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LECTURE 6

LECTURE 6. ACCOUNTING POLICIES, ESTIMATES AND ERRORS FRS 108. Development: FRS 108 (Revised)2006. IASB issued : IAS 8 (Revised) Replaces FRS 108 2004 : Net Profit or Loss for the Period

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LECTURE 6

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  1. LECTURE 6 ACCOUNTING POLICIES, ESTIMATES AND ERRORS FRS 108

  2. Development: FRS 108 (Revised)2006 • IASB issued : IAS 8 (Revised) • Replaces FRS 108 2004 : Net Profit or Loss for the Period • Revised standard: Eliminate alternatives, redundancies and conflicts within Standards, to deal with convergence issues (i.e. Malaysia to fully converge to IAS and IFRS by 1/1/2012) and make improvements

  3. Continue….IASBobjs for Changes • To remove allowed alternative to retrospective (i.e. to go back and assess previous accounting period reporting) application of voluntary changes in accounting policies and retrospective restatement to correct prior period errors (More ctrl of retrospective adj) • To eliminate concept of fundamental error • Articulate (i.e. Clarify) and Updates the hierarchy of guidance to which management refers when making decisions on accounting policies to be adopted in the absence of specific Standards and Interpretations

  4. Continue….IAS 108 (Revised) Objs • Define material omissions or misstatements, Describe how to apply concept of materiality when applying accounting policies and correcting errors • To incorporate consensus of SIC 2- Consistency: Capitalisation of Borrowing Costs and SIC-18: Consistency Alternative Methods (both had not been incorporated in FRS 108 2004)

  5. Main Changes to FRS 108 2004 (i) Selection of Actg Policies • Requirements for the selection and application of accounting policies in FRS 101 2004 transferred to FRS 108 (Revised) + Updates hierarchy of guidance for selection of actg policies, mgt refers when specific actg std not available

  6. Continue…Main Changes (ii) Materiality • FRS 108 (Revised) defines material omission and misstatement such that • X need to apply FRSs if the effect immaterial + complement FRS101 req. on disclosure x need if immaterial • F/s x comply with FRSs if material errors exist. • Material prior period errors are to be corrected retrospectively in the first set of financial statements authorised for issue after their discovery (e.g. If errors found in actg period 2009 wrt to actg period 2008, to correct 2009 accounts as well as 2008)

  7. (iii) Voluntary Changes in Actg Policies and Corrections of Prior Period Errors FRS 108(Revised) requiresretrospective application of voluntary changes in accounting policy and retrospective restatement to correct prior period errors byremoving allowed alternative in FRS 108 2004. As a result? Have to include in P&L of current period the adj from changing actg policy or the amount of a correction of a prior period error. JUSTIFIED? To present unchanged comparative information from financial statements of prior periods. WHY? Comparative information for prior periods is presented as if new accounting policies had always been applied and prior period had never occurred (YOUR HOMEWORK: TO FIND TO WHAT EXTEND PREPARER HAS TO REPORT COMPARITVE INFO OF PRIOR ACTG PERIOD IN CURRENT ACTG PERIOD F/S. Is it 1 year, 2 year, 5 years? Or depends) Continue….. Main Changes

  8. Continue…Main Changes (iv) Impracticability • This EXEMPTION criterion is retained, IF NOT PRACTICABLE, X change on comparative info when changing actg policies retrospectively or prior period errors corrected. FRS 108 (Revised) sets out def. ‘impracticable’ and its guidelines. [IS THIS NECESSARY? WHOM IT WILL PROTECT? ANY BENEFITS?] • When impracticableto determine cumulative effect, in particular at beginning of the current period of: (a) applying a new accounting policy to all prior periods (b) an error on all periods WHAT THE ENTITY NEEDS TO DO ? the entity changes the comparative info as if the new accounting policy had been applied, or the error had been corrected, prospectively from the earliest date possible

  9. Continue…Main Changes (v) Fundamental Errors Eliminated; Removing difference bet fundamental errors and materials errors (GOOD?), DEF. PRIOR PERIOD ERRORS (vi) Disclosures NOW REQUIRES, PREVIOUSLY ENCOURAGES (DIFFERENCE, IS THIS GOOD?) • To disclose impending (awaiting) change in actg policy when the Standards and Interpretations have been issued but implementation x yet compulsory. Together to disclose known or reasonably (?) estimable info. relevant to assessing the possible impact of New Std or Interpretation (?) will have on entity’s f/s in the period of initial application

  10. Continue…Main Changes…Disclosures • MORE DETAILED disclosure of amounts of adj. resulting from changing actg policues or correcting prior periods. Specifically on f/s line items, E.g FRS 133 EPS, to account for both basic and diluted EPS (viii) Other changes • Presentation req for P&L under FRS 101 • Incorporates consensus of SIC-18: Consistency –Alternatives Methods (a) Entity to select and apply actg policies CONSISTENTLY for similar transactions, events and conditions. UNLESS stds or interpretation specifically requires categorisation of items which result different policies > appropriate. In this case the diff policies need to be applied consistently for the respective category throughout accounting periods • Include def. of change in actg est. • Include EXCEPTIONS from including effects of changes in actg est. propectively in P&L. Provided that changes in actg estimate lead to change in assets, liabilities and/or equity, ADJUSTMENTS need to be made on the carrying amount of related asset, liability or equity IN THE PERIOD CHANGE TAKEN PLACE

  11. FRS 108 (Revised): OBJs • To prescribe the criteria for selecting and changing actg policies, actg treatment and disclosure of CHANGES in : (a) actg policies, (b) actg estimates and (c) corrections of errors • To enhance entity’s f/s : (a) relevance (b) reliability (c) comparability (to what extent?) • Deal with disclosure of CHANGES IN ACTG POLICIES, (Disclosure of Actg Policies to refer to FRS 101)

  12. FRS 108 (REVISED): SCOPE • Selecting and Applying Actg Policies • Accounting for Changes in Actg Policies • Changes in Actg Estimates • Corrections of Prior Period Errors

  13. Accounting PoliciesSelection and Application of Actg Policies • Selection based on Stds, Interpretations, Implementation Guidance (x form or be part of FRS) issued by MASB • Specifically, MASB concluded FRSs result in f/s contain relevant and reliable info when reporting transactions, events and conditions. UNLESS effects applying FRS immaterial. Further CAUTION need to be exercised when x following FRSs in the event of immateriality, consequence ur action may x be inappropriate, leave error uncorrected? THINK about it?

  14. Continue….Selecting + Applic. Actg Policies • Absence of Std or an Interpretations. What the preparer should do? VERY CRITICAL? Mgt Shall Use Its JudgementIn Developg And Applying Acounting Policies: FRS Govern this action by Requiring Results of info. have to be: • Relevant to the economic decision-making of users of a/c • Reliable • Faithfully represented, finl position, performance, cash flow of the reporting entity • Substance over form, reflect economic substance of transactions and x merely legal form • Neutral (x bias, balance?) • Prudent • Complete in all material respects

  15. Continue…. Para 11 -In making judgement Mgt shall refer to following sources in descending order: • The requirements and guidance in Standards and Interpretations wrt similar or related issues • Def., recog criteria and measurement concepts of assets, liabilities , income, expenses as set out in FRAMEWORK of Financial Stat

  16. Continue…… • In making the judgement, Mgt may also consider (i) most recent pronouncements of other standard setting bodies (that use similar conceptual framework to develop actg stds) (ii) actg literatures (iii) accepted industry practice PROVIDED that (i), (ii) and (iii) do not conflict With PARA 11 , FRS 108 (Revised)

  17. Continue…ConsistencyActg Policies • To apply actg policies CONSISTENTLY (is about time frame, types of transactions, events or condition) for similar and related transactions through out actg periods UNLESS CATEGORISATION of item (e.g. diff parts of large asset may be depreciated using diff methods) > appropriate --- > apply more appropriate Actg Policies--- > consistently Why Consistency Matters? To enable users to make comparative study of f/s?

  18. (1) Entity shall change its accounting policies ONLY if: Required by a Std or Interpretation It’ll make F/s more relevant and reliable wrt the effects of transactions, other events and conditions on the entity’s financial position, performance and c/f (Why the concentration on these 3 statements?) (2) Users to be able to compare f/s of an entity over time to identify trends in fin posit., perform, cash flow. Hence for this purpose same actg policies have to be apllied…CONSISTENCY in ACTG POLICIES (3) Followings, X Changes in actg Policies: (i)Apply actg policies for transact. etc, differ in substance from previous occurrence (ii) Apply new actg policies for transact. Etc did not occur previously or were immaterial Continue…Changes in Actg Policies

  19. Continue…… Changes in Actg Policies • Initial application of a policy to revalue assets - Considered a change in an actg policy (FRS 116: PPE; FRS 3: Intangibles

  20. Changes in Actg Policies ….. Applying Changes in Accounting Policies • When initial application of a Std or Interpretation in accordance with specific transitional provisions, triggers change in accounting policy • Change in accounting policy as a result of initial application of a Std or Interpretation that • does not include specific transitional provisions to that change (i.e. potential to effect prior period info.) • changes actg policies voluntarily Change to be applied retrospectively

  21. Continue • HOWEVER,early application of a std or an Interpreattaion is not a voluntary change in actg policy • When appropriate Stds / Interpretation not available, MGT may apply an actg policy from the most recent pronouncements of other std setting bodies that use similar conceptual framework

  22. Changes in Actg Policies …..Retrospective application • When change in actg policy applied retrospectively, the entity shall adjust the OPENING BAL. of each affected component of equity for the earliest prior period presented and the other comparative amounts disclosed for each prior period presented as if the new actg policy had always been applied (PARA 22)

  23. Continue …Changes in actg policies…Limitation on retrospective application PARA 23 -27 • Except to the extent that it is impracticable to determine either the period specific effects or cumulative effect of the change. • When entity applies new act policy retrospectively, it applies the new actg policy to comparative info. Retrospective application to a prior period is not practicable unless it is practicable to determine the cumulative effect on both opening and closing bal/sheet for that period. e.g adj to closing figure in 2009 as well as opening figure of 2009(closing figure for 2008)

  24. Limitation to Retrospective Application • Usually adj made to retained earnings, component of equity. • Any info about prior period, adjusted as far back as is practicable • When it is impracticable (length of time?) to apply change in actg policy retrospectively, bec x det. cumulative effect (i.e.cumulative adj to assets, liabilities and equity arising b4 this change took place) of applying the the policy to all prior periods, APPLIES the new policy prospectively from the start of earliest period practicable.

  25. Changes in Actg Policies…DISCLOSURE Initial application of a Std/ Interpretation has an effect on current, prior and future period (EXCEPT when it is impracticable. WHEN?), PREPARER shall disclose: • Title of the Std or Interpret. • Change in actg policy made within its transitional provisions • Nature of the change in actg policy • Description of transitional provisions • Transitional provisions effect on future periods • Adj made in the current period and each prior period presented Similar treatment for voluntary change in actg policy …READ further FRS 108 para 29

  26. Continue… • When an entity has not applied a new Std or Interpretation that has been issued but is not yet effective, preparer shall disclose: • (i) Current practice wrt to implementation of the new std, • (ii) known or reasonably the relevant of the info, discussion on implications of the new stds or Interpretation on the preparer’s f/s in the period of initial application (Read further para 31)

  27. Changes in Actg Estimates • Estimation of Items in f/s – Due to uncertainties inherent in bus activities, hence measurement x absolutely precise. By nature an approximations that need revision as new info becomes avail. • Judgement used when estimatg, wrt latest available and reliable info • Estimates requird for: • Bad debts • Inventory obsolescence (depriciate) • Fair Value of Finl Asset and Finl liabilities • Useful life, factors wrt depreciable assets • Warranty Obligations ESSENTIAL : REASONABLE ESTIMATES APPLIED WHEN PREPARING F/S

  28. Continue….Changes in Actg Estimate • To REVISE ESTIMATE : • (i) new info avail (ii) more experience acquired • Revision of estimate x adj for prior period BEC it is not correction of error • Change in measurement basis is a change in actg policy and X change in actg estimate • (when diificult or x differentiate them treat as change in actg est)

  29. Continue…. • The effect of Change in Actg Est. Recognised prospectively in in P&L…WHEN? • (i) In period change taken place and future (if later period also going to be affected) • Change in actg estimate may affect assets, liabilities and equity figures, accordingly their carrying amt need to be adjusted in the period of the change • Prospective adjustment reflected change in estimate has been carried out since the date it initially taken place

  30. Continue….Changes in Actg Estimate • E.g. Change in estimate of bad debts affects current period P&L This difference regards as income or expense in P&L in the current period ; Change in estimated useful life of assets, cost associated with depreciable assets, depreciation expense affect current and future period This difference regards as income or expense in P&L in the ______period . DISCLOSURE • To disclose nature and amount of change in actg estimate in current and future period. • When effect in future period impracticable to estimate, and hence x disclose it, this fact has to be reported in f/s

  31. Errors….. • ERRORS may arise in respect of: • Recognition • Measurement • Presentation • Disclosure • F/S X COMPLIES with FRS if there exist MATERIAL ERRORS or immaterial error made intentionally to achieve particular presentation of info wrt fin position, performance or cash flows. Of elements of F/S

  32. Continue…Errors • Potential current period errors found during this period corrected b4 the f/s authorised to be issued • Material errors may be discovered in subsequent period, appropriate adj to be made as well in prior period wrt comparative info presented in subsequent period • Para 42 – Entity to correct material prior period errors retrospectively in the 1st f/s authorised to be issued after their discovery…What preparer need to do? • Restate the comparative amounts for prior period(s) presented in which the error occurred OR • If errors occurred b4 the earliest prior period presented, to restate opening balances of assets, liabilities and equity for the earliest prior period presented

  33. Continue…Errors …Limitations on Restrospective Restatement • Prior period error corrected by restrospective restatement except if it is impracticable either wrt period specific effects or cumulative effects of error • When impracticable to determine period specific effects of an error, to restate opening bal. of assets, liabilities and equities for the earliest period restrospective stat applicable • When impracticable to determine cumulative effect at beging of current period of an error and all prior periods, to restate comparative info prospectively, the earliest date practicable • Correction of prior period carried out restrospectively as far as it is practicable • When impracticable to determine amt of error for all prior periods , restates comparative info propectively, Thus disregards cumulative restat. Of asset, liab and eq. Correction of errors X similar to changes in actg estimate

  34. Disclosure of Prior period errors • Para 49, Disclose nature of prior period errors, amt of correction (in ref to appropriate FRSs) • Subsequent F/s x need to repeat these disclosures

  35. Impracticability …Retrospective Application and Retrospetctive Restatement (READ PARA 50 -53) • E.g Data x gathered in prior period, impracticable to recreate info (dealing 20 yrs back) • Hindsight x be used when applying new actg policy, correcting amt for prior period . E.g. When entity corrects prior period error in measuring finl assets previously classified tas held-to-maturity invest according to FRS 139, this x change entity’s basis of measurement.

  36. Exercise… • Retrospective Adj to prior period comparative info • E.g: Radex Bhd capitalises its borrowing costs on all qualifying assets under construction (Accounting Policy). Year RM’000 1 250 2 350 3 400 In yr 4, it incurred borrowing costs of RM500K that could be capitalised. In the same year, it changed its accounting policy wrt to the borrowing cots, where it decided to write-off this cost as an expense as it incurred. PBT X4: 1250K , X3: 1100K; Ret Earnings b/f: X4: 2825K, X3:2000K Assets under construction as at 31/12/x3 was RM3900K including capitalisation of borrowing costs. Tax rate 25%. Required: To discuss the effects of change in actg policyn on the items in the income stat

  37. Solution…. • Since in yr 4 the borrowing costs incurred was treated as an expense, RM500K was a charge in P&L, i.e. finance costs. The cumulative amt of RM800K less 25% tax= RM600K will be adjusted against the opening Retained profit of year X4 which was a closing retained profit of year X3

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