What is the difference between an accounting policy and an estimate

The difference between an accounting policy and an accounting estimate is that changes in estimates are recognized prospectively, while changes in policies are applied retrospectively.

Changes in accounting estimates

Unlike accounting policies, estimates are based on an expectation made by a company based on the information currently available.

For this reason, these can change over time.

IAS 8 gives entities the power to apply changes in the estimates prospectively.

This is so because companies do not have control over new information that may arise in the future.

When reference is made to a prospective application, it means that an entity considers that exists new information that implies that it should update the estimate that an entity had made at the time.

This application should affect the present and subsequent financial statements, but never the financial statements prepared before the changes in the estimate.

It’s important to say that an accounting estimate is made based on the judgment, criteria, and information that the entity management obtained on a determinate date.

However, it’s necessary to take into account that an incorrect application in the judgment, in the criteria, or any omission in the information may indicate that we are not in the presence of a change in an accounting estimate but in the presence of an error, which according to IAS 8 must be applied retrospectively.

That is, the entity must affect the financial statements from the moment that the company found the mistake.

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Changes in accounting policies

Accounting policies are principles, bases, rules and procedures adopted by an entity for the preparation and presentation of its financial statements, in accordance with paragraph 14 of IAS 8.

An entity may only apply a change in an accounting policy if any of the following conditions are met

The first is that this change is to be required by some standard, or the other condition is that this change leads to having more relevant financial statements.

IAS 8 includes the concept of retrospective application.

This concept refers to the fact that a change in a policy should be treated as if it has always been applied.

For example, an entity chooses the cost method for the subsequent measurement of its buildings.

5 years later, the entity switches to the revaluation model because this method allows showing more reasonably the change in the value of these assets and thus show more reliable information to investors.

According to IAS 8, an entity must apply this change in its accounting policy adjusting the initial balances of each component, affecting equity for the oldest previous period that is present, revealing information about the other comparative amounts for each previous period presented, as if the new accounting policy had always been applied.

At the same way, paragraph 23 of IAS 8, contemplates the concept of limitation to retrospective application.

This means that when an entity must affect its previous financial statements due to changes in accounting policies, this application may be impractical.

In other words, the company cannot determine the impact on the financial statements after the oldest period.

In this case, the entity will apply the new accounting policy to the initial balances of assets and liabilities at the beginning of the oldest period for which the retrospective application is practicable, which could be the current period itself, and will make the corresponding adjustment to the initial balances of each component of equity that is affected for that period.

Changes in accounting policies examples

  • Changes in the progress of a performance obligation, in accordance with paragraph 43 of IFRS 15.

  • Liabilities arising from share-based payment transactions existing at the date of entry into force of IFRS 2, will be applied retroactively and for these liabilities, the entity will restate the comparative information.

  • Changes in the application of an accounting policy associated with the subsequent measurement of a property, plant and equipment or an intangible that consists of the revaluation of assets, as long as this application is not for the first time, in accordance with paragraph 17 of IAS 8.

  • Change in the asset presentation policy, from a current and non-current classification to a presentation based on the degree of liquidity of the assets.

Changes in accounting estimates examples

  • According to the information provided by the lawyers of a company, an entity established a provision for 200,000 for a possible payment of a claim for damage to the environment, a year later, the management adjusted the estimate in 250,000 due to new information provided by the legal department of the entity.
  • A company acquired a building for 600,000, a residual value of 50,000 is estimated, two years later, according to new information related to changes in the supply and demand of real estate, management considers that the residual value of the asset should change to 100,000.
  • An entity estimated that the useful life of one of its buildings should be 60 years, due to new information obtained, the entity changed this estimate and decided that the useful life of the asset should not be 60 years, but 45 years.
  • An entity establishes a provision for the guarantee of the products sold to its customers, according to the criteria of the entity management, its recognized a provision of 100,000, 6 months later it is necessary to update the estimate due to new information related to the quality of its goods, management believes that its necessary to adjust the estimated liability to 150,000.
  • An entity changed the way in which it depreciated its machines from straight line to units produced, this is a change in an accounting estimate in accordance with paragraph 61 of IAS 16.