Issue 2: Selection of Accounting Policies
In the March 2021 edition of Accounting Alert we started our new series on the top ten financial reporting issues that directors need to consider by examining how to account for unusual events with substantial impacts (such as COVID-19).
In this article we turn our attention to the second of the ten issues that will typically require the greatest attention by directors – selection of accounting policies.
Issue number 2 – selection of accounting policies
Typically, an entity that has been in operation for some time and has been reporting under the same financial reporting framework has accounting policies that only change when the underlying financial reporting standards are amended, or a new financial reporting standard is introduced. However, when an entity undertakes a new type of transaction, buys a new type of asset, or incurs a new type of liability, it must develop an appropriate accounting policy for that transaction, asset or liability.
Under New Zealand equivalents to International Financial Reporting Standards (“NZ IFRS”), the selection of accounting policies is addressed in NZ IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors (“NZ IAS 8”).
NZ IAS 8 set out a three step approach to the selection of accounting policies. The first step is to identify whether there is an NZ IFRS that specifically applies to a transaction, other event or condition. If there is, the accounting policy developed must comply with the requirements of that NZ IFRS.
If there is no NZ IFRS that specifically applies, management must use its judgement to develop an accounting policy that results in information that is both relevant to the economic decision-making needs of users and reliable.
Information in financial statements is reliable if those financial statements:
- Represent faithfully the financial position, financial performance and cash flows of the entity;
- Reflect the economic substance of transactions, other events and conditions, and not merely the legal form;
- Are neutral (i.e. free from bias);
- Are prudent; and
- Are complete in all material respects.
To meet these requirements, the second step that NZ IAS 8 requires is that management identify whether there are NZ IFRSs that deal with similar and related issues. If there are, the accounting policy that is developed must comply with the requirements of those NZ IFRSs.
If there are not NZ IFRSs that deal with similar and related issues, the third step that NZ IAS 8 requires is that management consider the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the New Zealand Equivalent to the IASB Conceptual Framework for Financial Reporting issued in 2018 (“the 2018 NZ Conceptual Framework”). The definitions of assets, liabilities, income and expenses in the 2018 NZ Conceptual Framework are as follows:
|Element of the financial statements
||An asset is a present economic resource controlled by the entity as a result of past events
||A liability is a present obligation of the entity to transfer an economic resource as a result of past events
||Income is increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions from holders of equity claims
||Expenses are decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims
The guidance provided in NZ IAS 8 is summarised in the decision tree below:
Finally, where there is not an NZ IFRS that specifically applies to a transaction, other event or condition, NZ IAS 8 also permits management to consider the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework to that used in NZ IFRS to develop accounting standards, other accounting literature and accepted industry practices, to the extent that these do not conflict with the sources outlined in steps two and three above.
On some occasions, there will be more than one NZ IFRS that applies to a transaction, asset or liability. For example, a building could be classified as property, plant and equipment, investment property, inventory or a non-current asset held for sale, depending on the purpose for which it is held. In such situations, the definitions and scoping paragraphs of individual NZ IFRSs provide guidance that will enable the selection of the NZ IFRS that applies to the entity’s specific circumstances.
In the May 2021 edition of Accounting Alert, we’ll examine the third issue on our Top 10 List - classification of relationships with other entities.
For more information on the above, please contact your local BDO representative.
This publication has been carefully prepared, but is general commentary only. This publication is not legal or financial advice and should not be relied upon as such. The information in this publication is subject to change at any time and therefore we give no assurance or warranty that the information is current when read. The publication cannot be relied upon to cover any specific situation and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact the BDO member firms in New Zealand to discuss these matters in the context of your particular circumstances.
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