Chapter 6: Accounting for tax effects of a prior period adjustment

An entity applies IAS 12 to account for and disclose the tax effects of correcting prior period errors and changes in accounting policies.

How should an entity account for the income tax when a change in accounting policy requires retrospective adjustments? Question: IAS 8 refers directly to IAS 12 when dealing with the accounting for the tax effects of correcting prior period errors and of retrospective adjustments made to apply changes in accounting policies. How should an entity account for the income tax when a change in accounting policy requires retrospective adjustments? Answer: Where an entity applies a change in accounting policy retrospectively, it should include the related tax effect as part of the prior period adjustments. This might affect current and/or deferred taxes. The tax effect is part of the adjustment to opening equity and should not be included in the current period’s tax expense. The same principle also applies to the accounting for the tax effects of correcting prior period errors.

Impracticability of retrospective application or restatement, and application of hindsight

In limited circumstances, full retrospective application or restatement might not be practicable. Full retrospective application or restatement is not required, to the extent that it is impracticable to determine either the period-specific effects or the cumulative effects of changing an accounting policy or the correction of material prior period errors.

An entity might consider that it would be impracticable to apply a change in an accounting policy, or correct a prior period error retrospectively, where:

1. the effects of the retrospective application or retrospective restatement are not determinable;
2. the retrospective application or restatement requires assumptions about what management’s intent would have been in that period; or
3. the retrospective application or restatement requires significant estimates of amounts, and it is impossible to distinguish objectively information about those estimates that:
4. provides evidence of circumstances that existed on the date(s) as at which those amounts are to be recognised, measured or disclosed; and
5. would have been available when the financial statements for that prior period were authorised for issue, from other information.

It might be impracticable to adjust comparative information where an entity did not collect data in the prior period and it is not practicable to create, or recreate, the information.

Estimates are often required when adjusting comparative information for prior periods. This does not, in itself, prevent reliable adjustments or correction of the comparative information. The estimate should reflect the circumstances that existed in the prior period. The passage of time, or circumstances arising since the affected transaction or event, could increase the difficulty in assessing the events or circumstances that existed when the affected transaction occurred. This does not, however, mean that it is impracticable to adjust the comparative information.

Retrospective application or restatement is not practicable where it is not practicable to distinguish the information type that was available, and is needed to recreate the circumstances in the earlier period, from other information.

For example, this might be the case for a fair value measurement that uses significant unobservable inputs. This is because such valuations would be highly subjective, and it would be impossible to reliably recreate the subjective considerations that management would have taken into account when making the estimate in an earlier period.

Use of hindsight is not permitted when applying a new accounting policy or correcting prior period errors, either to second-guess management’s intentions in the earlier period or in estimating amounts recognised, measured or disclosed in the prior period.

For example, management should not take into account its decision not to hold investments to maturity in a subsequent period when correcting an error in the measurement of held-to-maturity investments. Similarly, information about an unusually severe influenza epidemic in a later period should not affect the correction of errors in calculating an employee healthcare liability in the prior period.

Where it is impracticable to determine the period-specific effects of a change, the entity should retrospectively apply or restate the affected opening balances of assets, liabilities and equity for the earliest period for which it is possible to do so.

This could, in an extreme case, be the current period if it cannot determine the cumulative effect on the amounts in both the opening and closing balance sheets for the prior period. If one of these is not known, an entity cannot determine the effect on the income statement (and therefore the effect on opening or closing equity) of that prior period.

Example – Impracticable to determine the period-specific effects of a change in accounting policy An entity changes its accounting policy during 20X7. The change affects net assets and expenses in all periods presented, and is presumed to be consistent with the requirements of paragraph 14 of IAS 8. The entity reports current period financial information and comparative information for two prior periods. The entity’s accounting records do not enable it to determine the adjustments for all of the periods being reported. Instead, the entity can determine the increase in net assets at the beginning of the current period (and the end of the previous period) and at the beginning of the previous period, as follows: 20X7 20X6 20X5 Pre 20X5 C’000 C’000 C’000 C’000 At 1 January 800 600 Net adjustment for the year 400 200 At 31 December 1,200 800 600 Full retrospective application of the policy to all periods presented is impracticable, because the period-specific effect of the change in 20X5 is not known. In accordance with IAS 8, the entity applies the new policy as at the start of the earliest period for which retrospective application is possible (that is, 1 January 20X6). The adjustments made in the financial statements for 31 December 20X7 for the change in accounting policy are as follows: 20X7 20X6 20X5 Adjustment to opening net assets and opening equity 800 600 Adjustment to prior period income statement (200)

Where it is impracticable to determine the cumulative effect of retrospective application or restatement to all prior periods, an entity should adjust the comparative information from the earliest practicable date. This means that it disregards the portion of the cumulative adjustment before that date.

An entity might change an accounting policy, even if it is impracticable to apply it retrospectively (that is, to adjust figures) for any prior period. It would, however, be rare for an entity to voluntarily adopt an accounting policy that it could not apply retrospectively, because the lack of comparability would make the information less relevant.