 50%; controll (IAS 27)

(20 % - 50 %);

significant influence (IAS 28)

50 % ≤ IAS 39

interest of up to 20% of outstanding shares of any company could be (in accordance with IAS 39) recognized as follows:

a) securities held for trading; in this case any change in fair value is recognized through profit or loss

b) securities available for sale; in this case any change in fair value is recognized through equity , unless there is a severe and long-term impairment

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buildings which are held for renting purposes are after its initial measurement measured in accordance with IAS 40 either at:

a) costs, adjusted by accumulated depreciation and impairment charges (only such adjustment have a certain impact on profit or loss)

b) at fair value, any change of fair value is recognized through profit or loss

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In preparing financial statements, management should apply its judgment in various cases, e.g.:

what is the level of risk (required for determination of provisions)

materiality of respective items to be presentd in financial statements (e. g. whether they should be presented as a separate line items)

amount of cash-flows to be derived from the assets during its economic life (e. g. in accordance with IAS 36)

whether the rules of IFRS have to be applied before its effective dates 12

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There are accounting policy and accounting estimates

Both of them are related to the application of the judgment of a management

Accounting policy determines general rule (e.g which method of the depreciation shall be applied)

Accounting estimates specify parameters (e.g. what is the useful life of the depreciable asset)

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Accounting policy shall be amended only in following cases (IAS 8.14):

As a result of 8.14b, it is prohibited to change it without just reason

Accounting estimate could be changed anytime when the entity reaches to the conclusion, that the underlying conclusions have been changed (e.g. competing software has been introduced to the market) 15

Accounting estimate shall be changed prospectively:

for example, an asset with an estimated useful life of 5 years has been acquired at the beginning of 2008 for 200; annual depreciation charge is 40

at the beginning of 2010 , carrying amount will be 120 (= 200 – 2x40); at that moment it is assumed, that the useful life of the asset is only 4 years; thus the carrying amount need to be depreciated within remaining two years

as a result, depreciation charge is increased from 40 to 60; no amendment is made for former periods

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Amendment of the accounting policy is made in a following way (IAS 8.19):

There are only two exceptions : a) when it is impracticable to do so; b) if there is non-materiality exception in accordance with IAS 8.7

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In our example, the asset with useful life of 5 years has been acquired at the beginning of 2008 for 200

The asset shall be depreciated in accordance with straight-line method

If the company would like to change its depreciation method to units of production (as of 2010) it should do so from 2008, based on the estimate of the total production capacity and the production data for 2008

However, if there isn´t any production data for, say, 2009, (because nobody requires them at that time), new method of depreciation could be applied from 2010, even if there are available production data for 2008 18

Almost every IFRS calls for disclosure of further information

For example, IAS 8 requires information on:

first-time application of a new or amended IFRS (IAS 8.28) and a voluntary change of accounting policy (IAS 8.29)

amended IFRS which the company is not applying before their effective date (IAS 8.30)

any change of accounting estimates and their impact on a financial position and financial results of a company 19

There is a frequent requirement to reconcile ending balances of line items with their beginning balances

For cash and cash equivalents, there is a separate financial statement (prepared in accordance with IAS 7)

Accordingly, there is a separate reconciliation statement for equity (IAS 1 – Statement of Changes in Shareholders´Equity)

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For example, for provisions (IAS 37.84) following reconciliation is required:

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