Chapter 2: Selecting and applying accounting policies

Accounting policies are the specific principles, bases, conventions, rules and practices that an entity applies when preparing and presenting financial statements. An entity should select its accounting policies in accordance with the International Financial Reporting Standards (‘IFRS standards’), which the International Accounting Standards Board (the Board) develops and reviews based on the ‘Conceptual framework for financial reporting’ (the ‘Framework’). It should not develop its own accounting policies, unless not addressed in a standard.

Accounting policies contained in standards and interpretations

An entity should determine the accounting policy or policies to be applied to a particular item by reference to the requirements of the standard or interpretation that applies to a transaction, other event or condition. Where an accounting standard permits an entity to adopt one of the alternative accounting treatments, the entity should clearly indicate the adopted alternative.

For example, IAS 16 permits an entity to adopt either a historical cost policy or a revaluation policy for selected classes of assets.

IFRS standards are sometimes accompanied by guidance to assist entities in applying the requirements. All guidance will state

(a) whether it is an integral part of IFRS standards and, therefore, is mandatory and forms part of the requirements of the standard or interpretation, or

(b) whether it is not.

The guidance that is not integral is merely useful when applying IFRS standards and does not contain requirements for financial statements.

In addition, standards include paragraphs in bold type and plain type. The paragraphs have equal authority, although the paragraphs in bold type indicate the main principles.

Policies not contained in standards and interpretations

There might be no standard or interpretation that specifically applies to a transaction, other event or condition. In such cases, entities should use their judgement to develop and apply an accounting policy that is both relevant and reliable to the users. Reliability means that the financial statements should:

• faithfully represent the financial position, financial performance and cash flows
• reflect the economic substance of transactions, other events and conditions, and not merely the legal form
• be neutral (that is, free from bias)
• be prudent; and
• be complete in all material respects.

Management should also consider other guidance to assist it in exercising judgement to develop and apply an accounting policy. It should refer to the following sources and consider their applicability in descending order:

• Requirements in IFRS standards and interpretations that deal with similar and related issues.
• The definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.

Considerations where management develops an accounting policy by analogy with an IFRS Question: Existing standards might not provide specific guidance on new issues or transactions, so management might look to principles and guidance from existing standards to develop a policy. Management might also refer to proposals in exposure drafts and guidance in new standards that are not yet effective. What are the considerations where management develops an accounting policy by analogy with an IFRS? Answer: Management needs to use judgement to determine which aspects of the IFRS should be considered in developing an accounting policy by analogy. It might be inappropriate to apply only a certain aspect of IFRS if all of the requirements in the IFRS relate to the transactions or issues to which the policy is applied. In addition, if management applies proposals in exposure drafts and guidance in new standards that are not yet effective, it should consider if such proposals or guidance permit early adoption.

 The standard also suggests but does not require, that management consider the most recent pronouncements by other standard-setters that use a similar conceptual framework as that set out in the Framework, other accounting literature and accepted industry practices.

However, these sources should not conflict with the Board’s standards, interpretation and the Framework.

Materiality

Entities do not need to apply accounting policies contained in IFRS standards where the effect of applying them is immaterial. This complements the statement in IAS 1 that an entity does not need to make disclosures required by IFRS standards if the information is immaterial.

IAS 8 defines ‘material’ as it applies to omissions and misstatements. The definition is

“Omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions that users make based on the financial statements. Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. The size or nature of the item, or a combination of both, could be the determining factor”.

The definition is consistent with the definition of materiality in the Framework (as a subsidiary concept of relevance). So, an entity could also apply the definition in considering the application of accounting policies, particularly because failure to apply a policy will often result in an omission or misstatement. On 31 October 2018, the IASB issued amendments to the definition of material in IAS 1 and IAS 8.

The amendment clarifies that material is defined in IAS 1 and is used in IAS 8 with the same meaning. These amendments should be applied for annual periods beginning on or after 1 January 2020. Earlier application is permitted.

When considering materiality, an entity needs to understand the characteristics of the primary users of the general-purpose financial statements and how they could reasonably be expected to influence such users’ economic decisions (made on the basis of those financial statements).

The Framework states that financial reports are prepared for users who have a reasonable knowledge of business and economic activities, and who review and analyse the information diligently.

Reasonable knowledge of accounting would include the knowledge that an entity normally prepares financial statements on a going concern and accruals basis, and basic knowledge of the structure, content and purpose of the statement of comprehensive income, balance sheet, cash flow statement and statement of changes in equity.

An entity should apply a standard unless it is judged that the effects are clearly immaterial. This judgement will require an analysis, which should consider classification, recognition, measurement and disclosure issues. It is inappropriate to adjust or not adjust uncorrected, immaterial departures from IFRS to achieve a particular presentation of an entity’s financial position, financial performance or cash flows.

This implies that such adjustment could reasonably be expected to influence a user’s economic decisions, and would therefore be material. Examples of such departures would be where a small uncorrected error could trigger a breach of borrowing covenants or an employee share option award. Arguments that it is impracticable to apply a standard, or that amounts cannot be determined, are rarely reasons for considering the effect to be immaterial; this is because, in the absence of quantification, it is generally not possible to judge materiality.

Consistency

Entities should apply their accounting policies consistently unless a standard permits otherwise. A standard might permit or require an entity to apply different accounting policies to different categories of items. In such cases, an entity should select an appropriate policy for each category and apply those policies consistently within each of the categories.

For example, IAS 16 permits an entity to adopt a revaluation policy for a class of property, plant and equipment, and to measure another class at historical cost at the same time. The consistency principle requires that, in this case, the entity should apply the policy adopted for each class consistently to all assets included in that class, and from one accounting period to the next.

Should individual group entities adopt uniform accounting policies? Question: Group members might have adopted different accounting policies in their individual financial statements. An entity should make appropriate consolidation adjustments to achieve conformity when preparing consolidated financial statements. Should individual group entities adopt uniform accounting policies? Answer: IFRS does not require the accounting policies of the parent and its subsidiaries’ individual financial statements to be the same as those applied in the group’s consolidated financial statements. Each entity applies the same accounting policy selection process and exercises judgements in accordance with IAS 8. Group members that adopt different policies should be able to justify this with sound business or commercial reasons. Factors that the entity’s management might consider include: accounting policies for the group’s consolidated financial statements; comparability across group companies; effect of different accounting policies on subsidiaries’ distributable profits; level of non-controlling interest; and regulatory considerations.