FRED 21 Accounting policies
| by Neil D Stein
01 Sep 2000
FRED 21, Accounting Policies was issued in December 1999 at the same time as the final version of the ASB ’s Statement of Principles for Financial Reporting, and needs to be studied alongside it because there is some overlapping between them. It replaces SSAP 2, Disclosure of Accounting Policies, which appeared in 1971 when there was no statement of accounting principles in the UK.
ObjectiveThe objective of this (draft) FRS is to ensure that for all material items:
Estimation techniques include, for example:
Measurement basesThose monetary attributes of the elements of financial statements — assets, liabilities, gains, losses and changes to shareholders’ funds — that are reflected in financial statements.
Where a business holds an asset, purchased at some point in the past, that asset will have a number of different ‘values’. It will have a historical cost, being the amount for which it was originally acquired. In addition, it will have a current net realisable value and, if it is capable of being replaced, it will have a current replacement cost. These different ‘values’ are examples of monetary attributes of the asset.
Other examples arise when different attributes are combined in a formula. For example, in a historical cost system, stocks are stated at the lower of historical cost and net realisable value. Similarly, in a current cost measurement system, the current value of an asset, using the value to the business rule, is the lower of replacement cost and recoverable amount.
Some monetary attributes will be suitable for use in financial statements only in conjunction with others. A monetary attribute, or combination of attributes, that may be reflected in financial statements is called a measurement basis. Measurement bases fall into two broad categories — those that reflect current values and those that reflect historical values.
The requirements of FRED 21 as regards accounting policies An entity should adopt accounting policies that are, in the opinion of its directors, most appropriate to its particular circumstances for the purpose of giving a true and fair view and are consistent with the requirements of accounting standards and companies legislation.
If in exceptional circumstances compliance with the requirements of an accounting standard is inconsistent with the requirement to give a true and fair view, the requirements of the accounting standard should be departed from to the extent necessary to give a true and fair view, with full disclosure of the departure and the reasons for making it.
The objectives against which an entity should judge the appropriateness of accounting polices to its particular circumstances are:
The constraints that an entity should take into account in judging the appropriateness of accounting policies to its particular circumstances are:
The principles of relevance, reliability, comparability and understandability are, of course, the headings of the qualitative characteristics of financial statements as set out in the Statement of Principles.
An entity’s accounting policies should be reviewed regularly to ensure that they remain the most appropriate to its particular circumstances for the purpose of giving a true and fair view. If an entity’s present accounting policy is no longer judged most appropriate to its particular circumstances, the entity should implement whichever accounting policy is now judged most appropriate.
A material adjustment applicable to prior periods arising from a change to an accounting policy is accounted for as a prior period adjustment, in accordance with the requirements of FRS 3, Reporting Financial Performance.
The requirements of FRED 21 as regards estimation techniquesWhere estimation techniques are required to enable the accounting policies adopted to be applied, an entity should select estimation techniques that are, in the opinion of its directors, most appropriate to its particular circumstances and are consistent with the requirements of accounting standards and companies legislation.
In judging the appropriateness of estimation techniques to its particular circumstances, an entity should take account of the objectives and constraints set out above for accounting policies.
An entity’s estimation techniques should be reviewed regularly to ensure that they remain the most appropriate to its particular circumstances. An entity should implement a new estimation technique if it is judged more appropriate to the entity’s particular circumstances than the present estimation technique.
A change to an estimation technique should not be accounted for as a prior period adjustment.
Comparison of the two sets of requirementsYou can see from the above that the only difference between the two sets of requirements is in the accounting treatment of changes. A change in accounting policy may require a prior year adjustment whereas a change in estimation technique does not.
Distinguishing between changes in accounting policies and changes in estimation techniques
FRED 21 draws a clear distinction between changes in accounting policies and changes in estimation techniques as defined above, giving several examples to illustrate the difference:
A change of policy, because the interest is to be recognised as a loss rather than as part of the cost of an asset.
A change in estimation technique, because the vehicles are being recognised and presented in the same way, using the same measurement basis, namely historical cost.
The only change is to the estimation technique used to measure the unexpired portion of each vehicle’s economic benefits.
A change of policy, because presentation has changed.
So what general principles determine whether a change is to an accounting policy or to an estimation technique? FRED 21 sets up three questions, and if the answer to any one of them is ‘yes’, the change is to an accounting policy. The three questions are:
Applying these questions to the four examples, we see:
Example 1 — change in recognition, hence a change in policy.
Accounting conceptsSSAP 2 introduced and defined four fundamental accounting concepts, by now familiar to just about all accounting students — going concern, accruals, consistency and prudence. The Statement of Principles now provides a comprehensive set of accounting concepts, and FRED 21 refers specifically to only two of them — going concern and accruals — and requires a prominent note to the financial statements giving a full explanation if either of these concepts has not been followed in the financial statements.
Disclosure requirements — routineThe following information should be disclosed in the financial statements:
Disclosure requirements — exceptionalIf financial statements have been prepared on the basis of assumptions that differ from either the going concern assumption or the accruals concept, that fact should be stated prominently and an explanation provided.
For any material departure from the requirements of an accounting standard or companies legislation, particulars of the departure, the reasons for it and its effect should be disclosed. The information disclosed should include:
Where a departure continues in subsequent financial statements, the disclosures should be made in all such subsequent statements, and should include corresponding amounts for the previous year. Where a departure affects only the corresponding amounts, the disclosures should be given for those corresponding amounts.
ConclusionFRED 21 is not really controversial, and will thus probably become an FRS quite soon with few changes. From an examination point of view, while it remains an exposure draft, it is only examinable for paper 13. As an FRS, it will be examinable for papers 1, 10 and 13, and will frequently need to be considered alongside the Statement of Principles in answering questions.
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