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FINANCIAL ACCOUNTING 300 IAS 8: ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS NOTES AND CLASS EXAMPLES K B Leith

DEPARTMENT ACCOUNTING

UP

What does IAS 8 deal with? (IAS 8, pares 3 – 4)

IAS 8 deals with the following:

The selection and application of accounting policies paras 7 - 13 Changes in accounting policies paras 14 – 31 & 50 – 53 Changes in accounting estimates paras 32 – 40 Correction of prior period errors paras 41 – 49 & 50 – 53

Although each of the above will be revised briefly in this document, the accounting treatment of these situations has been largely addressed in FRK 201.

The focus for FRK 300 is thus primarily on the income tax implications of the retrospective application of accounting policies and the correction of prior period errors.

These income tax implications are not directly addressed by IAS 8 but rather by the normal principles of IAS 12, Income Taxes (IAS 8, para 4).

Changes in accounting estimates (IAS 8, paras 5 & 32 – 40)

Refer to the following definitions in IAS 8, para 5:

Changes in accounting estimate

Prospective application

Take note of the following from these definitions:

A change in estimate arises from new information or new developments. This is an important element of the definition since prior period errors result from the incorrect use of existing information.

Prospective application of a change in accounting estimate affects only the current

and future periods.

IAS 8, paras 32 – 34, explains why the use of estimates is necessary in the preparation of financial statements and why these estimates do sometimes change.

A change in accounting estimate is recognised prospectively from the period of the change being made (IAS 8, paras 36 – 38).

This means that if the useful life of a depreciable asset changes on the reporting

date, the depreciation / amortisation of the asset for that current reporting period


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must already be based on the latest estimation of useful life on the reporting date.

This requires that the change in estimate must be worked back to the beginning of the year to calculate the current year’s depreciation / amortisation. For example, a remaining useful life of six years on the reporting date is a remaining useful life of seven years at the beginning of that year, if the asset is available for use for the full year.

This principle is explained further in Class Example 1.

If an impairment indicator (for an impairment loss) and a change in estimate both

occur on the reporting date, it is difficult to determine which event occurred first.

The approach followed at UP is that the impairment loss is recognised in the current year. The depreciation / amortisation for the current year is thus based on the old estimate. The new estimate of useful life is applied in the following year following the recognition of the impairment loss in the prior year since that change in useful life is directly related to the impairment indicator. The impairment loss is calculated as the difference between the carrying amount and the recoverable amount at the reporting date (i.e. the carrying amount AFTER the depreciation for that year has been recognised).

Note that a change in the measurement basis is a change in accounting policy and NOT a change in accounting estimate. (IAS 8, para 35)

A measurement basis is for example, the cost model or the revaluation model (these are different accounting policies).

Since depreciation is written-off by applying both of these models, a change in the depreciation method (for example, from the straight-line method to the reducing balance method) is not a change in the measurement basis. The effect of the change in the method of writing off depreciation / amortisation is essentially a change in the rate at which depreciation / amortisation will be written off, and this is a change in estimate.

The disclosure requirements for changes in accounting estimates are set out in IAS 8, paras 39 – 40.

This information can be disclosed as part of the “Profit before tax” note or in a separate note called “Change in estimate”. In FRK300, the preferred method is the inclusion of this information in the “Profit before tax” note. If there is a change in estimate in a current year and you are specifically asked to prepare the “Profit before tax” note in a test or homework question, make sure that the change in estimate is disclosed in this note.

Income tax implications:

Changes in accounting estimates affect the starting point of the current and deferred tax calculations (that is, the profit before tax and the carrying amounts of the affected assets and liabilities).

This means that the basic principle to be applied is that the profit before tax and the carrying amounts of assets and liabilities are adjusted before the income tax calculations are done.


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If this principle is applied, the income tax implications (as explained in the IAS 12 material) of changes in accounting estimates are automatically taken into account in the current year It should be noted that a change in accounting estimate does not affect the calculation of the tax allowances or the tax base of an asset / liability.

Class example 1 – Changes in accounting estimates

X LIMITED has a patent that it purchased and which is accounted for on the cost model in terms of IAS 38, Intangible Assets. The patent was purchased on 30 June 20X1 for R360 000 and was available for use as intended by management on this date. Although the patent has a total economic life of 25 years (based on the contract period) on 30 June 20X1, management estimated that the useful life to X Limited was 12 years and that there was no residual value. Patents are amortised using the straight line method.

During the year ended 30 June 20X4, as a result of changes made to the legislation governing patents, management realised that an active market would exist for these types of patents and that this market will still exist at the end of the patent’s useful life. On this basis, the fair value of this patent would be R60 000 at the end of its useful life of 12 years and X Limited could sell it to a third party for this amount. Alternatively, X Limited could use this patent for another 6 years (i.e. a total of 18 years), after which it would have no value.

Ignore all tax implications.

REQUIRED:

a. Prepare the journal entries of X Limited for the year ended 30 June 20X4 assuming that X Limited would use the patent for as long as possible. Compliance with International Financial Reporting Standards (IFRS) is required.

Note: Round calculated amounts to the nearest Rand. Journal narrations are not required.

b. Prepare the “Profit before tax” note of X Limited for the year ended 30 June 20X4 in accordance with International Financial Reporting Standards (IFRS), assuming that X Limited would use the patent for as long as possible.

Note: Round calculated amounts to the nearest Rand.

c. Prepare the journal entries of X Limited for the year ended 30 June 20X4 assuming that X Limited would sell the patent to a third party at the end of its useful life. Compliance with International Financial Reporting Standards (IFRS) is required.

Note: Round calculated amounts to the nearest Rand. Journal narrations are not required.

d. Prepare the “Profit before tax” note of X Limited for the year ended 30 June 20X4 in accordance with International Financial Reporting Standards (IFRS), assuming that X Limited would sell the patent to a third party at the end of its useful life.



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Suggested solution: Part A

X Limited General journal

Dr R

Cr R

Amortisation expense (P/L) 18 750 Accumulated amortisation – patent (SFP) 18 750

Calculation: R Cost 360 000 Accumulated amortisation to 30 June 20X3 (R360 000 / 12 years total life x 2 years expired life)

(60 000)

Carrying amount 30 June 20X3 300 000 Amortisation 20X4 (R300 000 / 16 years (10 years left of original estimate + 6 years additional useful life due to changes in legislation)

18 750

For part A, it is assumed that X Limited will use the patent for the maximum period of time that it can (i.e. 18 years) following which it cannot be sold. There is thus no residual value and the change in estimate relates only to the change in its useful life. Note that the change in estimate on 30 June 20X4 is already given effect to from the beginning of this year (i.e. from 1 July 20X3). Part B

X Limited Notes for the year ended 30 June 20X4 2. Profit before tax Profit before tax is stated after the following items have been taken into account:

20X4 20X3 R R Amortisation – other - patent (included in the line item “cost of sales”)

18 750

30 000

(part A: 20X3: R360 000 / 12 years)

During the current year, the remaining useful life of the patent was revised. The effect of this change in estimate is a reduction in amortisation expense in the current year of R11 250 (R30 000 – R18 750) and a cumulative increase in amortisation expense in the future periods of R11 250.

Note: Since the depreciable/amortisable amount of the patent DID NOT change, the amount of the cumulative effect on future periods is the same as the current year’s effect.


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Proof: R Remaining amortisation 20X4 (old estimate) 270 000 (R300 000 – R30 000) or (R30 000 x 9 years) Remaining amortisation 20X4 (new estimate) 281 250 (R300 000 – R18 750) or (R18 750 x 15 years) Increase in future cumulative amortisation after 20X4 11 250 Part C X Limited General journal

Dr R

Cr R

Amortisation expense (P/L) 24 000

Accumulated amortisation – patent (SFP) 24 000

Calculation: R Cost price 360 000 Accumulated amortisation to 30 June 20X3 (R360 000 / 12 years x 2 years)

(60 000)

Carrying amount 30 June 20X3 300 000 Residual value (60 000) Depreciable amount 30 June 20X3 240 000 Amortisation 20X4 (R240 000 / 10 years remaining useful life)

24 000

For part C, it is assumed that X Limited will sell the patent at the end of the useful life of 12 years, thus the change in estimate relates to the change in residual value from Rnil to R60 000. Note that the change in estimate on 30 June 20X4 is already given effect to from the beginning of this year (i.e. from 1 July 20X3). Part D X Limited Notes for the year ended 30 June 20X4 2. Profit before tax Profit before tax is stated after the following items have been taken into account::

20X4 20X3 R R Amortisation – other - patent (included in the line item “cost of sales”)

24 000

30 000

(part C: 20X4: R240 000/10 years and 20X3: R360 000/12 years) During the current year, the residual value of the patent was revised. The effect of this change in estimate is a reduction in amortisation expense in the current year of R6 000 (R30 000 – R24 000) and a cumulative decrease in amortisation expense in the future periods of R54 000.


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Note: Since the depreciable/amortisable amount of the patent DID change, the amount of the cumulative effect on future periods is the NOT the same as the current year’s effect. The cumulative effect on the future periods can be calculated in one of the following ways: Alternative 1 R Total decrease in depreciable amount (due to increase in residual value) 60 000 Decrease in amortisation already recognised in current year (20X3) (6 000) Thus decrease in cumulative amortisation after 20X4 54 000 Alternative 2 R Remaining amortisation end 20X4 (old estimate) 270 000 (R300 000 – R30 000) Remaining amortisation end 20X4 (new estimate) (216 000) (R240 000 – R24 000) Thus decrease in cumulative amortisation after 20X4 54 000 Alternative 3 R Remaining amortisation end 20X4 (old estimate) 270 000 (R30 000 x 9 years) Remaining amortisation end 20X4 (new estimate) (216 000) (R24 000 x 9 years) Thus decrease in cumulative amortisation after 20X4 54 000 Alternative 4 R Amortisation per year (old estimate) 30 000 Amortisation per year (new estimate) 24 000 Difference per year (decrease) 6 000 Thus decrease in cumulative amortisation after 20X4 (R6 000 x 9 years remaining useful life)

54 000

The choice and application of accounting policies

(IAS 8, paras 5; 7 – 13 and 30 – 31)


Accounting policy

International Financial Reporting Standards (IFRS)

Material

With the help of the definitions listed above and IAS 8, paras 7 – 13, revise the general requirements relating to the choice and application of accounting policies.

Refer also to the general disclosure requirements when new International Financial Reporting Standards are issued but are not yet effective (IAS 8, paras 30 – 31).


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Changes in accounting policies: revision of basic principles

(IAS 8, paras 5; 14 – 16; 19 – 22 and 28 – 29)


Accounting policy

Retrospective application

IAS 8, para 14, distinguishes between two types of changes in accounting policies:

Changes required by an IFRS (compulsory changes) Changes that would result in more relevant and reliable information being included

in the financial statements (voluntary changes)

A change in accounting policy can only be made if it arises because of one of the above scenarios (IAS 8, paras 14 and 15).

The fact that a specific accounting policy has never been applied before, does not necessarily mean that this is a change in accounting policy. IAS 8, para 16, cites such circumstances.

Accounting for a change in accounting policy (IAS 8, paras 19 – 22) Changes that are required by an IFRS are normally dealt with in accordance with

the specific transitional provisions contained in that IFRS [para 19 (a)]. If an IFRS requires a change and does not have transitional provisions, or the

change in accounting policy is a voluntary change, the change in accounting policy is made retrospectively [para 19 (b)].

Retrospective application means that the accounting records and financial statements of the prior and current periods are adjusted so that amounts recognised in the accounting records and disclosed in the financial statements are as if that new accounting policy had always been applied. Refer to IAS 8, para 5 and para 22, for further explanations.

Retrospective application is sometimes not possible, but this is addressed later on in this document.

Disclosure of changes in accounting policies (IAS 8, paras 28 – 29)

Study the disclosure requirements for a compulsory change in accounting policy provided in para 28 and a voluntary change in accounting policy provided in para 29. Note that most of the requirements are the same as or similar for both types of changes in accounting policy.

A change in accounting policy is disclosed in a separate note. If there is more than one change in accounting policy, each change is normally disclosed in a separate note.


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Note: Refer to IAS 1, paras 40A – 44 and 106, for the impact of a retrospective application of a change in accounting policy on the statement of financial position and related notes.

The disclosure requirements for a voluntary change in accounting policy (para 29) are illustrated and explained briefly below: Example Limited Notes for the year ended 31 December 20X6 34. Change in accounting policy

During the year ended 31 December 20X6, the company changed its accounting policy related to ............... from ..................... to ...............[nature of the change]. This change provides more relevant and reliable information because...........................[provide reason for information being more relevant and reliable]. The change in accounting policy has been retrospectively applied [indicate if retrospective change was possible or not possible] and the impact on the line items in the financial statements is as follows: IAS 1, paras 40A – 40D, requires a SFP (balances) at the beginning of the comparative period. This requirement is not applicable to P/L or OCI (movements)!

Retrospective application of a change in accounting policy affects prior periods, the current period as well as the future periods. The future impact is uncertain and cannot thus be disclosed. The disclosure of the impact on the prior periods’ and the current period’s amounts presented ensures that the current year’s amounts can be compared with those of prior periods and other entities.

20X6 20X5 01/01/20X5 R R R Decrease in xxx List P/L line items Increase in xxx (note 1)

xxx (xxx)

xxx (xxx)

You will be penalised if you present amounts in

this part of this column!

Increase in profit for the year (note 5) xxx xxx Other comprehensive income for the year Decrease in xxx List OCI line items Increase in xxx (note 2)

(xxx) xxx

(xxx) xxx

Increase in total comprehensive income for the year (note 5)

xxx

xxx

Decrease in xxx List SFP line items Increase in xxx (note 3)

(xxx) xxx

(xxx) xxx

(xxx) xxx

Increase in equity (note 5) xxx xxx xxx Increase in xxx List components of equity Decrease in xxx (note 4)

xxx (xxx)

xxx (xxx)

xxx (xxx)

Increase in basic earnings per share Rx,xx Rx,xx Increase in diluted earnings per share Rx,xx Rx,xx


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Notes:

1. Remember that most entities use the by function (and not nature) form of presentation in the profit or loss section of the statement of profit or loss and other comprehensive income. Therefore, the line items “cost of sales” and “other income” are used instead of “depreciation” and “fair value adjustment” which represent the nature of the expenses / income.

2. Remember that the income tax effect on other comprehensive income items is presented in a separate line item.

3. Remember that the line items on the face of the statement of financial position

are collective nouns. Thus, use “property, plant and equipment” and not “machinery”!

4. If more than one component / reserve in equity is affected, the effect on each of

the individual reserves must be disclosed here. If only retained earnings are affected, a shorter form of disclosure for this section will be possible. Refer also to the examples provided later in this document.

5. No other sub-totals are required in this note (for example, total non-current assets, total current assets, or total assets)!

6. Remember to indicate the direction of the effect of the change on each of the line items. This must agree to the amounts that you have used to be awarded the marks! Make sure that brackets are used appropriately.

Class example 2 – Change in accounting policy (without tax)

The following extract from the annual financial statements of H LIMITED for the year ended 31 December are presented to you: H Limited Statement of profit or loss and other comprehensive income for the year ended 31 December 20X6 20X6 20X5 R R Gross profit 5 500 000 4 570 000 Other income 112 000 228 000 Other expenses (1 042 500) (958 900) Profit for the year 4 569 500 3 839 100 Other comprehensive income Items that will not be reclassified to profit or loss: Revaluation of machinery 89 000 114 000 Revaluation surplus 89 000 114 000 Income tax expense - - Total comprehensive income for the year 4 658 500 3 953 100


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H Limited 20X6 20X5 Statement of financial position as at 31 December 20X6

R R

Assets Non-current assets

Investment property 13 975 000 14 300 000 Other non-current assets 32 500 000 24 800 000

Current assets 15 000 000 12 000 000 Total assets 61 475 000 51 100 000 20X6 20X5 R R Equity and liabilities Equity

Share capital 1 000 000 1 000 000 Retained earnings 30 273 500 25 704 000 Other components of equity 374 000 285 000

Current liabilities 29 827 500 24 111 000 Total equity and liabilities 61 475 000 51 100 000 On 1 January 20X5, the balance on retained earnings was R21 864 900 (credit). The first revaluation of machinery was performed on 1 January 20X2. The revaluation surplus only realises on sale of the assets. H Limited owns an investment property that the company purchased on 1 January 20X2 for R15 600 000 (R2 600 000 attributable to the land). H Limited accounts for investment property in accordance with the cost model and writes off depreciation on the straight-line method. The investment property was available for use as intended by management immediately and the useful life was estimated to be 40 years on 1 January 20X2. There is no estimated residual value. On 31 December 20X6, H Limited decided to change its accounting policy and to account for investment property using the fair value model since the fair values are used by management in making decisions and this would ensure better communication with its investees. The extracts from the financial statements are before the change in accounting policy has been taken into account. The depreciation for the year ended 31 December 20X6 has already been accounted for. The fair value of the investment property (in total) disclosed in the financial statements over the past years was: R 31 December 20X3 15 900 000 31 December 20X4 16 200 000 31 December 20X5 16 550 000 On 31 December 20X6, the fair value of the investment property was R16 650 000. Ignore all tax implications. There have been no changes in the issued share capital of H Limited since its


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incorporation. The issued share capital comprises 1 million ordinary shares. There are no potentially dilutive instruments in issue on 31 December 20X5 and 20X6. Required: a. Present the statement of profit or loss and other comprehensive income for the

year ended 31 December 20X6 of H Limited in accordance with International Financial Reporting Standards (IFRS), having taken the change in accounting policy into account.

Note: Round all calculated amounts to the nearest Rand. Notes are not required.

b. Present the statement of financial position of H Limited as at 31 December 20X6 in accordance with International Financial Reporting Standards (IFRS), having taken the change in accounting policy into account.

Note: Round all calculated amounts to the nearest Rand. Notes are not required.

c. Prepare the “Investment property” note for H Limited for the year ended 31 December 20X6 in accordance with International Financial Reporting Standards (IFRS), having taken the change in accounting policy into account.

Note: Round all calculated amounts to the nearest Rand.

d. Prepare the correcting journal entries of H Limited for the year ended 31 December 20X6 to account for the change in accounting policy in accordance with International Financial Reporting Standards (IFRS).

Note: Round all calculated amounts to the nearest Rand. e. Prepare the accounting policy note of H Limited for the year ended

31 December 20X6 in accordance with International Financial Reporting Standards (IFRS) after the change in accounting policy has been made.

f. Prepare the “Change in accounting policy” note of H Limited for the year ended

31 December 20X6 in accordance with International Financial Reporting Standards (IFRS).


g. Present the statement of changes in equity of H Limited for the year ended

31 December 20X6 in accordance with International Financial Reporting Standards (IFRS) (in as far as the given information permits).


The total column is not required.


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Suggested solution: Part A H Limited Statement of profit or loss and other comprehensive income for the year ended 31 December 20X6 20X6 20X5 R R Gross profit 5 500 000 4 570 000 Other income 212 000 578 000 20X6: [R112 000 (given) + R100 000 (calc)] 20X5: [R228 000 (given) + R350 000 (calc)]

Other expenses (717 500) (633 900) 20X6: [R1 042 500 (given) – R325 000 (calc)] 20X5: [R958 900 (given) – R325 000 (calc)] Profit for the period 4 994 500 4 514 100 Other comprehensive income Items that will not be reclassified to profit or loss: Revaluation of machinery 89 000 114 000 - Revaluation surplus 89 000 114 000 - Income tax expense (told to ignore in this example) - -

Total comprehensive income for the year 5 083 500 4 628 100 Calculation: 20X6 20X5 R R Fair value adjustment 100 000 350 000 20X6: (R16 650 000 – R16 550 000) 20X5: (R16 550 000 – R16 200 000)

Depreciation [(R15 600 000 – R2 600 000 land) / 40 years]

325 000 325 000


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Part B H Limited Statement of financial position as at 31 December 20X6

Assets 20X6 20X5 01/01/20X5 R R R Non-current assets

Investment property 16 650 000 16 550 000 16 200 000 Other non-current assets 32 500 000 24 800 000 xxx

Current assets 15 000 000 12 000 000 xxx Total assets 64 150 000 53 350 000 xxx

Equity and liabilities 20X6 20X5 01/01/20X5 R R R Equity 34 322 500 29 239 000 24 610 900

Share capital 1 000 000 1 000 000 1 000 000 Retained earnings 32 948 500 27 954 000 23 439 900 Other components of equity 374 000 285 000 (a)171 000

Current liabilities 29 827 500 24 111 000 xxx Total equity and reserves 64 150 000 53 350 000 xxx (a) R285 000 – R114 000 = R171 000 Calculation: 20X6 20X5 01/01/20X5 R R R Carrying amount should be 16 650 000 16 550 000 16 200 000 Carrying amount was (13 975 000) (14 300 000) (14 625 000) [given; R15 600 000 – (R15 600 000 – R2 600 000) / 40 years x 3 years]

Increase in assets 2 675 000 2 250 000 1 575 000 Increase in liabilities - - - Increase in retained earnings 2 675 000 2 250 000 1 575 000 Retained earnings balance given 30 273 500 25 704 000 21 864 900 New retained earnings balance 32 948 500 27 954 000 23 439 900

Alternative calculation:

20X6 20X5 01/01/20X5 R R R Retained earnings (given) 30 273 500 25 704 000 21 864 900 Fair value adjustments (cumulative) (6) 1 050 000 (5) 950 000 (1) 600 000

Cumulative previous year 950 000 600 000 (1) 600 000

Period specific (7) 100 000 (8) 350 000 - Depreciation (4) 1 625 000 (3) 1 300 000 (2) 975 000

Cumulative previous year 1 300 000 975 000 (2) 975 000

Period specific (9) 325 000 (9 )325 000 -

32 948 500 27 954 000 23 439 900


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(1) R16 200 000 – R15 600 00 = R600 000 (2) R325 000 pa x 3 years (1/1/X2 – 31/12/X4) = R975 000 (3) R325 000 x 4 years (1/1/X2 – 31/12/X4) = R1 300 000 (4) R325 000 x 5 years (1/1/X2 – 31/12/X5) = R1 625 000 (5) R16 550 000 – R15 600 000 = R950 000 (6) R16 650 000 – R15 600 000 = R1 050 000 (7) R16 650 000 – R16 550 000 = R100 000 (8) R16 550 000 – R16 200 000 = R350 000 (9) (R15 600 000 – R2 600 000 land) / 40 years = R325 000

Part C H Limited Notes for the year ended 31 December 20X6

2. Investment property 20X6 20X5 R R Balance at beginning of year 16 550 000 16 200 000 Fair value adjustment 100 000 350 000 Balance at end of year 16 650 000 16 550 000

Note: The change in accounting policy has no disclosure impact on this note – only the amounts after the change in policy are disclosed. Refer also to IAS 1, para 40C. Part D H Limited General journal

Dr R

Cr R

Investment property (SFP) (R16 200 000 – R15 600 000) 600 000 Accumulated depreciation – investment property (SFP) 975 000 (R1 575 000 (calc Part B) – R600 000) or (R325 000 Part A x 3 years)

Retained earnings (opening) (SFP) 1 575 000 (Restatement of retained earnings beginning 20X5)

Investment property (SFP) (calc part A) 350 000 Accumulated depreciation – investment property (SFP) (calc Part A)

325 000

Retained earnings (opening) (SFP) 675 000 (Restatement of investment property movement 20X5)

Alternatively, the previous two journals can be combined (recommended): Investment property (SFP) (R16 550 000 – R15 600 000) 950 000 Accumulated depreciation – investment property (SFP) 1 300 000 (R2 250 000 (calc Part B) – R950 000) or (R325 000 Part A x 4 years)

Retained earnings (opening) (SFP) 2 250 000 (Restatement of retained earnings cumulative 20X5)


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Dr R

Cr R

Accumulated depreciation – investment property (SFP) 325 000 Depreciation (P/L) (calc Part A) 325 000

(Restatement of depreciation 20X6) Investment property (SFP) 100 000

Fair value adjustment (P/L) (calc Part A) 100 000 (Restatement of fair value adjustment 20X6) Alternatively, all the journal entries can be combined: Investment property (SFP) (R16 650 000 – R15 600 000) 1 050 000 Accumulated depreciation – investment property (SFP) 1 625 000 (R2 675 000 (calc Part) – R1 050 000) or (R325 000 Part A x 5 years)

Retained earnings (opening) (SFP) (calc Part B) 2 250 000 Depreciation (P/L) (calc Part A) 325 000 Fair value adjustment (P/L) (calc Part A) 100 000

(Restatement of investment property) Part E

H Limited Notes for the year ended 31 December 20X6

1. Accounting policy

1.1. Basis of preparation

The annual financial statements are prepared in accordance with International Financial Reporting Standards (IFRS) on the historical cost basis, other than for investment property which is carried at fair value. The accounting policies are consistent with those of the previous year, unless otherwise stated.

1.2. Investment property

Investment property is accounted for in accordance with the fair value model. This represents a change in accounting policy from the previous year – refer note 3.

Part F

H Limited Notes for the year ended 31 December 20X6

3. Change in accounting policy

During the year ended 31 December 20X6, the company changed its accounting policy in respect of investment property from the cost model to the fair value model. The fair value model provides more relevant information since this is the basis used by management in making decisions and would ensure better communication with its investees. The accounting policy has been retrospectively applied and the impact on the line items in the financial statements is as follows:


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20X6 20X5 01/01/20X5 R R R Increase in other income (calc part A) 100 000 350 000 Decrease in other expenses (calc Part A) 325 000 325 000 Increase in profit/total comprehensive income for the year

425 000

675 000

Increase in investment property (calc part B)

2 675 000 2 250 000 1 575 000

Increase in equity - retained earnings 2 675 000 2 250 000 1 575 000

Increase in retained earnings on 01/01/20X5 1 575 000

Increase in basic earnings per share (20X6: R425 000 above/1 million shares) (20X5: R675 000 above/1 million shares)

R0,425 R0,675

Note the relationship between the items that are disclosed: R Increase in retained earnings 01/01/20X5 1 575 000 Increase in profit for the year 20X5 (period specific effect) 675 000 Increase in retained earnings 31/12/20X5 (cumulative effect) 2 250 000 Increase in profit for the year 20X6 (period specific effect) 425 000 Increase in retained earnings 31/12/20X6 (cumulative effect) 2 675 000

Note: The amounts in the change in accounting policy note are literally the differences between the amounts of the line items of the financial statements based on the previous accounting policy and reported in the financial statements that were issued (as provided in the information) and the amounts (re-stated) of the line items of the financial statements based on the application of the new accounting policy following the retrospective application of the change in accounting policy (as prepared in parts A and B).

Direct calculations for parts D and F

Parts D and F amounts could also be calculated directly as follows:

20X6 20X5 01/01/20X5 R R R Carrying amount should be 16 650 000 16 550 000 16 200 000 Carrying amount was (13 975 000) (14 300 000) (14 625 000) [given; R15 600 000 – (R15 600 000 – R2 600 000) / 40 years x 3 years]

Increase in assets/retained earnings 2 675 000 2 250 000 1 575 000

Fair value adjustment must be 100 000 350 000 20X6: (R16 650 000 – R16 550 000) 20X5: (R16 550 000 – R16 200 000)

Fair value adjustment was - - Increase in other income 100 000 350 000

Depreciation must be - - Depreciation was [(R15 600 000 – R2 600 000) /40 yrs]

325 000 325 000

Decrease in other expenses 325 000 325 000


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Part G H Limited Statement of changes in equity for the year ended 31 December 20X6

Ordinary share capital

Retained earnings

Revaluation surplus

R R R Balance on 1 January 20X5 as previously presented

1 000 000

21 864 900

171 000

Effect of change in accounting policy (refer note 3)

-

1 575 000

-

Re-stated balance on 1 January 20X5 1 000 000 23 439 900 171 000 Re-stated amount of total comprehensive income for the year

-

4 514 100

114 000

Re-stated profit for year (note 3) - 4 514 100 - Other comprehensive income for year - - 114 000

Re-stated balance on 1 January 20X6 1 000 000 27 954 000 285 000 Total comprehensive income for the year 4 994 500 89 000 Profit for the year - 4 994 500 - Other comprehensive income for year - - 89 000

Balance 31 December 20X6 1 000 000 32 948 500 374 000

Changes in accounting policies: income tax implications

In order to account for the income tax implications related to changes in accounting policies, it is of paramount importance that you distinguish the re-opening of the accounting records from the re-opening of income tax returns.

Accounting records Income tax returns

Re-opening depends on the functionality of the accounting system itself

Re-opening depends on the decisions made by SARS

Re-open: Prior years’ profit and loss (and other comprehensive income) general ledger accounts can be used to post journal entries to account for the effects of the changes in accounting policy as if those general ledger accounts had not been closed off to retained earnings or other reserve general ledger accounts.

Re-open: SARS will re-calculate the entity’s current tax obligation for the prior years’ assessments issued.

Deferred tax for the prior periods will have to be re-calculated if the temporary differences change. In other words, if the carrying amounts and / or the tax base amounts change because of the retrospective application of the change in accounting policy, there will be a change in the temporary differences.


18

Accounting records Income tax returns

Not re-opened: Prior years’ profit or loss (and other comprehensive income) general ledger accounts are not available for the processing of journal entries.

Adjustments related to income and expense items are made directly in the opening balance of retained earnings (or other component of equity account, for example, revaluation surplus) by journal entry.

Not re-opened: SARS only accepts the new accounting policy when the current year’s current tax obligation is calculated. The current tax calculation includes an adjustment for the change in accounting policy where the retrospective application would have affected opening balances, for example, the opening balance of inventories.

Deferred tax for the prior periods would be re-calculated, if the temporary differences change. In other words, the carrying amounts of assets and / or liabilities change because of the retrospective application of the change in accounting policy. Since SARS has not re-opened any prior years’ assessments, there can be no changes to the tax base. Thus, there will be a change in the temporary differences due the change in the carrying amounts.

Re-opening of the accounting records (or not) affect only the journal entries. Disclosure remains the same.

Re-opening of income tax returns (or not) affect both the journal entries and disclosure because the current tax obligation (asset) and the deferred tax obligation (asset) are presented separately on the statement of financial position.

Unless a question specifically states otherwise, assume that the accounting records CANNOT be re-opened.

A question must always clearly indicate whether or not prior years’ income tax returns have been re-opened.

The example that follows will illustrate the effect of different scenarios related to the re-opening of accounting records and income tax returns / assessments when there is a change in accounting policy.

Class example 3 – Change in accounting policy (with tax)

V Limited has a 30 June reporting date. On 30 June 20X7, the company decided to change the inventories cost formula from the weighted average method to the first-in-first-out method. This decision was taken as the first-in-first-out method better reflects the physical flow of inventories. The impact on the closing inventories for the past financial years was as follows:


19

Closing inventories on Weighted average method

R

First-in-first-out method

R 30 June 20X5 510 000 528 000 30 June 20X6 625 000 655 000 30 June 20X7 730 000 743 000

V Limited only had finished goods on hand in each of the above financial years.

V Limited’s profit before tax amounted to R2,3 million for the year ended 30 June 20X7 after the change in accounting policy. There were no non-taxable or non-deductible items and no temporary differences, other than those that are evident from the information.

The tax rate remained unchanged at 28%.

V Limited uses a perpetual inventories system. Required:

Assuming that the South African Revenue Service (SARS) will re-open the income tax returns of prior years:

a. Calculate the current income tax expense of V Limited for the year ended 30 June 20X7.

b. Disclose the change in accounting policy in the notes of V Limited for the year ended 30 June 20X7 in accordance with International Financial Reporting Standards (IFRS).

c. Prepare the journal entries of V Limited in respect of the change in accounting

policy for the year ended 30 June 20X7 in accordance with International Financial Reporting Standards (IFRS).

Assuming that the South African Revenue Service (SARS) will not re-open the income tax returns of prior years:

d. Calculate the current income tax expense of V Limited for the year ended 30 June 20X7.

e. Disclose the change in accounting policy in the notes of V Limited for the year ended 30 June 20X7 in accordance with International Financial Reporting Standards (IFRS).

f. Prepare the journal entries of V Limited in respect of the change in accounting policy for the year ended 30 June 20X7 in accordance with International Financial Reporting Standards (IFRS).


20

Suggested solution: Part A R Accounting profit before tax (given) 2 300 000 Temporary differences - Taxable profit 2 300 000 Current tax at 28% (R2 300 000 x 28%) 644 000 Note: The tax base of inventories is the same as the re-stated accounting carrying amounts for all of the years as SARS has reopened prior year’s tax returns. Therefore, the change in accounting policy does not affect the current tax calculation since the amount of R2,3 million given is after the effect of the change in accounting policy has been taken into account. SARS has reopened prior years’ tax returns and therefore the current tax effect of the retrospective portion of the change in accounting policy is part of the opening balance of current tax for 20X7. Part B V Limited Notes for the year ended 30 June 20X7


During the year ended 30 June 20X7, the company changed the cost formula of inventories from the weighted average method to the first-in-first-out method, as it better reflects the physical flow of inventories. The change in has been applied retrospectively. The impact on the line items in the financial statements was as follows: 20X7 20X6 01/07/20X5 R R R (Increase) / decrease in cost of sales (17 000) 12 000 (Increase) / decrease in income tax expense 4 760 (3 360) Increase / (decrease) in profit and total comprehensive income for the year

(12 240)

8 640

Increase / (decrease) in inventories 13 000 30 000 18 000 (Increase) / decrease in current tax payable (3 640) (8 400) (5 040) Increase in equity – retained earnings 9 360 21 600 12 960 Increase in retained earnings on 01/07/20X5 12 960 Increase / (Decrease) in basic earnings per share

(xx.xx)

xx.xx

Increase / (Decrease) in diluted earnings per share

(xx.xx)

xx.xx


21

Calculations: 20X7 20X6 01/07/20X5 R R R (Decrease)/Increase in profit before tax (due to effect on cost of sales: 20X7: increase in COS; 20X6: decrease in COS)

(17 000) 12 000

Opening inventories (b)30 000 (a)18 000 Closing inventories (c) (13 000) (b) (30 000) Decrease/(Increase) in income tax 28% (R17 000 x 28%; R12 000 x 28%)

4 760 (3 360)

(Decrease)/Increase in profit after tax (12 240) 8 640

Increase in closing inventories (c)13 000 (b)30 000 (a)18 000 Tax effect at 28% (all increase in current tax owing) (R13 000 x 28%; R30 000 x 28%; R18 000 x 28%)

(3 640) (8 400) (5 040)

(Decrease)/Increase in retained earnings 9 360 21 600 12 960

(a) R528 000 – R510 000 = R18 000 (b) R655 000 – R625 000 = R30 000 (c) R743 000 – R730 000 = R13 000 Note: In this scenario, the tax base of the inventories changes by the same amount that the accounting carrying amount changes because SARS reopened the prior years’ tax returns (i.e. SARS accepted the change in accounting policy retrospectively). Therefore, there are no deferred tax consequences arising from this change in accounting policy. The deferred tax consequences are illustrated for 20X5 below (would be the same principle for 20X6 and 20X7):

CA

R

TB

R

TD

R

DT (SFP) (dr) / cr

R 20X5 (old policy) 28% Inventories 510 000 510 000 - -

20X5 (new policy) Inventories 528 000 528 000 - -

Difference -


22

Part C

V Limited General journal

Dr R

Cr R

Inventories (SFP) 30 000 Current tax payable (SFP) 8 400 Retained earnings (SFP/Equity) 21 600

Restate opening balances for change in accounting policy

Cost of sales (P/L) 17 000 Inventories (SFP) 17 000

Restate cost of sales for change in accounting policy

Current tax payable (SFP) 4 760 Income tax expense (P/L) 4 760

Tax impact of change in accounting policy

Note: In the absence of information to the contrary, it is assumed that the prior years’ accounting records cannot be reopened. Therefore the prior year’s income and expense accounts are not available for journal entries to be processed against them. This means that the net effect of all of the income and expense amounts for the prior years are processed against the opening balance of the retained earnings account in the general ledger account.

Should it be possible to reopen the income and expense accounts in the general ledger of 20X6 ONLY (but not 20X5), the journal entries would be the following:


Dr R

Cr R

20X6

Inventories (SFP) 18 000 Current tax payable (SFP) 5 040 Retained earnings (SFP/Equity) 12 960

Restate opening balances of 20X6 for change in accounting policy

Inventories (SFP) 12 000 Cost of sales (P/L) 12 000

Restate 20X6 cost of sales for change in accounting policy

Income tax expense (P/L) 3 360 Current tax payable (SFP) 3 360

20X6 tax impact of change in accounting policy

20X7



Current tax payable (SFP) 4 760 Income tax expense (P/L) 4 760



23

Part D R Accounting profit before tax (given) 2 300 000 Temporary differences 30 000 - opening inventories (accounting) 655 000 - opening inventories (tax) (625 000)

Taxable profit 2 330 000

Current tax at 28% (R2 330 000 x 28%) 652 400 Note: Since SARS only accepted the application of the change in the accounting policy for the inventories on 30 June 20X7 and onwards, there will be a difference between the carrying amount of inventories for accounting purposes, which will be the re-stated amount, and the carrying amount of the inventories for income tax purposes (i.e. the tax base) which will be the amount before re-statement, for the periods prior to 30 June 20X7. In respect of the inventories on hand on 30 June 20X6 (i.e. the opening inventories for the year ended 30 June 20X7), the accounting carrying amount was re-stated to R655 000 because of the retrospective application of the change in accounting policy. However, the carrying amount for tax purposes is still the amount before re-statement, namely R625 000. In the determination of the accounting profit before tax, the opening inventories would have been R655 000. This means that an adjustment will have to be made in respect of the opening inventories when calculating the taxable profit. The change in accounting policy affects the current tax calculation for 20X7 only. SARS did not reopen prior years’ tax returns and therefore the current tax impact of the change in accounting policy forms part of the current tax expense for 20X7. The tax impact of the change in accounting policy on previous financial years is recognised against deferred tax.


24

Part E V Limited Notes for the year ended 30 June 20X7 3. Change in accounting policy

During the year ended 30 June 20X7, the company changed the cost formula of inventories from the weighted average method to the first-in-first-out method, as it better reflects the physical flow of inventories. The change in method has been applied retrospectively. The impact on the line items in the financial statements was as follows: 20X7 20X6 01/07/20X5 R R R (Increase) / decrease in cost of sales (17 000) 12 000 (Increase) / decrease in income tax expense 4 760 (3 360) Increase / (decrease) in profit and total comprehensive income for the year

(12 240)

8 640

Increase / (decrease) in inventories 13 000 30 000 18 000 (Increase) / decrease in deferred tax liability - (8 400) (5 040) (Increase) / decrease in current tax payable (3 640) - - Increase in equity – retained earnings 9 360 21 600 12 960

Increase in retained earnings on 01/07/20X5 12 960

Increase / (Decrease) in basic earnings per share

(xx.xx)

xx.xx

Increase / (Decrease) in diluted earnings per share

(xx.xx)

xx.xx

Calculations:

20X7 20X6 01/07/20X5 R R R (Decrease)/Increase in profit before tax (due to effect on cost of sales: 20X7: increase in COS; 20X6: decrease in COS)

(17 000) 12 000

Opening inventories (b)30 000 (a)18 000 Closing inventories (c) (13 000) (b) (30 000) Decrease/(Increase) in income tax 28% (R17 000 x 28%; R12 000 x 28%)

4 760 (3 360)

(Decrease)/Increase in profit after tax (12 240) 8 640

Increase in closing inventories (c)13 000 (b)30 000 (a)18 000 Tax effect at 28% (20X7: increase in current tax owing; 20X6 and 1/7/20X5: increase in deferred tax liability) (R13 000 x 28%; R30 000 x 28%; R18 000 x 28%)

(3 640)

(8 400)

(5 040)

(Decrease)/Increase in retained earnings 9 360 21 600 12 960


25

(a) R528 000 – R510 000 = R18 000 (b) R655 000 – R625 000 = R30 000 (c) R743 000 – R730 000 = R13 000 Note: In this scenario, the tax base of the inventories changes by the same amount that the accounting carrying amount changes ONLY for the closing inventories on 30 June 20X7 because SARS DID NOT reopen the prior years’ tax returns (i.e. SARS did not accept the full retrospective application of the change in accounting policy). Since the closing inventories for the years ended 30 June 20X6 and 20X5 were not changed for tax purposes, there will be a difference between the carrying amount of the inventories for accounting purposes (which will be at the restated amounts) and the tax base (which will still be at the amount before restatement) Consequently a temporary difference would arise for 20X5 and 20X6, so a deferred tax liability would be recognised for 20X6 and 20X5 (1/1/20X6) measured at the tax rate of 28%. The deferred tax consequences of this situation are illustrated below:

CA

R

TB

R

TD

R

DT (SFP) (dr) / cr


20X5 (new policy) Inventories 528 000 510 000 18 000 5 040 Thus, an increase in the deferred tax liability of R5 040 would be recognised with an adjustment of R5 040 to the income tax expense, which will be made against retained earnings on 1/7/20X5.

CA

R

TB

R

TD

R

DT (SFP) (dr) / cr


20X6 (new policy) Inventories 655 000 625 000 30 000 8 400 Thus, a deferred tax liability of R8 400 would be recognised. This would require an increase in the deferred tax liability of R3 360 with an adjustment to the income tax expense of R3 360 (the change from R5 040 credit to R8 400 credit).

CA

R

TB

R

TD

R

DT (SFP) (dr) / cr

R 20X7 (new policy) 28% Inventories 743 000 743 000 - -


26

Thus, a deferred tax liability of Rnil would be recognised. This would require a decrease in the deferred tax liability of R8 400 with an adjustment to the income tax expense of R8 400 (the change from R8 400 credit to Rnil). Part F V Limited General journal

Dr R

Cr R

Inventories (SFP) 30 000 Deferred tax (SFP) 8 400 Retained earnings (SFP / Equity) 21 600

Restate opening balances for change in accounting policy


Restate cost of sales for change in accounting policy

Deferred tax (SFP) 8 400 Income tax expense (P/L) 8 400

Movement on deferred tax following change in accounting policy


Current tax impact of change in accounting policy Note: In the absence of information to the contrary, it is assumed that the prior years’ accounting records cannot be reopened. Therefore the prior year’s income and expense accounts are not available for journal entries to be processed against them. This means that the net effect of all of the income and expense amounts for the prior years are processed against the opening balance of the retained earnings account in the general ledger account. Should it be possible to reopen the income and expense accounts in the general ledger of 20X6 ONLY (but not 20X5), the journal entries would be the following: V Limited General journal

Dr R

Cr R

20X6

Inventories (SFP) 18 000 Deferred tax (SFP) 5 040 Retained earnings (SFP / Equity) 12 960

Restate opening balances of 20X6 for change in accounting policy



Income tax expense (P/L) 3 360 Deferred tax (SFP) 3 360



27


Dr R

Cr R

20X7



Deferred tax (SFP) 8 400 Income tax expense (P/L) 8 400

Movement on deferred tax following change in accounting policy for 20X7 effect


Current tax impact of change in accounting policy for 20X7 effect

Changes in accounting policy: retrospective application not possible (IAS 8, paras 5; 19 – 29 and 50 – 53)


Retrospective application

Impracticable

Prospective application

As discussed earlier, a change in accounting policy in normally applied retrospectively, unless the change is made in accordance with the transitional provisions of a new IFRS (IAS 8, para 19).

When the retrospective application of a new accounting policy is required, it may not always be possible to comply with this requirement. In such cases, full retrospective application of the change in accounting policy is not required (IAS 8, para 23).

? Impracticable

Impracticable means that a requirement cannot be complied with even after all reasonable attempts have been made to do so.

Retrospective application of a change in accounting policy may be impracticable for one of the three reasons (IAS 8, para 5):

The effect of the retrospective application cannot be determined;

Assumptions about what management intended would be required; or

Estimations are necessary for the application of the change in accounting policy and there are no objective ways to distinguish between information that was available when the policy was applied in previous years and other information.


28

IAS 8, paras 50 – 53, explain in broad terms what circumstances would have resulted in the retrospective application of the change in accounting policy being impracticable. Note that the actual outcomes in the prior periods cannot be used as the estimated amounts to be used for the prior periods (IAS 8, para 53).

? The impact of impracticable

Regardless of the reason why full retrospective application is impracticable, the result of this is that: either the cumulative effect of retrospective application, or the period-specific effect of the retrospective application, or both cannot be determined for one or more prior periods.

Note: The cumulative effect relates to the statement of financial position (i.e. balances involved). The period-specific effect relates to the statement of profit or loss and other comprehensive income (i.e. movements)

? The alternative to full retrospective

Impracticable to determine the period-specific effect on prior periods (IAS 8, para 24)

This means that the cumulative effect on the prior periods (i.e. the sum of all of the individual movements) can be determined but not the individual movements per period.

Thus, the accounting policy is retrospectively applied from the earliest date possible (i.e. the SFP is adjusted). From this date going forwards, the new accounting policy can be applied to the movements (i.e. the period-specific effects can be determined).

Impracticable to determine the cumulative effect at the beginning of the current year (IAS 8, para 25 and 27)

This means that the cumulative effect at the beginning of the current year (i.e. the sum of the movements of the prior periods) cannot be determined.

Thus the accounting policy is applied from the earliest date possible. This means that the balances (i.e. the SFP) before this date remained unchanged.

Note that an accounting policy can be changed even if it is not possible to determine the effect of this change on any of the prior periods (IAS 8, para 27).

The following examples explain the various scenarios where full retrospective application of a change in accounting policy is impracticable.


29

Class example 4 – Change in accounting policy (retrospective application impracticable; period-specific effect not determinable) On 31 December 20X11, K LIMITED decided to change its method of accounting for inventories from the weighted average method to the first-in-first-out method. This decision was taken as the first-in-first-out method is a more accurate reflection of the actual physical flow of inventories. The impact of this change in accounting policy on the past years is as follows: Closing inventories Weighted average method

R First-in-first-out method

R 31 December 20X9 510 000 ??? 31 December 20X10 625 000 655 000 31 December 20X11 730 000 743 000 K Limited cannot determine what impact the change in accounting policy would have had on the closing inventories on 31 December 20X9 as the purchases records for that year have all been lost because of a system error. K Limited only had finished goods on hand in each of the previous financial years. The tax rate has remained unchanged at 28%. The South African Revenue Service (SARS) has indicated that they will not re-open previous years’ income tax assessments and only accepted the new method of valuation on 31 December 20X11. Required: a. Prepare the journal entries of K Limited in respect of the change in accounting

policy for the year ended 31 December 20X11 in accordance with International Financial Reporting Standards (IFRS). Note: Round calculated amounts to the nearest Rand.

Journal narrations are not required. b. Disclose the note related to the change in accounting policy of K Limited for the

year ended 31 December 20X11 in accordance with International Financial Reporting Standards (IFRS). Note: Round calculated amounts to the nearest Rand.

c. Present the inventories line item on the statement of financial position of K

Limited as at 31 December 20X11 in accordance with International Financial Reporting Standards (IFRS). Note: Round calculated amounts to the nearest Rand.


30

Suggested solution: Part A Dr

R Cr R

Inventories (SFP) 30 000 Deferred tax (SFP) 8 400 Retained earnings – opening (SFP) 21 600

Cost of sales (P/L) 17 000 Inventories (SFP) 17 000 Deferred tax (SFP) 8 400

Income tax expense (P/L) 8 400 Income tax expense (P/L) 3 640

Current tax payable (SFP) 3 640 Calculations: 20X11 20X10 01/07/20X10 R R R (Decrease)/Increase in profit before tax (due to effect on cost of sales: 20X11: increase in COS)

(17 000) ???

Opening inventories (20X11: R655 000 – R625 000)

30 000 ???

Closing inventories (20X11: R743 000 – R730 000; 20X10: R655 000 – R625 000)

(13 000) (30 000)

Decrease/(Increase) in income tax 28% (R17 000 x 28%)

4 760 ???

(Decrease)/Increase in profit after tax (12 240) ???

Increase in closing inventories 13 000 30 000 ??? Tax effect at 28% (R13 000 x 28%; R30 000 x 28%

(3 640)

(8 400)

???

(Decrease)/Increase in retained earnings 9 360 21 600 ??? Note: Since the effect on the closing inventories of 20X9 cannot be determined, the period-specific effect (i.e. the effect on cost of sales) for 20X10 also cannot be determined. Accordingly, in terms of IAS 8.24, the new accounting policy is applied to the carrying amounts of assets and liabilities as at the beginning of the earliest period for which retrospective application is practicable with a corresponding adjustment to the opening balance of each affected component of equity (i.e. the new policy is applied from the first period for which the cumulative effect at the beginning of the year can be determined). In this scenario, this will be at the beginning of 20X11.


31

Part B K Limited Notes for the year ended 31 December 20X11 3. Change in accounting policy During the year ended 31 December 20X11, the company changed the method of accounting for the inventories from the weighted average method to the first-in-first-out method since this better reflected the actual physical flow of inventories. Full retrospective application of the change in accounting policy could not be applied due to the lack of purchases records that resulted in the period-specific effect on the 20X10 financial year not being possible to determine. Accordingly, the new accounting policy could only be applied retrospectively from the beginning of 20X11 to the line items in the financial statements as follows: 20X11 R Increase in cost of sales (17 000) Decrease in income tax expense 4 760 Decrease in profit/total comprehensive income for the year (12 240) Increase in inventories 13 000 Increase in current tax owing (3 640) Increase in equity – retained earnings 9 360 Increase in retained earnings on 01/01/20X11 21 600 Decrease in basic earnings per share (xx.xx) Decrease in diluted earnings per share (xx.xx) Part C K Limited 20X11 20X10 Statement of financial position as at 31 December 20X11 R R Assets Inventories 743 000 625 000 Note: The change in accounting policy could only be applied from the beginning of the current year. Thus the comparative amounts for 20X10 for the carrying amount of the inventories will still be the amount before the change in accounting policy. Also, only two statements of financial position are presented even though there has been a change in accounting policy. This is because full retrospective application of the accounting policy was not possible so it did not influence the opening and closing balances of 20X10.


32

Class example 5 – Change in accounting policy (retrospective application impracticable; cumulative effect not determinable)

On 31 December 20X11, K LIMITED decided to change its method of accounting for inventories from the weighted average method to the first-in-first-out method. This decision was taken as the first-in-first-out method is a more accurate reflection of the actual physical flow of inventories. The impact of this change in accounting policy on the past years is as follows: Closing inventories Weighted average method

R First-in-first-out method

R 31 December 20X9 510 000 ??? 31 December 20X10 625 000 ??? 31 December 20X11 730 000 743 000 K Limited cannot determine what impact the change in accounting policy will have on the closing inventories on 31 December 20X9 and 31 December 20X10 as the purchase records for those years have all been lost because of a system error. K Limited only had finished goods on hand in each of the previous financial years. The tax rate has remained unchanged at 28%. The South African Revenue Service (SARS) has indicated that they will not re-open previous years’ income tax assessments and only accepted the new method of valuation on 31 December 20X11. Required: a. Prepare the journal entries of K Limited in respect of the change in accounting

policy for the year ended 31 December 20X11 in accordance with International Financial Reporting Standards (IFRS). Note: Round calculated amounts to the nearest Rand.

Journal narrations are not required. b. Disclose the note related to the change in accounting policy of K Limited for the

year ended 31 December 20X11 in accordance with International Financial Reporting Standards (IFRS). Note: Round calculated amounts to the nearest Rand.

c. Present the inventories line item in the statement of financial position of K

Limited as at 31 December 20X11 in accordance with International Financial Reporting Standards (IFRS). Note: Round calculated amounts to the nearest Rand.


33

Suggested solution: Part A Dr

R Cr R


Income tax expense (P/L) 3 640

Current tax owing (SFP) 3 640 Calculations: 20X11 20X10 01/01/20X10 R R R (Decrease)/Increase in profit before tax (due to effect on cost of sales: 20X11: increase in COS)

13 000

???

Opening inventories ??? ??? Closing inventories (increase) (13 000) ??? (R743 000 – R730 000) Tax effect at 28% (R13 000 x 28%)

(3 640) ???

(Decrease)/Increase in profit after tax 9 360 ??? Closing inventories (change = increase)

13 000 ??? ???

Tax effect at 28% (R13 000 x 28%)

(3 640) ??? ???

Retained earnings 9 360 ??? ??? Note: Since the cumulative effect on the closing inventories of 20X10 cannot be determined, the period-specific effect (i.e. the effect on cost of sales) for 20X11 cannot be determined. Accordingly, in terms of IAS 8.25, the new accounting policy is applied prospectively from the first period practicable (i.e. at the beginning of 20X11) by accounting for inventories transactions from the beginning of 20X11 in accordance with the new accounting policy (i.e. purchases from 1/1/20X11 and closing inventories on 31/12/20X11).


34

Part B

K Limited Notes for the year ended 31 December 20X11


During the year ended 31 December 20X11, the company changed the method of accounting for the inventories from the weighted average method to the first-in-first-out method since this better reflected the actual physical flow of inventories. Full retrospective application of the change in accounting policy was not practicable since the cumulative effect on prior periods could not be determined due to the lack of purchases records. Accordingly, the new accounting policy could only be applied prospectively to transactions from the beginning of the 20X11 year to the line items in the financial statements as follows:

20X11 R Decrease in cost of sales 13 000 Increase in income tax expense (3 640) Increase in profit / total comprehensive income for the period 9 360 Increase in inventories 13 000 Increase in current tax payable (3 640) Increase in equity – retained earnings 9 360 Increase in retained earnings on 01/01/20X11 - Increase in basic earnings per share xx.xx Increase in diluted earnings per share xx.xx Part C K Limited 20X11 20X10 Statement of financial position as at 31 December 20X11 R R Assets Inventories 743 000 625 000 Note: The change in accounting policy has been applied prospectively from the beginning of the current year. Therefore the comparatives for 20X10 will still reflect the carrying amount of the inventories before the change in accounting policy. Also note that only two statements of financial position are presented, despite the fact that there was a change in accounting policy. This is because the new accounting policy could not be applied retrospectively and therefore did not affect the opening and closing balances of 20X10.

Changes in accounting policy that are not applied retrospectively (IAS 8, paras 17 – 18)

IAS 8, paras 17 – 18, states that a change in accounting policy from the cost model to the revaluation model (IAS 16 and IAS 38) shall not be applied retrospectively. These changes are applied prospectively from the date of the first revaluation.


35

Note: This treatment is in accordance with the general requirements IAS 8 that have already been discussed. It would be to almost impossible to obtain objective valuation amounts for past years and this makes it impracticable to apply the new accounting policy retrospectively. IAS 16 and IAS 38 do not require the disclosure of the fair value of the assets if they are accounted for on the cost model, so this information is not available. On the other hand, IAS 40 does require the disclosure of the fair value of the investment property if the cost model is applied, so the fair value information is easily obtainable. For this reason, it would be possible to do full retrospective application of a change in accounting policy from the cost model to the fair value model for investment property.

Correction of a prior period error: revision of basic principles (IAS 8, paras 5; 41 – 42 and 48 – 49)


Material

Prior period errors

Retrospective restatement

Note the following from these definitions:

Prior period errors arise from existing information that was available when the financial statements were authorised for issue.

Regardless of whether management had the information, if it can be shown that this information could have been reasonably obtained, a prior period error may arise.

Prior period errors can relate to various aspects of the financial statements. Refer to IAS 8, para 41, for examples.

Note that errors that are discovered before the issue of the financial statements must be corrected in the current reporting period before they are authorised for issue (IAS 8, para 41).

Take note of the difference between a prior period error and a change in accounting estimate. (IAS 8, para 48).

Correction of a prior period error (IAS 8, para 42)

Material prior period errors are corrected retrospectively (IAS 8, para 42).

Retrospective restatement means that the accounting records and the financial statements of the prior periods are adjusted as if the prior period error had never occurred. Refer to IAS 8, para 5 and para 42 for further explanations.

Retrospective restatement may sometimes be impracticable but this is addressed later in this document.

Disclosure of the correction of a prior period error (IAS 8, para 49)

Study the disclosure requirements for the correction of a prior period error (para 49).


36

Note the similarities and differences when comparing these disclosure requirements with those of the disclosure requirements for a change in accounting policy.

The effect of the correction of a prior period error is disclosed in a separate note. Normally, if there is more than one prior period error and those errors are related to each other, they would be disclosed in the same note. Sometimes the nature of the prior period errors are so distinctly different and they have no relationship with each other. In such cases, the effect of their correction may be disclosed in separate notes.

Note: Refer to IAS 1, paras 40A – 44 and 106, for the effect of the retrospective restatement for the correction of a prior period error on the presentation of the statement of financial position and the related notes.

The requirements related to the retrospective restatement of a prior period error are discussed briefly below:

Example Limited Notes for the year ended 31 December 20X6

34. Prior period error

During the year ended 31 December 20X4, the company made an error by omitting to ……... [nature of error]. The error has been corrected retrospectively [indication of whether retrospective restatement was possible or not] and the effect on the line items of the financial statements is as follows:

IAS 1, paras 40A – 40D, require an SFP (balances) at the beginning of the comparative period. This requirement is not applicable to P/L or OCI (movements)

Retrospective restatement for a prior period error affects only prior periods. The current year and the future years are corrected from the beginning of those years. The disclosure of the effect on prior periods ensures that the current year’s results will be comparable to those of the prior years and with the results reported by other entities.

20X5 01/01/20X5 R R Decrease in xxx List P/L line items Increase in xxx (note 1)

xxx (xxx)

You will be penalised if amounts are presented in

this part of this column!

Increase in profit for the year (note 5) xxx Other comprehensive income for the year Decrease in xxx List OCI line items Increase in xxx (note 2)

(xxx) xxx

Increase in total comprehensive income for the year (note 5)

xxx

Decrease in xxx List SFP line items Increase in xxx (note 3)

(xxx) xxx

(xxx) xxx

Increase in equity (note 5) xxx xxx Increase in xxx List components of equity Decrease in xxx (note 4)

xxx (xxx)

xxx (xxx)

Increase in basic earnings per share Rx,xx Increase in diluted earnings per share Rx,xx

You will be penalised if amounts

are presented

in a column for

current year


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Notes:

1. Remember that most entities use the by function (and not by nature) form of presentation in their profit or loss section of the statement of profit or loss and other comprehensive income. Accordingly, the line items “cost of sales”, “other income” etcetera, are used rather than “depreciation” or “fair value adjustment” that would represent the nature of the expenses / income.

2. Remember that the income tax implications of other comprehensive income items are disclosed in a separate line item.

3. Remember that the line items on the statement of financial position are collective nouns. Thus, use “property, plant and equipment” and not “machinery”!

4. If more than one component / reserve in equity is affected, the effect on each of the individual reserves must be disclosed. If the correction of the prior period error affects only retained earnings, a shorter form of disclosure is possible. Refer also to the examples later on in this document.

5. No other sub-totals are required in this note (for example, total non-current assets; total current assets and total assets)!

6. Remember to indicate the direction of each line item. This must also agree with the amounts to be awarded the marks! Make sure that brackets are used appropriately.

Correction of prior period error: income tax implications

The income tax implications of the correction of prior period errors is similar to the tax implications of a change in accounting policy. Refer to the summary of the income tax implications for the retrospective restatement of a prior period error:

Accounting records Income tax implications

Re-opening depends on the functionality of the accounting system itself

Re-opening depends on the decisions made by SARS

Re-open: Prior years’ profit and loss (and other comprehensive income) general ledger accounts can be used to post journal entries to account for the effects of the correction of the prior period error as if those general ledger accounts had not been closed off to retained earnings or other reserve general ledger accounts.

Re-open: SARS will re-calculate the entity’s current tax obligation for the prior years’ assessments issued.

Deferred tax for the prior periods will have to be re-calculated if the temporary differences change. In other words, if the carrying amounts and / or the tax base amounts change because of the retrospective restatement for the correction of a prior period error as there may be changes in the temporary differences.


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Accounting records Income tax implications

Not re-opened: Prior years’ profit or loss (and other comprehensive) general ledger accounts are not available for the processing of journal entries.

Adjustments related to income and expense items (or other comprehensive income items) are made directly in the opening balance of retained earnings (or other component of equity account, for example, revaluation surplus) by journal entry.

Not re-opened: SARS only accepts the new accounting policy when the current year’s current tax obligation is determined. The current tax calculation for the current year already includes an adjustment for the correction of the prior period error.

Deferred tax for the prior periods would need to be recalculated if the temporary differences have changed. The temporary differences would change if the carrying amounts and / or the tax bases change because of the retrospective restatement to correct the prior period error.

Re-opening of the accounting records (or not) affects only the journal entries. Disclosure remains the same.

The re-opening of the income tax returns (or assessments) affect both the journal entries and disclosure as current tax liabilities / assets and deferred tax assets / liabilities are presented separately on the face of the statement of financial position.

Unless a question specifically states otherwise, assume that the accounting records CANNOT be re-opened.

A question must always clearly indicate whether the previous years’ income tax returns (assessments) have been re-opened.

From the above summary, it should be clear that the income tax implications of the retrospective restatement for the correction of a prior period error are basically the same as the income tax implications related to the retrospective application of a change in accounting policy. A possible difference is that there is a greater chance that the tax base of an asset or liability will change as a result of a prior period error for which the prior years’ income tax returns (assessments) have been re-opened. This situation is illustrated in the following example.

Class example 6 – prior period error (tax base changes)

Q LIMITED manufactures furniture and has a 30 September year end. During the year ended 30 September 20X4, Q Limited imported plant from Germany that had an invoiced price of R1,8 million. This plant was available for use as intended by management on 30 June 20X4 and was taken into use on that date. The plant is accounted for in accordance with the cost model and depreciation is written off on the straight-line method over an estimated useful life of 10 years. The estimated residual


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value is insignificant. The South African Revenue Service (SARS) grants a wear and tear allowance of 20% per annum on plant that is not pro-rated. During the year ended 30 September 20X6, management realised that a material amount of non-refundable import taxes and transport costs of R360 000 had been paid in respect of this plant, and were recognised as an expense during the year ended 30 September 20X4. This amount was also claimed as an expense on the tax return of the 20X4 tax year. Q Limited immediately notified SARS of the error. SARS indicated that, due to the nature of the error, the previous years’ tax returns will be reopened. The tax rate is 28%. The company had no opening or closing inventories of the product range that is manufactured by the plant in question on hand at any time. Before taking the above information into account, the accounting records of Q Limited reflected the following: R Profit for the year ended 30 September 20X5 and 20X4 2 444 500 Retained earnings on 1 October 20X4 (credit) 10 447 800 Required: a. Prepare the prior period error note that will accompany the financial statements of

Q Limited for the year ended 30 September 20X6 in accordance with International Financial Reporting Standards (IFRS).


b. Prepare the journal entries of Q Limited to correct the prior period error for the year

ended 30 September 20X6 in accordance with International Financial Reporting Standards (IFRS).


Journal narrations are not required. c. Assume that the correct profit for the year of Q Limited (after adjustment for the

above information) amounted to R3 442 100 for the year ended 30 September 20X6.

Present the retained earnings column in the statement of changes in equity of Q Limited for the year ended 30 September 20X6 in accordance with International Financial Reporting Standards (IFRS).



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Suggested solution: Part A Q Limited Notes for the year ended 30 September 20X6 3. Prior period error

During the year ended 30 September 20X6, the company determined that non-refundable import taxes and transport costs related to the purchase of plant during the year ended 30 September 20X4 were expensed and not capitalised to the cost of the plant. The error has been corrected retrospectively and the impact on the line items in the financial statements was as follows: 20X5 01/10/20X4 R R Increase in cost of sales (36 000) Decrease in income tax expense 10 080 Decrease in profit and total comprehensive income for the year

(25 920)

Increase in property, plant and equipment 315 000 351 000 Increase in deferred tax liability (27 720) (17 640) Increase in current tax payable (60 480) (80 640) Increase in equity – retained earnings 226 800 252 720 Increase in retained earnings on 01/10/20X4 252 720 Decrease in basic earnings per share (xx.xx) Decrease in diluted earnings per share (xx.xx)


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Calculations

1. Impact on line items 20X5 01/10/20X4 R R Cost of sales - increase (R360 000/10 yrs) (36 000) - was (R1 800 000/10) 180 000 - should be [(R1 800 000 + R360 000)/10 yrs] 216 000 Tax at 28% (R36 000 x 28%) 10 080 Profit after tax (25 920) Plant (SFP) (f) 315 000 (c) 351 000 - was (d) 1 575 000 (a) 1 755 000 - should be (e) 1 890 000 (b) 2 106 000 Deferred tax (calc 2) (SFP) (27 720) (17 640) - was (liability) 138 600 88 200 - should be (liability) 166 320 105 840 Current tax (60 480) (80 640) - deductions were (i) (100 800) (g) (201 600) - deductions should have been (h) 120 960 (h) 120 960 - opening balance (80 640) -

226 800 252 720

(a) R1 800 000 – [R1 800 000/10 yrs x 3/12] = R1 755 000 (b) R(1 800 000 + 360 000) – R([1 800 000 + 360 000]/10 yrs x 3/12) = R2 106 000 (c) R360 000 – [R360 000/10 yrs x 3/12] = R351 000 (d) R1 755 000 – R180 000 depreciation = R1 575 000 (e) R2 106 000 – R216 000 depreciation = R1 890 000 (f) R351 000 – R36 000 = R315 000 (g) R(360 000 + [1 800 000 x 20%]) x 28% = R201 600 (h) R([360 000 + 1 800 000] x 20%) x 28% = R120 960 (i) R(1 800 000 x 20%) x 28% = R100 800

Alternative calculation of effect on current tax 30/9/20X4: 30/9/20X4 Was

R Should be

R Difference

R Accounting profit before depreciation 2 444 500 2 444 500 - Correction of expenses - 360 000 360 000 2 444 500 2 804 500 360 000 Less: tax allowances R1 800 000 x 20% (360 000) (72 000) R(1 800 000 + R360 000) x 20% (432 000) 2 084 500 2 372 500 288 000 Tax at 28% 583 660 664 300 80 640


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2. Deferred tax

CA (calc 1)

R

TB

R

TD

R

DT (SFP) (dr) / cr

R 20X4 (was) 28% Plant 1 755 000 (a)1 440 000 315 000 88 200

20X4 (should be) Plant 2 106 000 (b)1 728 000 378 000 105 840

Thus increase in deferred tax liability 17 640

CA (calc 1)

R

TB

R

TD

R

DT (SFP) (dr) / cr

R 20X5 (was) Plant 1 575 000 (c)1 080 000 495 000 138 600

20X5 (should be) Plant 1 890 000 (d)1 296 000 594 000 166 320

Thus increase in deferred tax liability 27 720

(a) R1 800 000 x 80% = R1 440 000 (b) R(1 800 000 + 360 000) x 80% = R1 728 000 (c) R1 800 000 x 60% = R1 080 000 (d) R(1 800 000 + 360 000) x 60% = R1 296 000

Part B

Q Limited General journal

Dr R

Cr R

Plant 360 000 Accumulated depreciation - plant (SFP) 45 000 [9 000 + 36 000 (calc 1)] Retained earnings – opening 315 000

Retained earnings – opening 88 200 Deferred tax (SFP) (calc 2) 27 720 Current tax payable (SFP) (calc 1) 60 480


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Part C Q Limited Statement of changes in equity for the year ended 30 September 20X6

Note Retained earnings

R Balance on 30 September 20X4 as previously reported 10 447 800 Retrospective correction of prior period error 3 252 720 Restated balance on 30 September 20X4 10 700 520 Restated total comprehensive income for the year 2 418 580 - Restated profit for the year (R2 444 500 – R25 920) 2 418 580 - Other comprehensive income for the year -

Restated balance on 30 September 20X5 13 119 100 Total comprehensive income for the year 3 442 100 - Profit for the year 3 442 100 - Other comprehensive income for the year -

Balance on 30 September 20X6 16 561 200

Class example 7 – Prior period error (tax rate changes)

Y Limited has a 31 December reporting date. During the audit for the year ended 31 December 20X9, the company’s auditors discovered a programming error in the spreadsheet used for the calculation of impairment losses. This spreadsheet was last used during the 20X5 financial year for the calculation of an impairment loss on the building component of an investment property. The following information was used to calculate and recognise the impairment loss: R Carrying amount of building component of investment property on 31/12/20X5

14 525 000

- Cost 16 000 000 - Accumulated depreciation (1 475 000) Fair value less costs of disposal 12 800 000 Value in use 10 441 500 The auditors established that the correct value in use amount, after correcting the programming error, would be R13 441 000 on 31 December 20X5. The investment property is accounted for in accordance with the cost model and depreciation is written off on the straight-line method. On 31 December 20X5, the estimated remaining useful life of the investment property buildings was 25 years with an insignificant residual value. The South African Revenue Service (SARS) grants a tax allowance of 5% per annum on the cost of this property (not pro-rated).


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On 31 December 20X5, the tax rate was 30%. On 28 February 20X8, the Minister of Finance lowered the tax rate in the budget speech to 25% for years of assessment beginning on or after 1 January 20X8. Required: a. Prepare the prior period error note, which will accompany the financial statements of

Y Limited for the year ended 31 December 20X9, in accordance with International Financial Reporting Standards (IFRS).


b. Prepare the general journal entries to correct the prior period error during the year ended 31 December 20X9 in the records of Y Limited in accordance with International Financial Reporting Standards (IFRS).

Note:

Round calculated amounts to the nearest Rand. Journal narrations are not required.

c. The income tax note of Y Limited for the year ended 31 December 20X9 included the

following information:

20X8 R Main components of income tax expense: Current tax - current year 5 418 900 Deferred tax 1 890 600 - origination and reversal of temporary differences 2 331 600 - tax rate change adjustment (441 000)

7 309 500

Prepare only the comparatives to the income tax expense note of Y Limited for the year ended 31 December 20X9, as far as the information provided allows, in accordance with International Financial Reporting Standards (IFRS).

Note:

Round calculated amounts to the nearest Rand. Narrative information to the note is not required.


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Y Limited Notes for the year ended 31 December 20X9


During the year ended 31 December 20X9, the company established that a programming error lead to the incorrect calculation and recognition of an impairment loss on investment property during the year ended 31 December 20X5. The error has been corrected retrospectively and the impact on the line items in the financial statements was as follows: 20X8 01/01/20X8 R R Increase in other expenses (25 640) Decrease in income tax expense 35 896 Increase in profit and total comprehensive income for the year

10 256

Increase in investment property 564 080 589 720 Increase in deferred tax liability (141 020) (176 916) Increase in equity – retained earnings 423 060 412 804 Increase in retained earnings on 01/01/20X8 412 804 Increase in basic earnings per share xx.xx Increase in diluted earnings per share xx.xx Calculations: 20X8 01/01/20X8 R R Other expenses (increase) (25 640) - depreciation was (g) 512 000 - depreciation should be (h) 537 640 Income tax expense (k) 35 896 - tax on difference in depreciation (reduction) (i) 6 410 - tax due to rate change (reduction) (j) 29 486

Profit after tax 10 256 Investment property 564 080 589 720 - investment property was (d) 11 264 000 (a) 11 776 000 - investment property should be (e) 11 828 000 (b) 12 365 720 Deferred tax liability (f)(141 020) (c)(176 916) Retained earnings 423 060 412 804


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(a) R12 800 000 / 25 yrs x 23 yrs = R11 776 000 or R12 800 000 – [R12 800 000 / 25 yrs x 2 yrs] = R11 776 000

(b) R13 441 000 / 25 yrs x 23 yrs = R12 365 720 or R13 441 000 – [R13 441 000 / 25 yrs x 2 yrs] = R12 365 720

(c) R589 720 x 30% = R176 916 (d) R12 800 000 / 25 yrs x 22 yrs = R11 264 000 or

R12 800 000 – [R12 800 000 / 25 yrs x 3 yrs] = R11 264 000 (e) R13 441 000 / 25 yrs x 22 yrs = R11 828 000 or

R13 441 000 – [R13 441 000 / 25 yrs x 3 yrs] = R11 828 000 (f) R564 080 x 25% = R141 020 (g) R12 800 000 / 25 yrs = R512 000 (h) R13 441 000 / 25 yrs = R537 640 (i) R25 640 x 25% = R6 410 (j) R176 916 x 5% / 30% = R29 486 or

31/12/20X8 R Carrying amount was 11 776 000 Carrying amount should be 12 365 700 Thus increase in temporary difference 589 720 x 30% 176 916 x 25% 147 430 Thus effect of change in tax rate 29 486

(k) R176 916 – R141 020 = R35 896 Note: The tax base of investment property would be calculated based on the original cost of the asset. It is not affected by the recognition of impairment losses for accounting purposes. Only the carrying amount for accounting purposes is affected by the recognition of any impairment losses. The temporary difference is the difference between the carrying amount and the tax base, so if the tax base does not change when the impairment loss is recognised, the change in the temporary difference could only be attributable to changes in the carrying amount of an asset caused by the recognition of the impairment loss. Therefore, it is not necessary to calculate the tax base of the asset in this example to work out the effect on deferred tax. Further, the building allowance granted by SARS wil not be influenced by the impairment loss, so taxable profit will be the same as the amount before the correction of the error. For this reason, SARS will not re-open tax assessments for an error on the impairment loss as current tax is not affected. (The depreciation and impairment loss added back to profit before tax amount to arrive at taxable profit will be the same as the corrected depreciation and impairment loss taken into account, thus zero impact.)


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Part B

Y Limited General journal

Dr R

Cr R

Investment property – accumulated depreciation (SFP) 564 080

Deferred tax (SFP) 141 020 Retained earnings (SFP) 423 060 (calc part A)

Part C

Y Limited Notes for the year ended 31 December 20X9

10. Income tax expense

20X8 R Main components of income tax expense: Current tax - current year 5 418 900

Deferred tax 1 854 704 - origination and reversal of temporary differences [R2 331 600 – R6 410 (calc part A)]

2 325 190

- tax rate change adjustment [- R441 000 - R29 486 (calc part A)] (470 486)

7 273 604

Correction of prior period error: retrospective restatement impracticable (IAS 8, paras 5; 47 – 41 and 50 – 53)


Retrospective restatement

Impracticable

As discussed earlier, a prior period error is normally retrospectively restated (IAS 8, para 42).

The retrospective restatement of a prior period may be impracticable. In such cases, full retrospective restatement is not required (IAS 8, para 43).


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? Impracticable

Impracticable means that a requirement cannot be complied with even after all reasonable attempts have been made to do so.

Retrospective restatement of a prior period error may be impracticable for one of the three reasons (IAS 8, para 5):

The effect of the retrospective application cannot be determined;

Assumptions about what management intended would be required; or

Estimations are necessary for the correction of the prior period error and there are no objective ways to distinguish between information that was available when the error was made in previous years and other information.

IAS 8, paras 50 – 53, explain in broad terms what circumstances would have resulted in the retrospective restatement of a prior period error being impracticable. Note that the actual outcomes in the prior periods cannot be used as the estimated amounts to be used for the prior periods (IAS 8, para 53).

? The impact of impracticable

Regardless of the reason why full retrospective restatement is impracticable, the result of this is that: either the cumulative effect of retrospective restatement, or the period-specific effect of the retrospective restatement, or both cannot be determined for one or more prior periods.

Note: The cumulative effect relates to the statement of financial position (i.e. balances involved). The period-specific effect relates to the statement of profit or loss and other comprehensive income (i.e. movements)

? The alternative to full retrospective

Impracticable to determine the period-specific effect on prior periods (IAS 8, para 44)

This means that the cumulative effect on the prior periods (i.e. the sum of all of the individual movements) can be determined but not the individual movements per period.

Thus, the correction of the prior period error is retrospectively restated from the earliest date possible (i.e. the SFP is adjusted). From this date going forwards, any further period-specific adjustments are made to the movements.

Impracticable to determine the cumulative effect at the beginning of the current year (IAS 8, paras 45 and 47)

This means that the cumulative effect at the beginning of the current year (i.e. the sum of the movements of the prior periods) cannot be determined.

Thus, the correction of the prior period error is applied from the earliest date possible. This means that the balances (i.e. the SFP) before this date


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remained unchanged. The following example illustrates a situation where full retrospective restatement for a prior period error is impracticable.

Class example 8 – Prior period error (retrospective restatement impracticable)

Z Limited manufactures electronic products and has a 31 March reporting date. It is the company’s accounting policy to account for machinery in accordance with the revaluation model. Machinery is revalued every three years in accordance with this policy. On revaluation, accumulated depreciation is eliminated against the gross carrying amount of the machine. Revaluations are actually performed at the end of a financial year but depreciation is calculated on the most recent revalued amount. On 31 March 20X9, during the revaluation of machinery in the normal revaluation cycle, management realised that one of the machines in the Cape Town factory was overlooked during the previous two revaluation cycles and was not revalued. This machine is not the same as the other machines used by the company and similar used machines do not trade in active markets. Therefore the company could only obtain a revaluation value as at 31 March 20X9. The following information with regard to the machine is available: R Carrying amount on 31 March 20X8 800 000 - Cost 1 500 000 - Accumulated depreciation (700 000)

Net replacement cost on 31 March 20X9 1 248 000

The machine was purchased on 31 March 20X1 for R1,5 million and was immediately available for use as intended by management. On this date, the total estimated useful life of the machine was 15 years with an insignificant residual value. This estimate was unchanged on 31 March 20X9. The tax rate is 28%. The South African Revenue Service (SARS) grants a wear and tear allowance of 20% per annum (not pro-rated). Required:

a. Prepare the prior period error note, which will accompany the financial statements of Z Limited for the year ended 31 March 20X9, in accordance with International Financial Reporting Standards (IFRS).


b. Prepare the general journal entries to correct the prior period error during the year ended 31 March 20X9 in the records of Z Limited in accordance with International Financial Reporting Standards (IFRS).

Note:

Round calculated amounts to the nearest Rand. Journal narrations are not required.


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Z Limited Notes for the year ended 31 March 20X9


During the year ended 31 March 20X9, a machine was identified that had not been revalued during the previous two revaluation cycles for machinery. As the machine is not the same as the other machines and it does not trade in an active market, the error could not be corrected by full retrospective restatement. Therefore, the error has been prospectively corrected during the current financial year and the whole amount of the revaluation surplus arising on the revaluation in the current year has been recognised in other comprehensive income.

Note: The previous reporting periods are not affected by this correction and therefore no impact on the line items can be disclosed. The adjustment to the carrying amount of machinery will be disclosed as part of the movements in the “Property, plant and equipment” note in the notes for the year ended 31 March 20X9.

The correction cannot be retrospectively restated since the revaluation surplus cannot be allocated to specific prior periods for the previous two revaluations performed. The period specific effect in the 20X8 financial year therefore cannot be determined. Part B Z Limited General journal

Dr R

Cr R

Machinery – accumulated depreciation (SFP) 700 000

Machinery (SFP) 700 000

Machinery (SFP) (calc below) 626 286 Revaluation surplus (OCI) 626 286

Revaluation surplus (OCI) 175 360 Deferred tax (SFP) 175 360 (R626 286 x 28%)

R Net replacement cost 31/3/20X9 1 248 000 Thus net replacement cost 1/4/20X8 (R1 248 000 / 7 yrs remaining 31/3/X9 x 8 yrs remaining 1/4/X8)

1 426 286

Carrying amount 1/4/20X8 (given) (800 000) Thus revaluation surplus 626 286

Documents

IAS 8 Notes and class examples - Blackboard Learn · · 2016-07-28i:\share\rek\frk 300\2016\kb leith\ias8\ias 8 notes and class examples.docx 1 financial accounting 300 ias 8: accounting