Accounting Policies, Estimates, Errors and Reporting Events

Introduction and context

Financial statements are prepared using judgments, estimates and accounting policies. Because economic conditions change and information may be incomplete, reported amounts cannot be understood solely as mechanical measurements. The reliability of financial reporting depends on whether management selects appropriate policies, revises estimates when new evidence becomes available, corrects errors transparently and evaluates events occurring after the reporting period consistently.

IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, establishes the framework for selecting and changing accounting policies, accounting for changes in estimates and correcting prior-period errors. IAS 10, Events after the Reporting Period, addresses events between the reporting date and the date on which the financial statements are authorised for issue. Together, the standards create a disciplined boundary between information that relates to conditions existing at year-end and information arising from conditions that developed afterwards.

These issues are central to financial reporting quality. A change in an estimate should not be used to manipulate earnings retrospectively, while a genuine prior-period error should not be disguised as a current-period estimate change. Similarly, an event after the reporting period may require adjustment, disclosure or no action, depending on the condition to which it relates.

Learning objectives

By the end of this chapter, students should be able to:

1. Explain the roles of accounting policies, accounting estimates and prior-period errors under IAS 8.
2. Select accounting policies when no IFRS Standard specifically applies.
3. Distinguish retrospective application from prospective application.
4. Analyse whether a change arises from new information or from an error.
5. Identify adjusting and non-adjusting events under IAS 10.
6. Prepare defensible documentation and appropriate disclosures.
7. Evaluate the governance, ethical and managerial implications of reporting judgments.

1. The IAS 8 decision framework

IAS 8 can be understood as a sequence of questions rather than as a collection of isolated rules.

Figure: A simplified decision framework for applying IAS 8 and IAS 10.

Accounting policies

Accounting policies are the specific principles, bases, conventions, rules and practices applied in preparing and presenting financial statements. Examples include the cost model or revaluation model for property, plant and equipment, the method used to measure inventories and the classification of financial instruments under applicable IFRS requirements.

An entity applies an accounting policy consistently to similar transactions, events and conditions unless an IFRS Standard specifically requires or permits categorisation that justifies different policies. Consistency improves comparability across periods and between entities.

Accounting estimates

Accounting estimates are monetary amounts in financial statements that are subject to measurement uncertainty. They arise when an amount cannot be measured directly and must be estimated using assumptions and available information. Examples include:

• expected credit losses;
• useful lives and residual values of depreciable assets;
• provisions and warranty obligations;
• fair values when observable market data are limited;
• impairment losses; and
• the percentage of completion or progress toward satisfying a performance obligation where relevant to another IFRS Standard.

The 2021 amendments to IAS 8 clarify that a change in accounting estimate results from new information or new developments, rather than from the correction of an error. A change in a measurement technique or input used to develop an estimate is normally a change in estimate unless it corrects an error.

Prior-period errors

Prior-period errors are omissions from, or misstatements in, an entity’s financial statements for one or more prior periods arising from failure to use, or misuse of, reliable information that was available when those statements were authorised for issue and could reasonably have been obtained and considered.

Errors may result from mathematical mistakes, incorrect application of an accounting policy, oversight, fraud or misinterpretation of facts. Material prior-period errors are corrected retrospectively. Immaterial errors may be corrected in the current period, but repeated immaterial errors should not be used to create a material intentional misstatement.

2. Selecting accounting policies

When an IFRS Standard applies

When a transaction or event is specifically addressed by an IFRS Standard, the entity applies that requirement. In some cases, a Standard permits a choice between accounting treatments. The chosen treatment must be applied consistently to transactions in the same category unless the Standard establishes different categories.

Management must also consider implementation guidance that forms part of the applicable Standard and relevant requirements concerning presentation, recognition, measurement and disclosure. A policy is not acceptable merely because it produces a convenient result or agrees with industry practice.

When no IFRS Standard specifically applies

If no IFRS Standard specifically applies, management uses judgment to develop and apply a policy that produces information that is relevant and reliable. The policy should faithfully represent the entity’s financial position, financial performance and cash flows; reflect the economic substance of transactions; be neutral; be prudent without deliberate bias; and be complete in all material respects.

In making that judgment, management considers, in the following order:

1. requirements and guidance in IFRS Standards dealing with similar and related issues; and
2. the definitions, recognition criteria and measurement concepts in the Conceptual Framework for Financial Reporting.

Management may also consider recent pronouncements of other standard-setting bodies using a similar conceptual framework, relevant accounting literature and accepted industry practices, provided these do not conflict with IFRS requirements.

Changes in accounting policy

A change in accounting policy is permitted only when:

• it is required by a new or amended IFRS Standard; or
• it results in financial statements providing reliable and more relevant information about the effects of transactions, other events or conditions.

A change made because an entity wishes to use an alternative policy that is less reliable or less relevant is not justified. A change in the basis of accounting is different from a change in an estimate. For example, changing inventory measurement from one permitted method to another is a policy change; revising the expected level of obsolete inventory is an estimate change.

3. Retrospective and prospective application

Retrospective application

Retrospective application means applying a new accounting policy to transactions, other events and conditions as though that policy had always been applied. The entity adjusts the comparative amounts for each prior period presented and adjusts the opening balances of assets, liabilities and equity for the earliest prior period presented.

For a prior-period error, retrospective restatement means correcting the comparative amounts as if the error had never occurred. The correction may affect assets, liabilities, equity, income, expenses and tax balances.

The general logic can be expressed as follows:

The expression is a presentation relationship, not a universal measurement formula. “Cumulative correction” includes the net effect of the policy change or error on periods before the earliest period presented; the calculation must reflect applicable tax and any related accounting requirements.

Prospective application

Prospective application means recognising the effect of a change in the current period and, where relevant, future periods affected by the change. Prior-period comparatives are not rewritten.

Changes in accounting estimates are applied prospectively because new information does not mean that the previous estimate was wrong when made. The effect is recognised in profit or loss in:

• the period of change, if the change affects that period only; or
• the period of change and future periods, if the change affects both.

If an estimate affects an asset, liability or equity item, the change is recognised by adjusting the carrying amount of the related item in the period of change.

Impracticability

A retrospective application or restatement is impracticable when the entity cannot apply it after making every reasonable effort. This may occur if the effects cannot be determined, assumptions about management’s past intentions would be required, or estimates require information that cannot be objectively distinguished from later information.

If retrospective application is impracticable for a particular prior period, the entity applies the new policy or correction from the earliest date practicable. The notes should explain the circumstances and the method used.

4. Worked applications under IAS 8

Example 1: change in depreciation estimate

An entity purchases equipment for CU120,000. At acquisition, it estimates a ten-year useful life and no residual value. After four years, engineering evidence indicates that the remaining useful life is eight years. Assume straight-line depreciation and no impairment.

Original annual depreciation is:

After four years, accumulated depreciation is CU48,000 and the carrying amount is CU72,000. The revised annual depreciation from year five is:

The entity does not restate the first four years. CU9,000 is recognised in each remaining year, subject to impairment, disposal or further changes. The revision reflects new engineering information and is therefore a change in estimate, not an error.

Example 2: prior-period error

In 20X4, an entity incorrectly expensed CU50,000 of equipment that met the recognition criteria for property, plant and equipment. The equipment had a five-year useful life, no residual value and was available for use at the beginning of 20X4. The error is discovered in 20X6. Ignore tax.

Had the equipment been capitalised, depreciation would have been CU10,000 per year. At the end of 20X5, the correct carrying amount would have been CU30,000. The cumulative correction at the beginning of 20X6 is therefore:

• increase property, plant and equipment: CU30,000;
• increase retained earnings: CU30,000;
• reduce cumulative expense by CU30,000 compared with the reported amounts.

The comparative 20X5 statement of profit or loss is restated: expense decreases by CU40,000 because the reported CU50,000 expense is replaced by CU10,000 depreciation. The 20X6 accounts include the correct CU10,000 depreciation for that year. The correction is retrospective because reliable information existed when the original statements were prepared.

5. Disclosure and documentation under IAS 8

A defensible accounting conclusion requires more than a journal entry. The accounting file should identify the transaction, applicable Standards, relevant facts, judgments, alternatives considered, materiality assessment, approval and disclosure consequences.

For a change in accounting policy, disclosures generally include the nature of the change, the reasons it provides reliable and more relevant information or the title and transitional provisions of a new Standard, the amount of adjustments for current and prior periods, and the amount relating to periods before those presented when practicable. If retrospective application is impracticable, the entity explains why and describes how the policy was applied.

For a change in accounting estimate, the entity discloses the nature and amount of the change in the current period, and the expected effect in future periods if estimable. If the future effect cannot be estimated, that fact is disclosed. A change in estimate need not be disclosed if its effect is immaterial.

For a material prior-period error, disclosures include the nature of the error, the correction for each affected line item, the correction at the beginning of the earliest prior period presented and, when impracticable, the circumstances leading to that condition and how the error was corrected.

Materiality is not determined solely by size. Qualitative factors include whether the item affects compliance with loan covenants, management remuneration, regulatory ratios, trends, segment performance or users’ assessment of stewardship.

6. IAS 10: events after the reporting period

An event after the reporting period is a favourable or unfavourable event occurring between the end of the reporting period and the date when the financial statements are authorised for issue. The authorisation date is important: it is not necessarily the date shareholders approve the statements, and it should be identified in the financial statements.

IAS 10 distinguishes two categories.

Adjusting events

Adjusting events provide evidence of conditions that existed at the end of the reporting period. The entity adjusts the amounts recognised in its financial statements or recognises items not previously recognised.

Examples include:

• settlement after year-end of a court case confirming that a present obligation existed at year-end;
• receipt of information after year-end showing that an asset was impaired at year-end;
• determination after year-end of the cost of assets purchased, or proceeds from assets sold, before year-end; and
• discovery of fraud or errors showing that the financial statements were incorrect.

The key question is not whether the event occurred after year-end, but whether it provides evidence about a condition existing at year-end.

Non-adjusting events

Non-adjusting events indicate conditions arising after the reporting period. The entity does not adjust recognised amounts. However, it discloses the nature of the event and an estimate of its financial effect, or states that such an estimate cannot be made, when the event is material and non-disclosure could influence users’ decisions.

Examples include a major business combination, disposal of a significant subsidiary, destruction of a major production facility by fire after year-end, a major restructuring announced after year-end and significant changes in share or exchange prices after year-end.

Dividends and going concern

Dividends declared after the reporting period but before authorisation are not recognised as a liability at the reporting date because no present obligation existed at year-end. They are disclosed in accordance with applicable presentation requirements.

The going-concern exception is fundamental. If management concludes after the reporting period that it intends to liquidate the entity, cease trading or has no realistic alternative, the financial statements should not be prepared on a going-concern basis. This is not merely a note disclosure; it changes the basis of preparation.

7. IAS 10 decision process

A professional assessment can use the following sequence:

1. Establish the reporting date and authorisation date.
2. Describe the event and identify the date it occurred.
3. Determine the condition to which the event relates.
4. Decide whether that condition existed at the reporting date.
5. If yes, adjust the financial statements.
6. If no, assess materiality and disclose the event if required.
7. Reassess going concern and consider whether the event reveals an error or fraud.

Applied scenario: illustrative case

Background. Northbridge Manufacturing Ltd has a 31 December 20X7 year-end. Its financial statements are authorised on 20 March 20X8. A customer owing CU2.4 million enters insolvency proceedings on 15 February 20X8.

Problem. Management initially proposes treating the insolvency as a non-adjusting event because the legal filing occurred after year-end.

Analysis. Credit records show that the customer had severe liquidity problems, missed payments and breached credit terms before 31 December 20X7. The February insolvency is therefore evidence of a credit-impaired condition existing at year-end. The event is adjusting. Northbridge must reassess the receivable and recognise the appropriate loss allowance under the applicable financial instruments requirements.

Approach and outcome. The audit committee obtains the aged receivable listing, correspondence, credit reports, post-year-end cash receipts and legal filings. It documents the year-end condition, estimates recoverable cash flows and records the adjustment. The note explains significant judgment and the effect of the loss allowance if material.

Learning points. Timing alone does not determine classification. Evidence about year-end conditions is decisive. Documentation should link the event, the condition, the measurement consequence and the disclosure conclusion.

8. Governance, ethics and professional judgment

IAS 8 and IAS 10 create opportunities for judgment but not for arbitrary earnings management. Ethical risks include selecting a policy solely to smooth earnings, delaying recognition of an error, changing assumptions without evidence, classifying a known year-end impairment as a future event and omitting material subsequent-event disclosures.

Effective governance includes:

• a formal accounting-issues memorandum;
• review by the controller, technical accounting function and audit committee for significant matters;
• independent challenge of assumptions and sensitivity analysis;
• controls over the financial close and post-year-end information search;
• a register of errors, estimates and subsequent events;
• documented materiality thresholds; and
• consultation with auditors or regulators when authoritative guidance is unclear.

Management should distinguish uncertainty from bias. Uncertainty exists because several outcomes are possible; bias exists when assumptions are selected systematically to produce a desired result. Prudence does not permit deliberate understatement of assets or overstatement of liabilities.

Technology can support, but not replace, judgment. Enterprise systems can flag unusual journals, compare estimate revisions with operational data and scan legal, sales and credit records for post-year-end evidence. AI tools may assist in extracting contracts or identifying anomalies, but their outputs require human validation, traceability, access controls and protection of confidential information. An algorithm’s classification of an event is not itself evidence that the event is adjusting or non-adjusting.

9. Challenges and limitations

The principal challenge is reconstructing what information was available and knowable at the relevant date. Later evidence may clarify a year-end condition, but it must not be used automatically to rewrite a valid estimate. Another challenge is distinguishing a change in estimate from an error. The assessment should focus on whether the original estimate was reasonable using information available at that time.

Further difficulties include:

• complex interactions among IAS 8, IAS 10 and other IFRS Standards;
• determining whether an event is material qualitatively;
• separating a new condition from evidence of an old condition;
• applying retrospective correction when records are incomplete;
• estimating tax effects and deferred tax consequences; and
• maintaining consistency across subsidiaries and reporting units.

The standards do not eliminate uncertainty. They establish a disciplined method for identifying it, measuring its effects and communicating it to users.

10. Best-practice implementation checklist

Before finalising the financial statements, an entity should ask:

• Has every significant transaction been linked to an applicable IFRS Standard?
• Are policies distinguished from estimates and errors?
• Does each estimate have current evidence, an owner and a review date?
• Were prior-period records searched for omitted or misapplied information?
• Has the post-year-end period been reviewed through the authorisation date?
• Does each subsequent event relate to a year-end condition or a later condition?
• Have going-concern implications been evaluated?
• Are retrospective adjustments mathematically reconciled and tax effects considered?
• Are judgments, estimation uncertainty and material effects disclosed clearly?
• Has the accounting conclusion been independently challenged?

Chapter Summary

IAS 8 governs the selection and consistent application of accounting policies, the treatment of changes in accounting estimates and the correction of prior-period errors. Policies change only when required by IFRS or when the change produces more reliable and relevant information. Policy changes and material errors are generally applied retrospectively, while changes in estimates are applied prospectively because they arise from new information rather than from mistakes in earlier reporting.

IAS 10 requires entities to assess events occurring between the reporting date and the authorisation date. Adjusting events provide evidence of conditions existing at year-end and require adjustment. Non-adjusting events arise from post-year-end conditions and require disclosure when material. Going concern, materiality, ethical judgment, governance and documentation are integral to applying both standards. A defensible conclusion connects authoritative requirements with evidence, measurement, controls and transparent disclosure.

Key Terms

Accounting estimate: A monetary amount in financial statements subject to measurement uncertainty.

Accounting policy: The principles, bases, conventions, rules and practices used to prepare financial statements.

Adjusting event: An event after the reporting period that provides evidence of a condition existing at the reporting date.

Authorisation date: The date on which financial statements are authorised for issue.

Comparative information: Prior-period amounts presented alongside current-period financial statements.

Estimation uncertainty: The uncertainty inherent in measuring an amount when direct observation is unavailable.

Impracticable: Unable to apply a requirement after making every reasonable effort.

Materiality: The significance of information whose omission or misstatement could influence users’ decisions.

Non-adjusting event: An event indicating a condition arising after the reporting period.

Prospective application: Recognising the effect of a change in the current and future periods affected.

Prior-period error: An omission or misstatement caused by failure to use, or misuse of, reliable available information.

Retrospective application: Applying a policy or correction as though it had always been applied.

Restatement: Re-presenting prior-period information to correct a material error.

Reporting date: The end of the financial reporting period.

Useful life: The period or number of units over which an asset is expected to be available for use.

Going concern: The assumption that an entity will continue operating for the foreseeable future.

Review Questions

5 Short Answer Questions

1. What is the difference between an accounting policy and an accounting estimate?
2. When is a change in accounting policy permitted under IAS 8?
3. Why are changes in accounting estimates normally applied prospectively?
4. What makes an event after the reporting period adjusting?
5. What information should an entity document when correcting a material prior-period error?

5 Long Answer Questions

1. Explain the IAS 8 hierarchy for selecting an accounting policy when no IFRS Standard specifically applies.
2. Compare retrospective application of a policy change with prospective application of an estimate change.
3. Discuss the distinction between a prior-period error and a change in accounting estimate, using examples.
4. Explain the recognition and disclosure consequences of adjusting and non-adjusting events under IAS 10.
5. Evaluate the governance and ethical risks associated with accounting estimates and subsequent events.

3 Analytical / Application Questions

1. An entity revises the useful life of machinery after receiving a new engineering report. Explain the accounting treatment and calculate the revised depreciation if the carrying amount is CU72,000 and the revised remaining life is eight years.
2. A customer becomes insolvent after year-end, but evidence shows repeated payment defaults before year-end. Determine whether the event is adjusting and identify the evidence that should be retained.
3. A company discovers that a prior-year asset purchase was incorrectly expensed. Design a process to determine whether retrospective restatement is required, including materiality, measurement and disclosure considerations.

Multiple Choice Questions with Answers

Question 1

Which item is an accounting estimate under IAS 8?

A. The choice between cost and revaluation models when permitted

B. The expected credit loss allowance

C. The date financial statements are authorised

D. The definition of a reporting period

Correct Answer: B. The expected credit loss allowance

Question 2

A change in accounting estimate generally results from:

A. New information or new developments

B. A desire to smooth earnings

C. A mathematical error made in a prior period

D. A change in the entity’s legal form

Correct Answer: A. New information or new developments

Question 3

How is a material prior-period error generally corrected?

A. By ignoring it if it is inconvenient to calculate

B. Prospectively through current-period revenue

C. By retrospective restatement

D. Only through a non-adjusting-event note

Correct Answer: C. By retrospective restatement

Question 4

An entity changes an estimate of useful life based on a new engineering assessment. The change is normally:

A. Applied prospectively

B. Applied retrospectively to all comparatives

C. Recognised as a prior-period error

D. Prohibited under IAS 8

Correct Answer: A. Applied prospectively

Question 5

When no IFRS Standard specifically applies, management should first consider:

A. The accounting policy producing the highest profit

B. Requirements for similar and related issues in IFRS Standards

C. The tax authority’s preferred treatment in every case

D. The policy used by the largest competitor

Correct Answer: B. Requirements for similar and related issues in IFRS Standards

Question 6

Which is an adjusting event under IAS 10?

A. A fire destroying a factory after year-end

B. A major acquisition completed after year-end

C. A customer insolvency after year-end confirming year-end credit impairment

D. A decline in share prices caused by a post-year-end market shock

Correct Answer: C. A customer insolvency after year-end confirming year-end credit impairment

Question 7

A dividend declared after the reporting period but before authorisation is generally:

A. Recognised as a year-end liability in all cases

B. Ignored in every circumstance

C. Recognised as revenue

D. Not recognised as a year-end liability but disclosed as required

Correct Answer: D. Not recognised as a year-end liability but disclosed as required

Question 8

Prospective application of an estimate change means that the change is recognised:

A. Only in the earliest comparative period

B. In the current period and future periods affected

C. Only in opening retained earnings

D. Only after shareholder approval

Correct Answer: B. In the current period and future periods affected

Question 9

The key question in classifying a subsequent event is whether:

A. The event was reported by the media

B. The event occurred outside the entity’s country

C. The underlying condition existed at the reporting date

D. The event changed the share price

Correct Answer: C. The underlying condition existed at the reporting date

Question 10

In the depreciation example, equipment with a CU72,000 carrying amount and an eight-year revised remaining life has annual depreciation of:

A. CU8,000

B. CU9,000

C. CU10,000

D. CU12,000

Correct Answer: B. CU9,000