Chapter 21: Accounting Changes and Correction of Errors

Perspective and Issues

Information contained in an enterprise's financial statements over a period of time must be comparable if they are to be of value to users of those statements. Users of financial statements usually seek to identify trends in the enterprise's financial position, performance, and cash flows by studying and analyzing the information contained in those statements. Thus it is imperative that the same accounting policies be applied from year to year in the preparation of financial statements, and that any departures from this rule be clearly indicated.

Financial statements are the results of choices among different accounting principles and methodologies. Companies select those accounting principles and methods that they believe depict, in their financial statements, the economic reality of their financial position, results of operations, and changes in financial position. Changes take place because of changes in the assumptions and estimates underlying the application of these principles and methods, changes in the acceptable principles by a promulgating authority, such as an accounting standard-setting body, or other types of changes.

Accounting for and reporting of these changes is a problem that has faced the accounting profession for years. Much financial analysis is based on the consistency and comparability of annual financial statements. Any type of accounting change creates an inconsistency; thus, a primary focus of management in making the decision to change should be to consider its effect on financial statement comparability.

IAS 8 deals with accounting changes (i.e., changes in accounting estimates and changes in accounting principles) and addresses the correction of errors. IAS 8 also prescribes the classification, disclosure, and accounting treatment of certain items in the income statement, such as extraordinary items, which is the subject matter of Chapter 3. The objectives of this standard in prescribing such accounting treatment and disclosures is to enhance comparability both with an enterprise's financial statements of previous years and with the financial statements of other enterprises. Even though the correction of a fundamental error in financial statements issued previously is not considered an accounting change, it is discussed in this standard and therefore is covered in this chapter.

In the preparation of financial statements there is an underlying presumption that an accounting principle, once adopted, should not be changed in accounting for events and transactions of a similar type. This consistent use of accounting principles enhances the utility of the financial statements. The presumption that an entity should not change an accounting principle may be overcome only if the enterprise justifies the use of an alternative acceptable accounting principle on the basis that it is preferable.

The IASB has proposed substantial changes to the current standard dealing with accounting errors and voluntary changes in accounting principles. In brief, the allowed alternative treatment set forth in current IAS 8—whereby the reporting entity includes the effect of the change in policy or the correction of an error in profit or loss for the current period and presents comparative information as it was reported in the financial statements of prior periods without restatement—will be eliminated. It will then be required of all entities that the current benchmark treatment, under which comparative prior period data is restated and the earliest reported retained earnings balance is adjusted for the effect of the correction of an error or a voluntary change in accounting policy, be employed in all instances.

Amendments to IAS 8 will furthermore move some guidance currently found in IAS 1 to IAS 8, while other guidance found presently in IAS 8 will be relocated to IAS 1. The incumbent term "fundamental error" will be superseded by a somewhat more broadly defined "error." Also, a formal hierarchy of IAS will be set forth for the first time by revised IAS 8.

Sources of IAS

IAS 8

SIC 8