Accounting policies, judgements and estimates

Accounting policies and judgements

An entity should disclose its significant accounting policies, being the measurement basis and each specific accounting policy that is relevant to understanding the financial statements. The entity should indicate the categories of assets and liabilities to which each measurement basis (historical cost, net realisable value, fair value or recoverable amount) is applied.

The entity should disclose the accounting policies that it considers will assist users in understanding the financial statements. It should consider the nature of its operations and the policies that users of its financial statements would expect to be disclosed for that type of entity.

Disclosure of particular accounting policies is especially important where no policy is prescribed or where alternative policies are allowed. It enables users to make proper comparisons of the financial statements of different entities.

Accounting policies to be disclosed An entity discloses accounting policies that are relevant to its particular circumstances. Entities might disclose accounting policies related to the following: Revenue recognition. Consolidation principles. Business combinations. Application of the equity method of accounting for investments in associates and joint ventures. Joint ventures. Share-based payments. Earnings per share. Depreciation and amortisation of tangible and intangible assets. Capitalisation of borrowing costs and other expenditure. Construction contracts. Investment properties. Derivative financial instruments and hedging. Other financial instruments and investments. Impairment of assets. Leases. Inventories.Taxes, including deferred taxes. Provisions. Employee benefit costs. Functional currency and presentation currency. Foreign currency translation and hedging. Government grants.

An accounting policy might still be significant because of the nature of the entity’s operations, even though the amounts shown for the current and prior periods are not material.

Financial statements should disclose the judgements, apart from those involving estimations, that management has made in the process of applying the accounting policies and that have the most significant effect on the amounts recognised in those financial statements.

Examples of judgements made by management include:

• When substantially all of the significant risks and rewards of ownership of financial assets and lease assets are transferred to other entities.
• Whether, in substance, particular sales of goods are financing arrangements, and so they do not give rise to revenue.
• Whether a financial asset’s contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

Other standards might require an entity to explain management’s judgements in applying accounting policies. Under IAS 40, for example, an entity discloses the criteria by which management has distinguished investment property from owner-occupied property and from property held for sale, where classification of the property is difficult.

Similarly, IFRS 12 includes a more explicit requirement for an entity to disclose the judgements that it has made in determining whether it controls another entity. IAS 1 places a general obligation on management to disclose the judgements made, where there are no specific requirements in other standards.

Estimation uncertainty

An entity discloses the assumptions that it makes about the future, and other major sources of estimation uncertainty at the end of the reporting period, that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year. The entity discloses the nature of such assets and liabilities and their carrying amount as at the end of the reporting period.

Information should be provided in a way that helps users of the financial statements to understand the judgements made by management where there is estimation uncertainty. The following are examples of the types of disclosure:

• Nature of the assumption or other estimation uncertainty.
• Sensitivity of carrying amounts to the methods, assumptions and estimates underlying their calculation, including the reasons for the sensitivity.
• Expected resolution of an uncertainty and the range of reasonably possible outcomes within the next financial year in respect of the carrying amounts of the assets and liabilities affected.
• Explanation of changes made to past assumptions concerning those assets and liabilities, if the uncertainty remains unresolved.

The disclosures required in respect of estimation uncertainty do not relate to those required in respect of significant judgements in applying accounting policies. The estimation uncertainty disclosures deal with situations where the entity has incomplete or imperfect information, often relating to the future. However, an entity might have complete information but still have to exercise judgement in applying accounting policies.

For example, an entity might have complete knowledge of its ownership and voting rights in another entity but, in complex situations, it still exercises judgement to determine whether it has control of that entity.

Estimation uncertainty disclosures required by other standards The disclosure of estimation uncertainty is required by other standards. Areas that could require disclosure in respect of estimation uncertainty include the following: Recoverable amount of property, plant and equipment. Fair value of revalued items of property, plant and equipment Effect of technological obsolescence on inventories. Significant assumptions applied in estimating fair values of financial assets and financial liabilities that are carried at fair value. Major assumptions about future events affecting classes of provisions. Significant actuarial assumptions used to determine the present value of the defined benefit obligation. Recoverable amount of trade receivables. Recoverability of deferred tax assets.

Disclosure of estimation uncertainty is required only where there is a significant risk of material adjustment to the carrying amount of asset and liabilities within the next financial year.

Management might make estimates in respect of material amounts in the financial statements, but this does not necessarily mean that there is a significant risk of material adjustment.

Material adjustments are most likely to arise in difficult, subjective or complex judgments. The judgments become more complicated as the number of variables and assumptions increases, and the potential for future material adjustment increases accordingly.

Assets and liabilities carried at fair value Assets and liabilities that are carried at fair value, where this fair value is based on a quoted price in an active market for an identical asset or liability (as per IFRS 13), create little estimation uncertainty. The market value of those assets and liabilities might change in the next financial year but they are valued accurately as at the balance sheet date. IAS 1 does not require identification of assets and liabilities that might be subject to significant market fluctuations in the following year. Disclosure is only required where the fair value as at the balance sheet date is subject to estimation uncertainty. IFRS 13 includes specific disclosure requirements in respect of fair value measurements for assets and liabilities that are measured at fair value.

Entities are not required to disclose budget information or forecasts in making the required disclosures.

The standard restricts the disclosures to those that have a significant risk of material adjustment within the next financial year. However, the assessment of the carrying amount of assets and liabilities is not based solely on expectations for the following financial year, but on the full amount of time in which the asset will be recovered or the liability settled.

So, a material adjustment to the carrying amount of an asset or liability could occur in the following financial year, as a result of a reappraisal in that period of the recoverability of an asset or settlement of a liability over a much longer period.

It might be impracticable to disclose the extent of the possible effects of an assumption or another source of estimation uncertainty at the balance sheet date.

If so, the entity discloses that it is reasonably possible, based on existing knowledge, that outcomes within the next financial year that are different from the assumption could require a material adjustment to the carrying amount of the asset or liability affected. In all cases, the entity discloses the nature and carrying amount of the specific asset or liability (or class of assets or liabilities) affected by the assumption. ‘Impracticable’ is defined in IAS 1.

Capital disclosures and puttable financial instruments classified as equity

Entities must disclose information that will enable users of its financial statements to evaluate the entity’s objectives, policies and processes for managing capital.

IAS 1 also requires entities to disclose, to the extent not disclosed elsewhere, information on puttable financial instruments classified as equity instruments.

Other disclosures

An entity includes the following information in the financial statements, or includes in other information published with them: The entity’s domicile and legal form, its country of incorporation and address of the registered office (or principal place of business, if different from the registered office). A description of the nature of the entity’s operations and principal activities. The name of the entity’s parent and the name of its ultimate parent. If it is a limited-life entity, information regarding the length of its life.