Accounting policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements. (IAS 8.5)
Following are some examples of accounting policies:
- Basis of inventory valuation such as FIFO, AVCO, etc.
- Basis of measurement of fixed assets such as historical cost basis or fair value model.
- Timing of recognition of revenue (e.g. upon dispatch of goods to customers).
- Accounting policies should be applied consistently over accounting periods to promote the comparability of information.
- Accounting policies may only be changed if required by IFRS or if a change in accounting policy is expected to improve the relevance and reliability of financial statements.
- Where accounting policy is changed due to an amendment in IFRS or the introduction of a new IFRS, the change must be applied in light of the transitional provisions of the new or amended IFRS.
- Where the change in accounting policy is applied voluntarily, the effect of the change should be accounted for retrospectively in financial statements as if the new accounting policy had always been in place.
- Retrospective application requires restatement of prior period comparative figures reported in subsequent financial statements to make them compatible with the new accounting policies.
- Where the effect of a change in accounting policy is not determinable for any prior period due to impracticability, the change in accounting policy must be accounted for prospectively from the start of the period in which the effect of change is determinable. In other words, the change is accounted for retrospectively to the extent that it is practicable.
- If it is not clear whether a change represents a change in accounting policy or estimate, the change must be accounted for as a revision of accounting estimate.
- Where the effect of a change in accounting policy is not material, the change may be accounted for prospectively.
- Change in accounting policy may be accounted for prospectively where the nature of transactions and events differ substantially from those recognized previously.
- Where non-current assets are subject to the application of revaluation models under IAS 16 and IAS 38 for the first time, the change in policy is accounted for prospectively according to those standards rather than IAS 8.
Accounting estimates are the estimations used by management to recognize amounts in the financial statements where precise values cannot be determined.
Examples of accounting estimates include:
- Depreciation expense.
- Value of pension benefit obligations.
- Fair value of assets.
- Impairment assessment of non-current assets.
- NRV assessment of inventory.
- Using reasonable accounting estimates where precise amounts cannot be determined is essential to the preparation of reliable financial statements.
- Accounting estimates must be revised when new information becomes available.
- Accounting estimates are accounted for prospectively. As a result, any change in the value of estimate is incorporated in the period in which the estimate is revised and subsequent periods if necessary.
- Prior period comparative figures are unaffected by a change in accounting estimate.
- Where an accounting estimate has to be revised based on information that was already available at the time of preparation of prior period financial statements, the effect of revision must be recognized retrospectively as it constitutes a correction of prior period error.
Accounting errors are the omissions and misstatements in financial statements resulting from the misuse or disregard of reliable information that was either available at the time of preparation of financial statements or could be reasonably expected to have been obtained at that time.
- Mathematical errors.
- Ommissions and mistakes in transactions, balances and disclosures of financial statements.
- Misapplication of IFRS and GAAP.
- Incorrect classification of transactions and balances.
- Accounting errors undermine the reliability of financial statements.
- Errors must be corrected as soon as they are discovered.
- Current period errors discovered during that period should be corrected before the financial statements are issued.
- Prior period errors must be corrected retrospectively, i.e. prior period comparative figures must be restated as if no errors were previously reported.
- Where a prior period error is not material, it may be corrected prospectively.
- Where the effect of an accounting error is not determinable for any prior period due to the reason of impracticability, the prior period error may be corrected prospectively from the start of the period in which the effect of the error is determinable. In other words, the prior period error is corrected retrospectively to the extent that it is practicable.