ABC LTD until now has valued inventory using LIFO method. However, following changes to IAS 2 Inventories, the use of LIFO method has been disallowed. Therefore, management of the company intends to use FIFO method for the valuation of the company’s stock.
Following are extracts of ABC LTD’s most recent financial statements before the application of FIFO method.
| Statement of Financial Position as at 31 December 20X2 | ||
|---|---|---|
|
|
20X2 |
20X1 |
|
Current Assets: |
|
|
|
Cash and Bank |
6 |
4 |
|
Short Term Investments |
5 |
8 |
|
Inventory |
10 |
12 |
|
Total |
21 |
24 |
| Income Statement for the year ended 31 December 20X2 | ||
|---|---|---|
|
|
20X2 |
20X1 |
|
Cost of Sales: |
|
|
|
Opening Inventory |
12 |
8 |
|
Purchases |
48 |
44 |
|
Closing Inventory |
(10) |
(12) |
|
Total |
50 |
40 |
| Statement of Changes in Equity for the year ended 31 December 20X2 | ||
|---|---|---|
|
|
20X2 |
20X1 |
|
Retained Earnings: |
|
|
|
Opening Reserves |
40 |
30 |
|
Net Profit |
30 |
20 |
|
Dividend |
(10) |
(10) |
|
Closing Reserve |
60 |
40 |
Accounting Treatment
The switch from LIFO method to FIFO method represents a change in accounting policy which must be accounted for retrospectively in the financial statements. Therefore, the change must be applied as if the new accounting policy was always in place.
Consequently, entity shall adjust all comparative amounts presented in the financial statements affected by the change in accounting policy for each prior period presented.
Management estimates that the value of its inventory using FIFO method would be as follows:
| 20X2 $M | 20X1 $M | 20X0 $M | |
|---|---|---|---|
|
Inventory |
12 |
13 |
10 |
Management further believes that the valuation of inventory using FIFO method for periods prior to 20X0 would produce materially similar results.
The financial statement extracts of ABC LTD would appear as follows after the retrospective application of the change in accounting policy.
| Statement of Financial Position as at 31 December 20X2 | ||
|---|---|---|
|
|
20X2 |
20X1 |
|
Current Assets: |
|
|
|
Cash and Bank |
6 |
4 |
|
Short Term Investments |
5 |
8 |
|
Inventory |
12 |
13 |
|
Total |
23 |
25 |
The amount of inventory is adjusted for current period as well as the prior period.
| Income Statement for the year ended 31 December 20X2 | ||
|---|---|---|
|
|
20X2 |
20X1 |
|
Cost of Sales: |
|
|
|
Opening Inventory |
13 |
10 |
|
Purchases |
48 |
44 |
|
Closing Inventory |
(12) |
(13) |
|
Total |
49 |
41 |
| Statement of Changes in Equity for the year ended 31 December 20X2 | ||
|---|---|---|
|
|
20X2 |
20X1 |
|
Retained Earnings: |
|
|
|
Opening Reserves |
40 |
31 |
|
Net Profit |
31 |
19 |
|
Dividend |
(10) |
(10) |
|
Closing Reserve |
61 |
40 |
Note that the change is applied to both current period and prior period comparative amounts presented (i.e. retrospectively). The estimated effect of the change in accounting policy relating to the prior periods that are not presented (i.e. before 20X1) is adjusted in the opening reserves of 20X1.
The nature of the change in accounting policy must be disclosed in the financial statements of ABC LTD.
The example is for illustration purpose only and is just a simplified view of how a change in accounting policy is accounted for. In practice, the effects of changes in accounting policy may be hard to determine. Transitional provisions for adoption of policies specified by new standards must also be considered when applying a change in accounting policy due to changes in the requirements of the reporting standards.