AC4301 Corporate Accounting II
HKAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
In-Class Assignment Solution
Question 1
Since accounting treatments are not the same between changes in accounting policies
and changes in accounting estimates, their differences should be properly identified.
An accounting policy selected by an entity on an element of the financial statements
determines its recognition, measurement and presentation of this element in the
financial statements. Thus, a change of accounting policy occurs where there is any
change to any one of the components of (1) recognition criteria, (2) measurement
basis and (3) method of presentation. Any change that does not affect any of these
three components is not a change in accounting policy and it may only be a change in
accounting estimates.
HKAS 8 also clarifies that, when it is difficult to distinguish a change in accounting
policy from a change in an accounting estimate, the change is treated as a change in
an accounting estimate.
Accounting estimates represent an entity’s estimates which may affect the elements in
the financial statements. Estimation should involve entity’s judgements based on the
latest available, reliable information. Many items affecting the elements in the
financial statements cannot be measured with precision but can only be estimated
because of the uncertainties inherent in business activities. The use of reasonable
estimates is an essential part of the preparation of financial statements and does not
undermine their reliability.
A change in accounting estimates is defined in HKAS 8 as an adjustment of the
carrying amount of an asset or a liability, or the amount of the periodic consumption
of an asset, that results from the assessment of the present status of, and expected
future benefits and obligations associated with, assets and liabilities. Changes in
accounting estimates result from new information or new developments and,
accordingly, and they are not corrections of errors.
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Question 2
The statement is incomplete, incorrect and misleading.
HKAS 8 requires that (except to the extent that it is impracticable to determine either
the period-specific effects or the cumulative effect of the error) an entity shall correct
material prior period errors retrospectively in the first set of financial statements
authorized for issue after their discovery by:
restating the comparative amounts for the prior period(s) presented in which the
error occurred; or
if the error occurred before the earliest prior period presented, restating the
opening balances of assets, liabilities and equity for the earliest prior period
presented.
Retrospective restatement corrects the recognition, measurement and disclosure of
amounts of elements of financial statements as if a prior period error had never
occurred. The correction of a prior period error is excluded from profit or loss for
the period in which the error is discovered. Any information presented about prior
periods, including any historical summaries of financial data, is restated as far back as
is practicable.
For a particular prior period, it is impracticable to make a retrospective restatement to
correct an error if:
- the effects of the retrospective restatement are not determinable;
- the retrospective restatement requires assumptions about what management’s
intent would have been in that period; or
- the retrospective restatement requires significant estimates of amounts and it is
impossible to distinguish other information objectively from the information
about those estimates that:
(1) provides evidence of circumstances that existed on the date(s) as at which
those amounts are to be recognised, measured or disclosed; and
(2) would have been available when the financial statements for that prior period
were authorised for issue.
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When it is impracticable to determine the period-specific effects of an error on
comparative information for one or more prior periods presented, the entity shall
restate the opening balances of assets, liabilities and equity for the earliest period for
which retrospective restatement is practicable (which may be the current period).
When it is impracticable to determine the cumulative effect, at the beginning of the
current period, of an error on all prior periods (e.g. a mistake in applying an
accounting policy), the entity shall restate the comparative information to correct the
error prospectively from the earliest date practicable. It therefore disregards the
portion of the cumulative restatement of assets, liabilities and equity arising before
that date.
Question 3
(a) Both the cost method and revaluation method are acceptable measurement
basis after recognition under HKAS 16.
HKAS 8.17 considers an initial application of a policy to revalue assets in
accordance with HKAS 16 is a change in an accounting policy and requires
this to be dealt with as a revaluation in accordance with HKAS 16, i.e.
prospective application.
(b) HKAS 20.10A requires that the benefit of a government loan at a
below-market rate of interest is treated as a government grant. The loan
shall be recognised and measured in accordance with HKAS 39. The benefit
of the below-market rate of interest shall be measured as the difference
between the initial carrying value of the loan determined in accordance with
HKAS 39 and the proceeds received. The benefit is accounted for in
accordance with HKAS 20. This accounting treatment was newly required
for the accounting period beginning on or after 1 January 2009 and shall be
applied prospectively in accordance with HKAS 20.43.
Under HKAS 8.19A, an entity shall account for a change in accounting policy
resulting from the initial application of a HKFRS in accordance with the
specific transitional provisions, if any, in that HKFRS. Accordingly, no
retrospective application of the new accounting requirement for Loan A is
required.
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(c) Change in the useful lives of depreciable assets is considered as a change in
accounting estimate.
Under HKAS 8.36, the effect of a change in an accounting estimate shall be
recognised prospectively by including it in profit or loss in the period of the
change and future periods, if the change affects both.
(d) The understatement of the closing inventory balance as at 30 June 2009 is
considered as an error.
Under HKAS 8.42, if the error is considered material, the entity shall correct
the error retrospectively in the financial statements by restating the
comparative amounts, i.e. the statement of financial position as at 30 June
2009 and the statement of profit or loss and other comprehensive income for
the year then ended.
Question 4
(i) Inventories
Under HKAS 8 a change in accounting policy occurs if a company changes its
measurement basis. Under HKAS 2 Inventories, all inventories should be valued at
the lower of their cost and net realizable value. Included as cost are the costs of
purchasing raw materials and goods as well as the costs of converting the materials
into a finished product. Those costs should include all overheads which are
necessary in bringing the stocks to their exact location and condition. The
accounting policy is to adopt a particular measurement base but the exact allocation
will vary from period to period and management will often have to change their
estimate of the appropriate amounts of overheads to allocate to a particular product.
These changes in allocation are therefore changes in accounting estimate and should
be charged to profit or loss in the period they arise.
The disclosure required by HKAS 8 requires all reporting entities to clearly disclose
any material changes in accounting estimates, particularly if there are material
changes in those estimates. In addition all material estimation techniques should be
disclosed if there are significant differences between such estimates.
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(ii) Change in Property Classification
If a company decides to switch properties out of current to non-current asset, that is
classified as a change in presentation. Under HKAS 8 such a change is treated as a
change in accounting policy. Normally a change in accounting policy would result
in a prior period adjustment being recorded. However, in this case, there would be
no change to equity but it will require a change in comparatives so that the 'old prior
year' figures are recorded in line with the new policy. Again, because this is a
change in accounting policy, that fact and a brief explanation for the change should be
provided, under HKAS 8.
Question 5
Situations 1 and 2
The key issue arising from situation 1 and 2 is whether the change constitutes a
change in accounting policy or a change in accounting estimated under HKAS 8. It
was stated in HKAS 16 “an entity should disclose the nature and effect of a change in
an accounting estimate that has an effect in the current period or is expected to have
an effect in the subsequent periods.” For property, plant and equipment, such
disclosure may arise from the changes in estimates with respect to:
♦ Residual values;
♦ The estimated costs of dismantling, removing or restoring items of property,
plant and equipment
♦ Useful lives; and
♦ Depreciation methods
HKAS 8 requires that the effect of a change in an accounting estimate (other than a
change in an accounting estimate gives rise to changes in assets and liabilities or
relating to an item of equity) should be recognized prospectively by including it in
profit and loss in:
♦ The period of change, if the change affects that period only; or
♦ The period of the change in the future periods, if the change affects both.
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Situation 3
The misclassification of capital expenditure as operating expense was likely to be a
material prior period error under HKAS 8. The next issue was whether it is
impracticable to make a retrospective restatement to correct the error.
HKAS 8 requires that, except to the extent it is impracticable to determine either the
period specific effects or the cumulative effect of the error, and entity should correct
material prior period errors retrospectively in the first set of financial statements
authorized for issue after their discover by:
♦ Restating the comparative amounts for the prior period(s) presented in which the
error occurred; or
♦ If the error occurred before the earliest prior period presented, restating the
opening balances of assets, liabilities and equity for the earliest prior period
presented.
For a particular prior period, it is impracticable to make a retrospective restatement to
correct an error if:
♦ The effects of the retrospective restatement are not determinable;
♦ The retrospective restatement requires assumptions about what management’s
intent would have been in that period; or
♦ The retrospective restatement requires significant estimates of amounts and it is
impossible to distinguish other information objectively from the information
about those estimates that;
Provides evidence of circumstances that existed on the date(s) as at which
those amounts are to be recognized, measured or disclosed; and
Would have been available when the financial statements for that prior
period were authorized for issue.
In this case, Glory Limited should correct the prior period error retrospectively in its
financial statements for the year ended 31 December of Year 3 and restate the
amounts for the period ended 31 December of Year 2 presented as comparatives.
The carrying of property, plant and equipment and retained earnings as at
31 December of Year 2 should be adjusted.
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Question 6
(a) Errors discovered in January 2019 (current period)
(i) This is an accounting error for the current period, i.e. for the year ended 31
December 2018. Prior periods’ financial statements are not affected.
Current period (2018) insurance expense should be $24,000/24*6 = $6,000
Current period (2018) insurance expense is overstated by $24,000 – $6,000 =
$18,000
Dr. Prepaid Insurance 18,000
Cr. Insurance Expense 18,000
To correct overstated insurance expense and understated prepaid insurance.
(ii) This is an accounting error for the current period, i.e. for the year ended 31
December 2018. The correct entries for 2018 should be:
Dr. Salary Expense 75,000
Cr. Salaries Payable 75,000
To correct understated salary expense and understated salary payable.
(b) Errors discovered in January 2020 (subsequent period)
(i) This is an accounting error made in 2018 and the current period is for the year
ended 31 December 2019. Therefore, it requires a prior year adjustment.
Insurance for the year ended 31.12.2018 should be $24,000/24*6 = $6,000 but the
company wrongly recorded $24,000 as insurance expense in 2018.
Expense in 2018 is overstated by $18,000 and therefore profit for year 2018 is
understated by $18,000. The cumulative effect on retained profit as at 1.1.2019 is
understatement of $18,000.
Expense in 2019 is understated by $12,000 and therefore profit for year 2019 is
overstated by $12,000. The cumulative effect on retained profit as at 31.12.2019:
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Understatement of 2018 profit $18,000
Overstatement of 2019 profit $12,000
Understatement on retained profits $6,000
Adjusting entries in 2019:
Dr. Prepaid insurance premium 18,000
Cr. Retained profit (b/f) 18,000
To correct the beginning retained profit due to a prior year error.
Dr. Insurance premium expense 12,000
Cr. Prepaid insurance premium 12,000
To record the insurance expense for the year 2019 and adjust the prepaid
insurance as at 31.12.2019.
As a result, the balance remaining in the prepaid insurance account as at
31.12.2019 would be $6,000.
Dr. Prepaid insurance premium 6,000
Dr. Insurance premium expense 12,000
Cr. Retained earnings (b/f) 18,000
(ii) Salary expense in 2018 is understated by $75,000 and therefore retained profit for
2018 is overstated by $75,000. Salary expense in 2019 was overstated by
$75,000.
Dr. Retained Profit b/f 75,000
Cr. Salary Expense 75,000
To reduce beginning balance of retained profit in 2019 and salary expense
for 2019 by $75,000.
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Question 7
Accumulated depreciation at 1/1/2018= (220,000 – 20,000) / 10 * 5 yrs = $100,000
Carrying amount 1/1/2018: $220,000 – 100,000 = $120,000
Due to the change in accounting estimate of the asset’s useful life, the remaining
depreciable amount of the asset should be allocated over the asset’s estimated
remaining useful life:
Depreciation per year after reflecting the revised useful life = $120,000 ÷ 3 = $40,000
Depreciation expense for 2018 = $40,000
Question 8
The following disclosure should be made in the statement of comprehensive income
and its notes:
Caparo Company Limited
Statement of Comprehensive Income – extracts
2018 2017
(restated)
$ $
Sales 114,000 83,500
Cost of goods sold (78,000)* (62,000)*
Profit from ordinary activities before taxation 36,000 21,500
Taxation (10,800) (6,450)
Profit for the year 25,200 15,050
Since the ending inventory for 2017 was overstated by $8,500, the cost of goods sold
for 2017 should be corrected to $53,500 + $8,500 = $62,000. As a result, the
beginning inventory of 2018 was overstated by the same amount of $8,500. Cost of
goods sold therefore for 2018 should be revised to $86,500 - $8,500 = $78,000.
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Caparo Company Limited
Statement of Changes in Equity
2018 2017
(restated)
$ $
Opening retained earnings as previously reported 41,000 20,000
Correction of fundamental error (net of taxation of $2,550) (5,950) _____-
Opening retained earnings as restated 35,050 20,000
Profit for the year 25,200 15,050
Closing retained earnings 60,250 35,050
Notes to the financial statements
Certain products that were sold in 2017 were incorrectly included in inventory at
31 December 2017 for $8,500. The financial statements of 2017 have been restated
to correct this error.
Workings for the tax effect: $8,500 x (1-30%) = $5,950 ; 8,500 x 30% = $2,550
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Question 9
Entick Company Limited
Statement of Changes in Equity
For the years ended December 31
2018 2017
$000 $000
Opening Retained profit as previously reported 700 250
Correction of fundamental errors (Note) 912 491
Opening Retained profit restated 791 299
Net profit for the year 500 4923
Closing Retained Profit 1,291 791
Note to the financial statements – extract
The company did not record a profit before tax in the amount $70,000 (tax impact
$21,000) in 2016 and $60,000 (tax impact $18,000) in 2017. The financial
statements of prior years have been restated to correct the error.
Workings:
1$70,000x (1-30%) = $49,000
2($70,000+ $60,000) x (1-30%) = $91,000
3$450,000 + [$60,000 x (1-30%)) = $492,000
30% is the tax rate.
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