Change in Accounting Policy

What is Accounting Policy?

Accounting policy is the principle, rule, and practices which company uses as the basis to prepare financial statements. Accounting policy must follow the accounting standard that the company has complied with. As we know, accounting standard (IFRS) is the principle base which does not provide an exact rule to comply. So the management has to decide and set the specific rule in accounting policy. Proper accounting policy will help to prepare reliable and relevant financial information.

The accounting policy will impact the company profit during the year as well as the statement of financial position. For example, the longer PPE’s useful life, it will decrease depreciation expense and increase profit during the year.

For example

Property Plant and Equipment: Based on accounting standards, we have options to use cost or revaluation model for subsequent measurement. So the company policy must select one of these models. If management decides to use the cost model, they must set a specific useful life of each fixed asset category. The useful life depends on the exact type of assets and business operation, moreover, company need to define minimum amount to be capitalized as a fixed asset otherwise, they will classify as an expense.

Inventory: Accounting standard allows the company to measure inventory by using specific, FIFO, and weighted average. So again managements have to decide base on the inventory nature and select one to use as well as put in accounting policy.

Section Accounting Framework Company Policy
Inventory Costing method
  • Weighted average cost
  • First-in-first-out (FIFO)
  • Specific identification
First-in-first-out (FIFO).
Property Plan and Equipment subsequent measurement
  • Cost model
  • Revaluation model
Cost model
Accounting Method for subsidiary
  • Cost method
  • Equity method
Cost method

Management must review the policy to ensure it is reflected in the actual operation and accounting standards. The change should be made when it no longer fit with business and result in less reliable and relevant financial statements. They must ensure that the policy will guide company to produce an appropriate financial statement.

Change in Accounting Policy

The company must use consistent accounting policy from one accounting period to another. It easy for the readers to compare the reports. It also prevents company from taking advantage of accounting treatment. As we know that the revenue and expense will impact from different accounting policies. Management may wish to change policy when it can give a better look at financial statements.

However, company is allowed to change the existing accounting policy when:

Change in IFRS

The change will require when there is an update in IFRS or other frameworks. Management needs to make a change in its policy otherwise it will conflict with the framework.

Voluntary Change

Management may change the policy to improve the reliability and relevancy of accounting information of income statement, balance sheet, and cash flow. The new accounting policy must reflect with economic substance and nature of operation moving forward. Management has to provide proper explain why it is better than the previous one.

However, it is very subjective to conclude the change. Management should access impact to ensure the change will result in a true and fair financial statements. The change must not be done to window-dressing the report otherwise it is considered as a fraud.

Accounting Treatment for Change

If the change is required by the new IFRS standard or interpretation, it must be applied retrospectively. It means that we need to make an adjustment to the opening balance of related line items as the new policy has applied since the earliest period. After the change, it looks like the financial statement has been prepared base on the new policy since the beginning.

All income statement adustment since the beginning will be adjusted to the retained earnings. There will an adjustment in the beginning balance of retained earnings in the comparative statement of change in equity. Other adjustments after that will be reflected in current and comparative period.

The retrospective application ensures financial statements are comparable and allow for trend analysis.

However, if company is not able to obtain the data since the earliest date or it is costly to do so, the partial retrospective application is allowed. It means that the only adjust the opening balance of the current year and ignore prior impact.

In the worst-case scenario, the company is not able to quantify the difference in the comparative year. The change in accounting policy will be applied prospectively which is the same to change in accounting estimate.

Disclosure

When there is change in accounting policy, company require to disclose the following:

  • List the name of standard and interpretation which causes the change to policy.
  • The nature of change in accounting policy, it will show what has been changing.
  • The amount adjustment in the current and prior periods.
  • Quantify the amount impact by the change in each financial line items.
  • The reason for a new policy which can provide more reliable and relevant financial information if the change is voluntarily made.
  • The effect of the new policy to a future period of financial statements
  • If company cannot apply a new policy full retrospective, we need to provide an explanation. How we handle the change and the assumption to the prior period.