International Accounting Standard (IAS) 8 is about the Accounting Policies, Changes in Accounting Estimates and Errors. This standard helps entities to select which accounting policies are most relevant for them and prescribes in what circumstances an entity should make changes to an accounting policy. IAS 8 also deals with the accounting treatment and disclosure of changes in accounting policies, changes in accounting estimates and correction of prior period errors.
Accounting policies are the specific principles, rules, bases which are applied by an entity in preparing and presenting the financial statements.
When selecting an accounting policy, the policy must comply with applicable international standards. If the policy doesn't, then the entity should refer to one of the following for further guidance; the international standards which relate to similar issues, the IASB framework, any assertions from other standard-setting bodies or accounting literature and accepted industry practices.
Changes within the accounting policy are rare. They will only be changed under two circumstances; if the change is required by an international standard, or if the change makes the information more relevant and reliable.
When accounting for a change in the accounting policy, if the change is a result from the application of an international standard, then the change is accounted for in accordance with the transitional provisions provided in that particular standard. Otherwise the change is accounted for retrospectively. This means that all the comparative figures are adjusted and are presented as if the new policy had always been applied. Appendix 1 shows new standards and interpretations implemented by Arriva.
If an entity changes any of its accounting policies, then IAS 8 requires three main disclosures in the notes; for changes caused by initial application of an international standard or interpretation, the title of the standard should be disclosed and a description of any transitional provisions in that standard. For voluntary changes in accounting policies; the reason why the new policy will provide more relevant and reliable information should be added. Finally for all changes in accounting policies; IAS 8 requires disclosure of the nature of the change and adjustments of current and prior information to enable fair comparability.
A change in accounting estimate is an adjustment of an asset, liability or a related expense resulting in the entity to reassess the expected future benefits or obligations related to that asset or liability.
IAS 8 states:
"Many items in financial statements cannot be measured with precision but can only be estimated"
"The use of reasonable estimates is an essential part of the preparation of financial statements and does not undermine their reliability"
For example, doubtful debts are an estimated figure. Changes in accounting estimates should be accounted for prospectively and not retrospectively and comparative figures for earlier periods should not be restated.
If financial statements contain material errors then they do not comply with the international standards. Potential errors can be corrected before the financial statements are authorised for issue. However, some errors may not be detected until a subsequent accounting period. Such errors are referred to as “prior period errors”.
These errors can be caused by simple mathematical mistakes, wrong application of accounting policy, misinterpretation of fact or by fraud and should be corrected retrospectively and previous year's figures should be changed to maintain comparability. Once a material prior period error has been corrected, IAS 8 requires that some additional notes need to be disclosed in the financial statement.
In relation to IAS 8, the IASB (International Accounting Standards Board) have introduced a Framework for the Preparation and Presentation of Financial Statement. This framework describes the basic concepts to prepare financial statements. The framework is a guide to the board in developing standards and resolving accounting issues which do not have direct answers in the International Accounting Standard or International Financial Reporting Standard.
The IASB framework states that there are four “qualitative characteristics” which make the information in the financial statement useful:
Understandability. It is clear that some people will understand things which others may not. Therefore the framework suggests that the information should be understandable by users who have “a reasonable knowledge of business...” However, relevant information should not be excluded merely because it is too difficult for some users to understand.
Relevance. Information needs to be relevant and needs to help users evaluate past, present or future events. It also needs to help users evaluate future events, “predictive value”.
Reliability. Reliable information must be free from material error. It must also be ‘faithfully represented', i.e. figures should be real. ‘Substance over form' is when for example an asset is recorded as sold legally but the entity is still enjoying its economic benefits. This would not be classed as faithful representation. ‘Neutrality' i.e. non biased information should be presented. ‘Prudence' for example, uncertainties such as the collectability of doubtful trade receivable. This figure can easily be manipulated easily but neutrality should be bared in mind. Finally, ‘completeness' where all financial statements must be complete within the bounds of materiality and cost.
Comparability. Users should be able to compare the entities financial statements with its prior years for trends etc. Also the financial statement should be comparable with other entities. Comparability can be satisfied by following International Standards.
Arriva plc is a multinational company which provides public transport all over the UK and mainland Europe. As the ‘basis of preparation' in the accounting policies, Arriva, a UK listed company is required to prepare its group accounts in accordance with EU endorsed International Financial Reporting Standards (IFRS) and the International Financial Reporting Interpretations Committee (IFRIC) interpretations. The financial statements that are going to be analysed are for periods ending 31 December 2008. Arriva have used historical cost basis of accounting to prepare most of their financial statements. The objective of IAS 1 is to prescribe the general presentation of financial statements which Arriva has satisfied. Although IAS 1 is standardised, many areas enable the entity to choose from a range of options.
Under Arriva's accounting policies, information on their Property, plant and equipment is given which is related to IAS 16. Their land and buildings that are used for delivery of passenger transport services and for administration purposes are stated in the balance sheet at a total cost of £1559.9m. Depreciation is calculated on this figure using the straight-line method so that costs can be allocated. Or the residual value is taken away from the value of the asset and then divided by its estimated useful life. The estimated useful life of an asset can vary as it is an estimate, therefore Arriva have enclosed what figures they have used i.e. Buildings, 50years.
It is very important to disclose these pieces of information as if the estimated useful life is not disclosed then it could be any figure and therefore potential investors won't understand how the final numbers have been calculated. Also the method used for depreciation is very important as there is more than one type of depreciation calculation and each one will generate a different result.
Disclosures of Arriva's current taxation methods are also enclosed in the accounting policy. Arriva's current tax assets and liabilities are measured on the expected amount to be received or paid to the taxation authorities, using the tax rates and laws which are valid when the balance sheet was constructed. Therefore Arriva paid the normal tax rate for 2008. It is stated that deferred tax is paid in full and is paid by the liability method. This is essential to know as the entity may pay tax in a different period to when the activity happened. The deferred tax is determined using the tax rates and laws that are applicable during the balance sheet date and which are expected to apply when the related tax asset is realised or the deferred tax liability is settled.
Arriva is a company which provides a service to its customers rather than a product and therefore doesn't hold as much inventories as other sectors may i.e. supermarkets. However, Arriva still records traces of inventories on their balance sheet of £52.3m. Calculations are in accordance with IAS 2. The policy doesn't tell us what inventory Arriva holds but assumptions can be made that the majority is related to current work in progress, raw materials and consumables as Arriva are extending their railways. It is also stated that the inventories are recorded at the lower of cost and net realisable value. This information is essential as inventories can be listed at their resell value, their scrap value or purchase value. It is also mentioned that the figure stated includes allowances for slow moving or obsolete items. This eliminates any dead stock Arriva may have, making the calculation fair and reliable. Inventory measuring methods would also vary this figure, for example first-in first-out method would usually give low inventory figures therefore cost of sales would decrease and profit would increase.
Arriva has many overseas subsidiaries and therefore large amounts of the takings are translated into British sterling pound. In their accounting policy it is mentioned that they use the average rates of exchange. This is not the fairest way of translating money as some years the currency may be struggling and in other years the currency may be experiencing a boom. For example the UK was going through a recession in 2008 and therefore the value of the pound had decreased so this would result in Arriva getting less money as to if the UK was experiencing a boom, the value of the pound would increase and you would get more pounds after translation. The main issue with this is that it doesn't make it fair when comparing yearly figures within Arriva. It could be deceiving to potential investors when they see that the profits generated from Arriva's subsidiaries have decreased when in actual fact it is the exchange rate which has differed this figure.
The assets and liabilities from Arriva's overseas subsidiaries are translated into sterling at the rates of exchange at the balance sheet date.
Arriva has recorded cash and cash equivalents of £147.7m and the note in the accounting policy states that cash compromises of both cash in hand and demand deposits (cash in bank). The cash equivalents are short-term highly liquid investments with maturity levels of no more than 90 days. These investments are readily convertible to known amounts of cash by Arriva at any time and the investments are subject to an insignificant risk of change in value, therefore they never lose huge amounts of cash. If this highly liquid investment goes down in value it will be immaterial to Arriva. Arriva being a company who is dealing with cash payments from customers daily could be losing out if the cash is not well invested rapidly. Therefore it would be most efficient for Arrive to invest the money as soon as possible to maximise profits if the money is not being used i.e. to buy further assets.
In conclusion, the set of published accounts by Arriva plc are very informative and thorough. The layout and format of the financial statements are very clear and easy to understand. The previous year's set of figures are also displayed on the 2008 accounts to enable easier comparability. On the other hand some items in the accounting policies would be difficult to understand to anyone but an accountant. For example the taxation policy:
“Deferred tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated financial statements. However, deferred tax is not recognised if it arises from initial recognition of an asset or liability in a transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable profit or loss.”
The reader here would need to have knowledge on deferred tax and the liability method. An average investor who wants to invest their small amounts of savings or retirement funds most probably would not have this knowledge and would therefore need to read up on it before making sense of it.
Also another point which was not made clear was the inventories. A supermarket for example would obviously have large amounts of inventories, but Arriva should list examples of their inventories here to make it clearer to the reader as they are not apparent.
The list of individual policies was excellent as it gives the reader a clear and concise view as to how the figures were calculated and what means of measures were used. For example under property, plant and equipment we were told that the straight-line method was used to calculate depreciation, this then enables the reader to check how the final figure was reached.
So to finalise, after reviewing the accounting policies for Arriva plc the purpose is apparent; for the readers to have clear knowledge of the reporting methods, measurement systems and various other disclosures that the company has used to make sense of the figures in the financial statements. Arriva's accounting policy is informative yet slightly difficult to understand especially for someone with little accounting knowledge. Although on the positive side it is easy to read and enables easy comparability.
MELVILLE, Alan, 2008. International Financial Reporting: A Practical Guide. 1st Ed. London: Financial Times/ Prentice Hall.
IAS Plus, 2010. IAS Plus: Framework for the Preparation of Financial Statements [online]. Available at: http://www.iasplus.com/standard/framewk.htm [accessed 24 January 2010].
IAS Plus, 2010. IAS Plus: IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors [online]. Available at: http://www.iasplus.com/standard/ias08.htm [accessed 25 January 2010].