Change in Accounting Policy
What is Accounting Policy?
Accounting policy is the principle, rule, and practice that 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 that does not provide an exact rule to comply with. 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 will decrease depreciation expense and increase profit during the year.
Example of change in accounting policy
Property Plant and Equipment: Based on accounting standards, we have options to use a 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 for each fixed asset category. The useful life depends on the exact type of assets and business operation, moreover, company needs to define the minimum amount to be capitalized as a fixed asset otherwise, it 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 based on the inventory nature and select one to use as well as put in accounting policy.
|Inventory Costing method
|Property Plan and Equipment subsequent measurement
|Accounting Method for subsidiary
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 fits with the 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 a consistent accounting policy from one accounting period to another. It is 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 by different accounting policies. Management may wish to change policy when it can give a better look at financial statements.
However, the 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.
Management may change the policy to improve the reliability and relevancy of accounting information on income statement, balance sheets, and cash flow. The new accounting policy must reflect with economic substance and nature of operation moving forward. Management has to provide a proper explanation 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 true and fair financial statements. The change must not be done to window-dressing the report otherwise it is considered a fraud.
Accounting Treatment for Change in Accounting Policy
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 been 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 be 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 from the earliest date or it is costly to do so, the partial retrospective application is allowed. It means that they 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.
When there is change in accounting policy, company require to disclose the following:
- List the name of the standard and interpretation which causes the change to policy.
- The nature of change in accounting policy will show what has been changing.
- The amount adjustment in the current and prior periods.
- Quantify the amount impacted by the change in each financial line item.
- 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 on future period of financial statements
- If the company cannot apply a new policy full retrospective, we need to provide an explanation. How do we handle the change and the assumption to the prior period?