Intermediate Accounting — Changes in Accounting Policies and Estimates, and Errors

Financial statement figures are not finished once published. When an entity changes a policy, revises an estimate or discovers a past mistake, it must decide in which period to reflect the effect. K-IFRS 1008 (IAS 8) treats the three cases differently, because figures prepared on different bases cannot be compared over time.

1. Distinguishing the three kinds of change

An accounting policy may be changed only if a K-IFRS requires it or the change provides more reliable and relevant information. When it is hard to tell a policy change from an estimate change, it is treated as a change in estimate. The 2023 amendment clarified the distinction by defining accounting estimates as “monetary amounts in financial statements that are subject to measurement uncertainty”. A change in depreciation method is a change in estimate.

2. Change in accounting policy: retrospective application

In 20X2 company MM changed its inventory cost formula from FIFO to weighted average. Ignore tax effects.

Retrospective application restates the 20X1 financial statements on the weighted average basis. Closing inventory for 20X1 becomes ₩4.6 million, and 20X1 profit (and hence opening retained earnings for 20X2) falls by ₩400,000. Cost of sales for 20X2 is higher than under FIFO by the closing difference of 60 less the opening difference of 40, i.e. ₩200,000.

Opening retained earnings for the earliest comparative period presented are adjusted, and if retrospective application materially changes the opening statement of financial position, a third statement of financial position (at the beginning of the preceding period) is also presented. Where it is impracticable to determine the effect on past periods, the policy is applied from the earliest period for which it is practicable.

3. Change in accounting estimate: prospective application

Company NN bought a machine for ₩10 million at the beginning of 20X1 (useful life ten years, no residual value, straight-line). At the beginning of 20X4 it revised the remaining useful life to five years instead of seven. The carrying amount at the beginning of 20X4 is $1{,}000 - 100 \times 3 = 700$ (₩10,000), and annual depreciation thereafter is $700 / 5 = 140$. The 20X1–20X3 financial statements are not changed, because a change in estimate updates a judgement on the basis of new information; it is not a past mistake.

4. Prior-period errors: retrospective restatement

A material prior-period error is not included in profit for the year it is found; instead, the comparative financial statements for the period in which it occurred are restated. If the error occurred before the earliest period presented, opening retained earnings for the earliest comparative period are corrected.

In 20X3 company OO discovers that ₩800,000 of depreciation was omitted in 20X1. This error does not counterbalance (accumulated depreciation stays understated). When preparing the 20X3 financial statements, opening retained earnings and accumulated depreciation for 20X2, the comparative period, are each reduced by ₩800,000. The ₩800,000 is not included in the 20X3 income statement.

A. Counterbalancing errors

Errors in inventory or accrued expenses correct themselves over two periods (chapter 2). If closing inventory for 20X1 was overstated by ₩500,000, profit is overstated by ₩500,000 in 20X1 and understated by ₩500,000 in 20X2. If found in 20X3, retained earnings at the end of 20X2 are already correct, so only the year-by-year profits in the comparatives need correcting. If found in 20X2, opening retained earnings for 20X2 are reduced by ₩500,000 and the effect is removed from 20X2 cost of sales.

Check your understanding

While preparing its 20X3 financial statements, company PP discovers two errors: closing inventory for 20X2 was understated by ₩300,000, and ₩2 million of equipment repairs expensed at the beginning of 20X2 was in fact capital expenditure with a useful life of four years (no residual value, straight-line). Both errors are material. Ignoring tax, by how much does the 20X2 profit presented as a comparative change, and what effect must be reflected in 20X3 profit?

The inventory error overstated 20X2 cost of sales by ₩300,000, so 20X2 profit rises by ₩300,000. For the repairs, depreciation of ₩500,000 should have replaced the ₩2 million expense in 20X2, so 20X2 profit rises by ₩1.5 million. The comparative 20X2 profit increases by ₩1.8 million. In 20X3, the reversal of the inventory error raises opening inventory by ₩300,000 and so cost of sales by ₩300,000, and depreciation of ₩500,000 on the equipment is newly recognized. 20X3 profit is therefore ₩800,000 lower than in the uncorrected books — the amount it would have been had the errors never occurred.

References

• Korea Accounting Standards Board, K-IFRS 1008 Accounting Policies, Changes in Accounting Estimates and Errors (including the 2023 amendment defining accounting estimates)
• Korea Accounting Standards Board, K-IFRS 1001 Presentation of Financial Statements (third statement of financial position)
• Donald Kieso, Jerry Weygandt and Terry Warfield, Intermediate Accounting: IFRS Edition, ch. 22