There’s been a change…but was the change a change in accounting policy or a change in accounting estimate? This question has been a source of frustration for years under IFRS (and U.S. GAAP too!). The IASB realized help was needed and published amendments to IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors in 2021.
Definitions of accounting policy and accounting estimate
Let’s begin by refreshing the definitions of each per IFRS.
An accounting policy is the specific principles, bases, conventions, rules, and practices applied by an entity in preparing and presenting financial statements. An example of an accounting policy would include the measurement basis (or bases) used (e.g., amortized cost, fair value, etc.).
Accounting estimates are monetary amounts in financial statements that are subject to measurement uncertainty. An example of an accounting estimate would be a loss allowance for expected credit losses when applying IFRS 9, Financial Instruments.
The above definitions came straight from IFRS, but I want to point out that the above definition of an accounting estimate was added as a result of the recent amendments to IAS 8. Previously only a change in accounting estimate was defined. The lack of definition for “accounting estimate” contributed to the overall confusion, so the IASB felt that defining it would be helpful. The definition of a change in accounting policy was removed but the explanatory paragraphs were retained.
Why does this matter?
Now that we’ve defined accounting policy and accounting estimate, let’s step back and understand why the determination between a change in accounting policy versus a change in accounting estimate matters. The accounting treatment differs based on the type of change; therefore, it is critical to make the proper determination in the type of change.
If the change is determined to be a change in accounting estimate, the change is accounted for prospectively. If the change is determined to be a change in accounting policy, the change should be accounted for retrospectively. If the change in accounting policy is resulting from the initial application of an IFRS, the change in policy should be accounted for in accordance with the provisions in the IFRS. Changes as a result of errors are to be accounted for retrospectively (refer to IAS 8 for additional details).
How exactly do you differentiate between the two types of changes?
We’ve established that determining the type of change is essential, so how do we do that? I think an example is the best way to illustrate this concept, so let’s take a look at the example below pulled from our 2021 IFRS Update course.
So, what do you think – does Luna Bank have a change in accounting policy or a change in accounting estimate? If you said “change in accounting estimate” you’d be correct! Let me explain why.
Luna Bank accounts for the investment at fair value through profit or loss in accordance with IFRS 9. The accounting treatment, fair value through profit or loss (FVPL), is Luna’s accounting policy. Luna previously used a market approach to value the investment, however changed to use an income approach to value the investment. Luna never changed its accounting policy, instead how Luna arrives at the fair value is what changed. This is a change in measurement technique applied to estimate the fair value of the investment, which is a change in accounting estimate.
Just because IFRS requires a certain accounting treatment does not mean that this treatment is not an accounting policy. For example, IAS 40 allows an accounting policy choice for investment property to be accounted for subsequently at either the fair value model or using the cost model. Whichever model is chosen by the entity becomes the entity’s accounting policy. Under IFRS 9, certain financial assets in scope of the standard are required to be accounted for at FVPL, even though this is the required accounting treatment, this is also the entity’s accounting policy.
The above logic is not new or changed, however, you can see why this determination between policy and estimate can get cloudy! Recent amendments help to further explain application of this logic. There’s quite a bit of wording added to the standard but stick with me – I’ll explain the importance of each addition!
Paragraph 32 of IAS 8 was heavily revised to focus on the definition of accounting estimates and now says:
An accounting policy may require items in financial statements to be measured in a way that involves measurement uncertainty – that is, the accounting policy may require such items to be measured at monetary amounts that cannot be observed directly and must instead be estimated. In such a case, an entity develops an accounting estimate to achieve the objective set out by the accounting policy. Developing accounting estimates involves the use of judgments or assumptions based on the latest available, reliable information.”
I want to highlight a key point here… “an entity develops an accounting estimate to achieve the objective set out by the policy.” Luna’s policy (FVPL) is achieved by the use of an estimate (the measurement technique to arrive at fair value).
Paragraph 34 had two statements added:
An entity may need to change an accounting estimate if changes occur in the circumstances in which the accounting estimate was based or as a result of new information, new developments, or more experience…”
The effects on an accounting estimate of a change in an input or a change in a measurement technique are changes in accounting estimates unless they result from the correction of prior period errors."
The two statements above were added to help further clarify the logic used in our example. The guidance says that an estimate may need to change if new information becomes available, and that’s just what Luna did! Our case facts explained that Luna felt an income approach was more representative because of changes in the industry.
Lastly, the second statement sums up our answer quite nicely! A change in a measurement technique (the change from market approach to income approach for Luna) is a change in accounting estimate.
The IASB’s goal of these amendments was to make it easier to differentiate between a change in accounting policy and a change in accounting estimate, and I think the amendments achieved this goal! Well done, IASB! These amendments are effective for annual reporting periods beginning on or after 1 January 2023. Earlier application is permitted.
IFRS update training
Hopefully, you found today’s post helpful. The GAAP Dynamics team works hard to break-down tricky issues. The above class discussion was taken from our annual Essential IFRS Update course collection where we tackle recent IASB developments and application issues in two, 2-hour courses (4 CPE credits).
Whether you’re scrambling to meet CPE requirements before 2021 comes to a close or tired of the same old content, the GAAP Dynamics team is here for you! Our annual updates under IFRS and U.S. GAAP are live and available for immediate purchase in their self-study eLearning formats right now on the Revolution, our online learning library!
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