Chapter 5 HKAS 8

Answer Exercise 1 The income statement extract and statement of changes in equity for the year ended 31 December 2005 (with 2004 financial statements as com arati!e figures" are as follows# Gamma Co. Extract from the Income Statements 2005 $ 30&000 (3&000" 2*&000 ('&100" 1'&+00 Gamma Co. Statement of Changes in Equity ,hare ca ital .alance at 31 Dec 2003 as re!iously re orted /hange in accounting olicy for the ca itali0ation of interest (net of income taxes of $1&5)0" (1ote 1" .alance at 31 Dec 2003 as restated %rofit for the year ended 31 Dec 2004 (restated" .alance at 31 Dec 2004 %rofit for the year ended 31 Dec 2005 .alance at 31 Dec 2005 -etained earnings (restated" 20&000 Total 2004 (restated" $ 1'&000 (2&)00" 15&400 (4&)20" 10&*'0

%rofit before interest and tax (nterest ex ense %rofit before tax (ncome taxes %rofit for the year

10&000

30&000

(3&)40" 10&000 2 10&000 10&000 1)&3)0 10&*'0 2*&140 1'&+00 4)&040

(3&)40" 2)&3)0 10&*'0 3*&140 1'&+00 5)&040

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The nature& reason and effect of the change in accounting olicy can be disclosed as follows# Note 1 Change in accounting policy During 2005& 4amma changed its accounting olicy for the treatment of borrowing costs related to a hydro2electric ower station under construction for use by 4amma5 %re!iously& 4amma ca itali0ed such costs5 They are now written off as ex enses as incurred5 6anagement 7udges that this olicy ro!ides reliable and more rele!ant information because it results in a more trans arent treatment of finance costs and is consistent with local industry ractice& ma8ing 4amma9s financial statements more com arable5 This change in accounting olicy has been accounted for retros ecti!ely& and the com arati!e statements for 2004 ha!e been restated5 The effect of the change on 2004 is tabulated below5 : ening retained earnings for 2004 ha!e been reduced by $3&)40 which is the amount of the ad7ustment relating to eriod rior to 20045 Effect on !!" (ncrease in interest ex ense Decrease in income tax ex ense Decrease in rofit Effect on perio# prior to !!" Decrease in rofit ($5&200 interest ex ense less tax of $1&5)0" Decrease in assets in the course of construction and in retained earnings at 31 December 2004 $ (2&)00" *'0 (1&'20"

(3&)40"

1'&+00

Answer Exercise ;or each of the items& as8 whether the following answer is yes or not& it yes& it is a change in accounting olicy5 -ecognition %resentation 6easurement basis Therefore# (a" The answer to all three questions is no5 This is only a change in estimation technique5 (b" This is a change in resentation and therefore a change in accounting olicy5
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(c"

This is a change in measurement basis and therefore a change in accounting olicy5

Answer Exercise $ Statement of comprehensi%e income &or the year en#e# $1 'ecem(er !!) 200* $000 )0&000 (40&000" 20&000 (4&000" 1)&000 (1&000" 15&000

-e!enues /ost of sales (32&000 < 4&000" 4ross rofit Distribution and administrati!e ex enses %rofit before tax (ncome tax ex enses %rofit for the year

200) (restated" $000 50&000 (3)&000" 14&000 (3&000" 11&000 (1&000" 10&000

Statement of changes in equity *extract+ &or the year en#e# $1 'ecem(er !!) ,hare -etained ca ital earnings (restated" $000 $000 ,alance at 1 -an !!. = 50&000 Total com rehensi!e income for the year 14&000 ,alance at $1 'ecem(er !!. %rior eriod ad7ustment -estated balance Changes in equity for !!) Total com rehensi!e income for the year ,alance at $1 'ecem(er !!) = = )4&000 (4&000" )0&000 15&000 = *5&000

Total

$000 = 14&000 = (4&000" = 15&000 =

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Examination Style /uestions Answer 1

(a" Thame >td ? ,tatement of retained rofit 2010 $000 : ening retained rofit as re!iously re orted /orrection of error : ening retained rofit as restated 1et rofit /losing retained rofit @xtract from notes to the financial statements# 15 The com any failed to record a rofit before tax in the account $'0&000 (tax ? $40&000" in 200' and $100&000 (tax ? $45&000" in 200+5 The financial statements of 2010 ha!e been restated to correct the error5 500 +5 5+5 400 ++5 200+ $000 150 40 1+0 405 5+5

(b"(i" 3 change in accounting olicy should only be made where the new olicy is referable to the one it re laces and it is antici ated that the new olicy will ro!ide a fairer resentation5 This is art of the accounting conce t of consistency5 Aowe!er& a change in accounting olicy in order to com ly with a new Aong Bong 3ccounting ,tandard or (nter retation would be regarded as sufficient 7ustification to change an accounting olicy5 (b"(ii" 3n error in the !aluation of the closing in!entories two years re!iously would be accounted for as an ad7ustment for accounting errors o!er a two year eriod& would correct itself since the closing in!entories of one eriod is the o ening in!entories of the next5 (t would therefore not be necessary to disclose this error in a note to allow for this5 (t would robably be necessary to disclose this error in a note to the financial statements& to indicate its effect on com arati!e results5 (b"(iii" The directors9 decision to ro!ide the loss on long2term construction wor8 in rogress would
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be considered as a normal recurring correction of an estimate made in a re!ious year5 (b"(i!" The rate at which to ro!ide for de reciation on fixed assets of a high technological nature is difficult and firms !ery often ha!e little ex erience on which to base their decision5 3lthough the loss in this exam le is large& it would be regarded as a normal recurring correction of an estimate made in a re!ious year5 (b"(!" (t often is the case on a lease that the tenant ays for the re airs to the remises all at once at the end of the lease5 (t may be the case that the firm should ha!e aid for the re airs during the lease eriod5 Aowe!er& it is not the ur ose of a rior eriod ad7ustment to smooth out inter2 eriod aymentC the fact is that the re airs were not aid5

Answer
(a" 3ccounting olicies are defined as those rinci les& bases& con!entions& rules and ractices a lied by an entity that s ecify how the effects of transactions and other e!ents are to be resenting assets& liabilities& gains& losses and changes to shareholders9 funds5 3ccounting olicies by definition do not include estimation techniques5 3ccounting olicies define the rocess whereby transactions and other e!ents are reflected in financial statements5 ;or exam le& an accounting olicy for a articular ty e of ex enditure may s ecify whether an asset or a loss is to be recogni0edC the basis on which it is to be measuredC and where in the statement of com rehensi!e income or the statement of financial osition it is to be resented5 @stimation techniques are the methods ado ted by an entity to arri!e at estimated monetary amounts& corres onding to the measurement bases selected& for assets& liabilities& gains losses and changes to shareholders9 funds5 @stimation techniques im lement the measurement as ects of accounting olicies5 3n reflected in its financial statements through recogni0ing& selecting measurement bases for& and

accounting olicy will s ecify the basis on which an item is to be measuredC where there is uncertainty o!er the monetary amount corres onding to that basis& the amount will be arri!ed at by using an estimation technique5 The distinction is im ortant because changes in accounting olicy are accounted for as rior
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eriod ad7ustments& whereas the effects of changes in estimation techniques are ta8en through the current year income statement5 (b" (i" De reciation (1" Dehicles are being recogni0ed and resented in the same way as before& and using the same& historical cost measurement basis5 The only change is to the estimation technique used to measure the unex ired ortion of each !ehicle9s economic benefits5 This is not a change of accounting olicy5 (2" This accounting change in!ol!es both a change to resentation and a change of estimation technique& as in (i" (1" abo!e5 3s the method of resentation has changed& the former is a change of accounting olicy but the latter is not5 The two changes must therefore be accounted for se arately5 1o change is made to the amount of de reciation charged in earlier eriods& but the income statement for the receding eriod is restated to mo!e the de reciation charge from cost of sales to administrati!e ex enses5 (ii" :!erheads 3lthough there is no change to the recognition and measurement of costs& they are being resented differently5 This is therefore a change of accounting olicy5 (iii" (ndirect o!erheads in stoc8 !aluation Directly attributable costs& once estimated& must be treated as art of an asset as they continue to be and always ha!e been5 3ccordingly there is no change to recognition5 (n addition& both stoc8s and o!erheads continue to be resented in the same way and measured on the same basis (stoc8s are measured at the amount of directly attributable historical costs"5 This is a change of estimation technique5 (i!" ;inance costs The transaction whose effects are being reflected is the incurring of directly attributable finance costs5 That transaction is still being measured in the same way& but there is a change to recognition& in that it is now being recogni0ed as art of an asset rather than as an ex ense5 There is also& consequently& a change to the income5 This is a change of accounting olicy5 (!" %ro!isions AB3, 3* requires entities to re ort ro!isions at the best estimate of the ex enditure required to settle the resent obligation at the statement of financial osition date5 Ehere that estimate is based on future cash flows& it is ermissible to use undiscounted amounts only where the effect of the time !alue of money is not material5 (n such circumstances& the use of undiscounted future cash flows is& in effect& an estimation
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resentation of the

transaction in the statement of financial osition and the statement of com rehensi!e

technique for arri!ing at the resent !alue5 Therefore this is not a change in accounting olicy5

Answer $ (a" 3ccounting olicies can be described as the rinci les& con!entions& rules and ractices a lied by an entity that rescribe how transactions and other e!ents are to be reflected in its financial statements5 This includes the recognition0 presentation an# measurement (asis to be a lied to assets& liabilities& gains& losses and changes to shareholders funds5 :nce these olicies ha!e been ado ted& they are not expecte# to change frequently an# compara(ility requires that i#eally they #o not change from year to year5 Aowe!er& AB3, ' does en!isage situations where a change of accounting olicy is required in the interests of fair resentation5 3n entity may ha!e to change an accounting olicy in res onse to changes in a Stan#ar# or in applica(le legislation5 :r it may be an internal #ecision which can be 7ustified on the (asis of presenting a more relia(le picture 5 3n accounting olicy ado ted to deal with transactions or e!ents which did not arise pre%iously is not treate# as a change of accounting policy5 Ehere a change of accounting olicy has ta8en lace it must be accounted for by retrospecti%e restatement5 This means that the com arati!e financial statements must be restated in the light of the new accounting olicy5 This ma8es it ossible to com are results for these years as if the new accounting olicy had always been in lace5 The financial statements must #isclose the reason for the change of accounting policy an# the effects of the change on the results for the pre%ious year. (b" This issue is one of the timing of when re!enue should be recognised in the income statement5 This can be a com lex issue which in!ol!es identifying the transfer of significant ris8s& reliable measurement& the robability of recei!ing economic benefits& rele!ant accounting standards and legislation and generally acce ted ractice5 3 lying the general guidance in AB3, 1' -e!enue& the re!ious olicy& a lied before cancellation insurance was made a condition of boo8ing& seemed a ro riate5 3t the time the holiday is ta8en it can no longer be cancelled& all monies would ha!e been recei!ed and the flights and accommodation ha!e been ro!ided5 There may be some com ensation costs in!ol!ed if there are roblems with the
352*

holiday& but this is a8in to roduct warranties on normal sales of goods which may be immaterial or ro!ided for based on re!ious ex erience of such costs5 The a endix to AB3, 1' s ecifically refers to ayments in ad!ance of the Fdeli!ery9 of goods and says that re!enue should be recognised when the goods are deli!ered5 (nter reting this for %artway9s transaction would seem to confirm the a ro riateness of its re!ious olicy5 The directors of %artway wish to change the timing of recognition of sales because of the change in circumstances relating to the com ulsory cancellation insurance5 The directors are a arently arguing that the new Ftransactions and e!ents9 are substantially different to re!ious transactions therefore the old olicy should not a ly5 @!en if this does 7ustify re!ising the timing of the recognition of re!enue& it is not a change of accounting olicy because of the reasons outlined in (a" abo!e5 3n issue to consider is whether com ulsory cancellation insurance re resents a substantial change to the ris8s that %artway ex eriences5 3n analysis of ast ex erience of losses caused by uninsured cancellations may hel to assess this& but e!en if the ast losses were material (and in future they won9t be"& it is unli8ely that this would o!erride the general guidance in the a endix to AB3, 1' relating to ayments made in ad!ance of deli!ery5 (t seems the main moti!ation for the ro osed change is to im ro!e the rofit for the year ended 31 :ctober 200) so that it com ares more fa!ourably with that of the re!ious eriod5 Answer " (t is not a change of accounting olicy because a change of accounting olicy only occurs where the same circumstances are treate# #ifferently5 (n this case there are #ifferent circumstances5 Derringdo has change# its metho# of tra#ingC it is no longer res onsible for any errors that may occur during the fitting of the car ets5 3n accounting olicy that is a lied to circumstances that #iffer from pre%ious circumstances is not a change of accounting policy5 (ncome statement $000 /ar ets fitted under the old terms of trade (these will not ha!e been claimed in the re!ious year" /ar ets sold under the new terms of trade Total re!enue for this year 1&200 23&000 24&200

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Answer 1 The calculation of de reciation of a non2current asset in!ol!es the ma8ing of a number of accounting estimates5 (n this case two of the estimates& the useful economic life of the asset and the ex ected residual !alue& ha!e changed5 AB3, ' ? 3ccounting olicies& changes in accounting estimates and errors ? states that when accounting estimates change the change should be made ros ecti!ely5 .rought forward numbers are not ad7usted5 (n this case the future de reciation required on the non2current asset from 1 3 ril 2010 is $2&'00&000 ($3&000&000 2 $200&000"5 This should be charged to the income statement the remaining ex ected future useful life of the asset from 1 3 ril 2010& in this case two years5 Therefore de reciation of $1&400&000 will be charged in the year ended 3 6arch 2011 and 2012& unless the accounting estimates change again next year5

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