Chapter 9 IAS-8 Accounting Policies, Change in Estimates and Errors

Chapter - 9 IAS-8 Accounting policies, change in estimates and errors
IAS-8 Accounting policies, changes in estimates and errors
This IAS discusses three items:
(i) Accounting policies

(ii) Change in estimates
(iii) Errors
1. Accounting Policies
When an IFRS specifically applies to a transaction, other event or condition, the accounting policy or
policies applied to that item shall be determined by applying the IFRS.
In the absence of an IFRS that specifically applies to a transaction, other event or condition,
management shall use its judgement in developing and applying an accounting policy that results in
information that is:
(a) relevant to the economic decision-making needs of users; and

(b) reliable, in that the financial statements: (i) represent faithfully (ii) reflect the economic substance
(iii) are neutral, ie free from bias; (iv) are prudent; and (v) are complete in all material respects.
1.1 Consistency of accounting policies
An entity shall select and apply its accounting policies consistently for similar transactions,
other events and conditions, unless an IFRS specifically requires or permits categorisation of
items for which different policies may be appropriate. If an IFRS requires or permits such
categorisation, an appropriate accounting policy shall be selected and applied consistently to
each category.
1.2 Changes in accounting policies
An entity shall change an accounting policy only if the change:
(a) is required by an IFRS; or

(b) results in the financial statements providing reliable and more relevant information.
1.3 The following are not changes in accounting policies
(a) the application of an accounting policy for transactions, other events or conditions
that differ in substance from those previously occurring; and
(b) the application of a new accounting policy for transactions, other events or conditions
that did not occur previously or were immaterial.
The initial application of a policy to revalue assets in accordance with IAS 16 Property, Plant
and Equipment or IAS 38 Intangible Assets is a change in an accounting policy to be dealt
with as a revaluation in accordance with IAS 16 or IAS 38, rather than in accordance with
this Standard. (i.e: prospective application)
1.4 Applying changes in accounting policies
CAF-7 Financial accounting and reporting II 176 Anjum Maqsood - ACA

(a) an entity shall account for a change in accounting policy resulting from the initial
application of an IFRS in accordance with the specific transitional provisions, if any, in that
IFRS; and
(b) when an entity changes an accounting policy upon initial application of an IFRS that does
not include specific transitional provisions applying to that change, or changes an accounting
policy voluntarily, it shall apply the change retrospectively.
1.5 What is retrospective application
Retrospective application is applying a new accounting policy to transactions, other events

and conditions as if that policy had always been applied.
The entity shall adjust the opening balance of each affected component of equity for the
earliest prior period presented and the other comparative amounts disclosed for each prior
period presented as if the new accounting policy had always been applied.
1.6 Limitations on retrospective application
When retrospective application is required, a change in accounting policy shall be applied

retrospectively except to the extent that it is impracticable to determine either the period-
specific effects or the cumulative effect of the change.
When an entity applies a new accounting policy retrospectively, it applies the new
accounting policy to comparative information for prior periods as far back as is practicable.
1.7 Disclosures
When a voluntary change in accounting policy has an effect on the current period or any
prior period, would have an effect on that period except that it is impracticable to determine
the amount of the adjustment, or might have an effect on future periods, an entity shall
disclose:
(a) the nature of the change in accounting policy;

(b) the reasons why applying the new accounting policy provides reliable and more relevant
information;
(c) for the current period and each prior period presented, to the extent practicable, the
amount of the adjustment:
(d) the amount of the adjustment relating to periods before those presented, to the extent
practicable; and
(e) Limitation on retrospective application, if any, and circumstance which led to limitation
and date from when change in accounting policy has been applied.
2. Changes in accounting estimates

As a result of the uncertainties inherent in business activities, many items in financial
statements cannot be measured with precision but can only be estimated. Estimation
involves judgements based on the latest available, reliable information. For example,
estimates may be required of:
(a) bad debts;

(b) inventory obsolescence;
(c) the fair value of financial assets or financial liabilities;
(d) the useful lives of, or expected pattern of consumption of the future economic
benefits embodied in, depreciable assets; and

(e) warranty obligations.
2.1 Effect of change in estimate
The effect of a change in an accounting estimate shall be recognised prospectively by

including it in profit or loss in:
(a) the period of the change, if the change affects that period only; or
(b) the period of the change and future periods, if the change affects both.
2.2 Disclosure
An entity shall disclose the nature and amount of a change in an accounting estimate that
has an effect in the current period or is expected to have an effect in future periods, except
for the disclosure of the effect on future periods when it is impracticable to estimate that
effect.
If the amount of the effect in future periods is not disclosed because estimating it is
impracticable, an entity shall disclose that fact.
3. Errors
An entity shall correct material prior period errors retrospectively in the first set of financial
statements authorized for issue after their discovery by:
(a) restating the comparative amounts for the prior period(s) presented in which the error
occurred; or
(b) if the error occurred before the earliest prior period presented, restating the opening
balances of assets, liabilities and equity for the earliest prior period presented.
3.1 Limitations on retrospective restatement
A prior period error shall be corrected by retrospective restatement except to the extent that
it is impracticable to determine either the period-specific effects or the cumulative effect of
the error.
When it is impracticable to determine the period-specific effects of an error on comparative

information for one or more prior periods presented, the entity shall restate the opening
balances of assets, liabilities and equity for the earliest period for which retrospective
restatement is practicable (which may be the current period).
Corrections of errors are distinguished from changes in accounting estimates. Accounting

estimates by their nature are approximations that may need revision as additional
information becomes known. For example, the gain or loss recognised on the outcome of a
contingency is not the correction of an error.
3.2 Disclosure of prior period errors
An entity shall disclose the following:
(a) the nature of the prior period error;

(b) for each prior period presented, to the extent practicable, the amount of the
correction:

(c) the amount of the correction at the beginning of the earliest prior period presented;
and
(d) if retrospective restatement is impracticable for a particular prior period, the
circumstances that led to the existence of that condition and a description of how and
from when the error has been corrected.

Comprehensive illustration
CI-1: Chief Accountant of Careless Ltd. has prepared the following financial statements for
the year ended 30 June 2011.
Statement of Comprehensive Income
2011 2010
Rs. in 000 Rs. in 000
Sales 25,000 20,000
Cost of sales 15,000 13,000
Gross profit 10,000 7,000
Operating expenses 3,000 2,700
7,000 4,300
Income tax @ 50% 3,500 2,150
Net profit 3,500 2,150
Statement of Changes in Equity
Retained earnings
2011 2010
Rs. in 000 Rs. in 000
At the beginning of year 5,000 3,600
Net profit 3,500 2,150
8,500 5,750
Less: Dividend 1,000 750
At the end of year 7,500 5,000
During the audit it was discovered that sales for the year ended 30 June 2009 and 2010
amounting to Rs. 500 (000) and Rs. 700 (000) respectively had been omitted and have been
included in sales for the year 2011. However, relevant costs were properly accounted for
Auditor also pointed out the operating expenses of Rs.3,000 (000) included overtime for the
year 2010 amounting to Rs. 150 (000) which was approved and disbursed in August 2010
before the finalization of financial statements for the year ended 30 June 2010.
Required:
(a) How would you describe the above matters.

(b) Account for the above. Also give the necessary disclosures.
CI-2: Dynamic Ltd used to account for revenue on despatch of goods. They observed that
over the years instances of goods dispatched being rejected by customers at the time of
receipt were on the increase. Also due to unreliable courier services, quantity received by
customers was often less than the quantity dispatched. The directors, therefore, decided that
revenue should be recognized after receiving the acknowledgement from customers.
Financial statements before the change are as under:
Statement of Comprehensive Income

2005 2004
Rs. in 000 Rs. in 000
Sales 300,000 291,000
Cost of sales 200,000 194,000
Gross profit 100,000 97,000
Operating expenses 30,000 31,000
70,000 66,000
Income tax @ 33% 23,100 21,780
Net profit 46,900 44,220
Retained earnings
2005 2004
Rs. in 000 Rs. in 000
At the beginning of year 44,000 30,000
Net profit 46,900 44,220
90,900 74,220
Less: Dividend 40,900 30,220
50,000 44,000
Relevant amounts of goods dispatched but not received in relevant year by customers are
as under:
Rs.
30 June 2003 30,000,000
30 June 2004 35,000,000
30 June 2005 37,000,000
Required:
How would you describe the above change and do you agree with it? Account for the effect
of above and give necessary disclosures.
CI-3: Wonder Limited (WL) is engaged in the manufacturing and sale of textile machinery.
Following are the draft extracts of the statement of financial position and the income
statement for the year ended 30 June 2012:
Statement of Financial Position

2012 2011
------Rs. in million----
Property, plant and equipment 189 130
Retained earnings 166 108
Deferred tax liability 45 27
Income Statement
2012 2011
------Rs. in million----
Profit before taxation 90 120
Taxation 32 42
Profit after taxation 58 78

Following additional information has not been taken into account in the preparation of the
above financial statements:
(i) Cost of repairs amounting to Rs. 20 million was erroneously debited to the machinery
account on 1 October 2010. The estimated useful life of the machine is 10 years.
(ii) On 1 July 2011, WL reviewed the estimated useful life of its plant and revised it from 5
years to 8 years. The plant was purchased on 1 July 2010 at a cost of Rs. 70 million.
Depreciation is provided under the straight line method. Applicable tax rate is 30%.
Required:
Prepare relevant extracts (including comparative figures) for the year ended 30 June 2012
related to the following:
(a) Statement of financial position
(b) Income statement
(c) Statement of changes in equity
(d) Correction of error note
CI-4: The following information pertains to a listed company, Fu-tech (Pakistan) Limited.
(i) Shareholders’ equity as at 1 January 2013:
Share capital (Rs. 10 each) Rs. 116 million

Retained earnings Rs. 58 million
(i) Profit after tax for the year ended 31 December 2013 amounted to Rs. 47 million.
(2012: Rs. 38 million)
(ii) In May 2013 the management discovered that inventories costing Rs. 18 million have
been misappropriated. The entire loss has been recorded in 2013. However, it is
estimated that inventories costing Rs. 13 million and Rs. 5 million were
misappropriated in the years 2012 and 2013 respectively.
(iii) Depreciation expense for the year ended 31 December 2013 included incremental
depreciation amounting to Rs. 6.5 million on account of revaluation surplus.
(iv) Right shares were issued on 15 September 2013 at Rs. 12 per share in the ratio of 1
right share for every 4 shares held by the shareholders of the company.
(v) Dividend information is as under:
2013 2012 2011

Cash dividend – Interim *18% - 10%
Cash dividend – Final 14% 15% -
Bonus shares – Final - - 16%
*interim dividend was announced before the issue of right shares.
(vi) Applicable tax rate for the company is 34%.
Required:
Prepare a statement of changes in equity for the year ended 31 December 2013 in
accordance with the requirements of the Companies Ordinance, 1984. (Show comparative
figures)
♣

Practice Questions
PQ-1
The following information has been extracted from the financial statements of Fine Fibre
Limited (FFL) for the year ended 30 June 2013:
2013 2012
Rs. in million
Profit before tax 140 128
Tax expense: Current (39) (36)
Deferred (8) (10)
Share capital (Rs. 10 each) 30 30
Retained earnings at the end of the year 186 105
Subsequent to preparation of the draft financial statements, an error has been detected in
the financial statements for the year ended 30 June 2012 whereby the accounting
depreciation on an assembly plant was mistakenly accounted for at Rs. 21.8 million instead
of Rs. 12.8 million.
Other relevant information is as under:

(i) The assembly plant was installed on 1 July 2010 at a cost of Rs. 80 million and is
depreciated at 20% per annum using the diminishing balance method.
(ii) The error has not affected the tax depreciation which has been worked out correctly.
(iii) Applicable tax rate is 35%.
(iv) Final cash dividend for the year ended 30 June 2012 was approved at the Annual
General Meeting held on 25 September 2012 at Rs. 4 per share (2011: Rs. 5 per
share).
Required:
Prepare the following extracts (including comparative figures) from FFL’s financial
statements for the year ended 30 June 2013 in accordance with the International Financial
Reporting Standards:
(a) Retained earnings column as would appear in the statement of changes in equity; and
(b) Correction of error note.
PQ-2
Clay Pakistan Limited (CPL), a public listed company is in the process of finalizing its
accounts for the year ended 30 June 2011. The following information is available:
(i) The profit after tax and other comprehensive income for the years ended 30 June
2009, 2010 and 2011 (based on draft financial statements) are as follows:
2011 2010 2009
Rs. in million
Profit after tax 5,240 4,120 3,710
Other comprehensive income
Exchange difference on translation of foreign operations 155 120 110
Total comprehensive income 5,395 4,240 3,820

(ii) CPL changed the method of valuation of inventories from weighted average to first-in
first out (FIFO), for the year ended 30 June 2011. The impact of this change on
inventory valuation is given in the following table.
Year ended Impact on inventory valuation

30 June 2009 Increased by Rs. 20 million
30 June 2010 Decreased by Rs. 30 million
30 June 2011 Increased by Rs. 20 million
The above change has not been incorporated in the financial statements.
(iii) Incremental depreciation for the year ended 30 June 2010 and 2011 amounting to
Rs. 1,769 million and Rs. 1,483 million respectively was directly transferred from
surplus on revaluation of property, plant and equipment to retained earnings.
(iv) Cash dividend and bonuses declared/paid during the three years are as follows:
Cash dividend Bonus

Interim Final Interim Final
For the year ended 30 June 2009 15% 25% - -
For the year ended 30 June2010 - 20% 10% 10%
For the year ended 30 June 2011 20% 30% - -
(v) CPL follows a policy of transferring 30% of its profit after tax to general reserve.
(vi) Share capital and reserves as at 30 June 2009 and 2010 were as follows:
2010 2009
Rs. in million
Share capital 10,340 9,400
Capital reserve 3,210 3,210
Translation reserve 870 750
General reserve 10,141 8,905
Un-appropriated profit 6,242 5,410
(vii) Tax rate applicable to the company is 30%.
Required:
Prepare Statement of Changes in Equity for the year ended 30 June 2011 in accordance
with the requirements of Companies Ordinance, 1984 and International Financial Reporting
Standards.
PQ-3

On July 1, 2005, Humayun Chemicals Limited acquired a machine at a cost of Rs. 10 million.
The useful life of the machine and its salvage value was estimated at 5 years and Rs. 3.0
million respectively. The cost of machine is being depreciated under the straight line method.
Based on the practice followed by similar type of companies, the company has determined
that the remaining useful economic life of the machine is six years. It has also been
established that the residual value at the end of the useful life will be equal to 10% of the
cost of machine.
Required:
Compute the depreciation expenses and other adjustments (if any) required to be made in
the financial statements of the company for the year ended June 30, 2008 under each of the
following assumptions:
(i) the review of useful life and residual value was carried out on June 30, 2008;
(ii) the review of useful life and residual value was carried out on June 30, 2007 but in
the financial statements for the year then ended the depreciation expense was
erroneously recorded on the previous basis.
PQ-4
The following is an abridged profit and loss account of Mumtaz & Co.
Rs. Rs.
2004 2003
Sales 1,200,000 850,000
Cost of goods sold 900,000 680,000
Gross Profit 300,000 170,000
Selling and Administrative expenses 180,000 127,500
Profit before tax 120,000 42,500
Taxation (40%) 48,000 17,000
Profit after tax 72,000 25,500
Opening Retained Earnings 475,500 450,000
In 2004 the company decided to change its costing method of inventories from lastin-first out
(LIFO) to first-in-first out (FIFO) in order to follow the benchmark treatment of IAS 2.
The impact on the cost of inventories was as follows:
2004 2003
Closing Inventories (understated) 25,000 35,000
Required:
The company has decided to follow the benchmark treatment of IAS 8 [Net Profit or Loss for
the Period, Fundamental Errors and Changes in Accounting Policies] and has requested you
to prepare all related disclosures including the profit and loss account and statement of
retained earnings, as required under the IAS.
PQ-5

Following is the fixed assets schedule and partial income statement of Plastic Card (Pvt)
Limited for the year ended 30 June, 2003:
Fixed Asset Schedule
Opening
AccumulatedDepreciation
W.D.V. on
Particulars Cost as on Addition Total RateDepreciation for the year
30.6.2003
Rs. Rs. Rs. % Rs. Rs. Rs.
Land 1,000,000 -- 1,000,000 -- -- --
1,000,000
Building 3,500,000 -- 3,500,000 5% 175,000 175,000
3,150,000
Plant & Machinery 56,000,000 -- 56,000,000 10% 5,600,000 5,600,000
44,800,000
Office Equipment 1,680,000 -- 1,680,000 10% 168,000 168,000
1,344,000
Vehicles 1,082,977 52,902 1,135,879 20% 216,595 227,176
692,108
Total 63,262,977 52,902 63,315,879 6,159,595 6,170,176
50,986,108
Partial Income Statement
2003 2002
Rs. Rs.
Profit before tax 5,650,000 4,560,000
Tax @ 43% (2002 : 45%) 2,429,500 2,052,000
Net profit after tax 3,220,500 2,508,000
Retained earning – opening 2,508,000 -
Retained earning – closing 5,728,500 2,508,000
The company was incorporated in the month of July 2001 and acquired assets just after
incorporation. At the time of finalizing of financial statements of the company for the year
ended June 30, 2003, it was found that the vehicle was acquired on lease having cost of Rs.
1,000,000/- and subsequent additions to vehicle are in fact, markup paid to the leasing
company. There were no other additions. Company's policy is to charge depreciation on
reducing balance method.
Required:
(a) Redraft fixed assets schedule.

(b) Prepare partial Income Statement and Statement of Changes in Equity as per related
IAS.
PQ-6
On January 1, 2001, Sigma Enterprises purchased a machine for Rs. 20,000 that had an
estimated useful life of 5 years. The accountant incorrectly charged of this machine in 2001.
the error was discovered in 2002. The company desires to use straight-line depreciation

method on this asset.
Required:
Pass the entry and give computation in this effect on December 31, 2002, to correct for this
error, given that the:
(i) Books have not been closed for 2002
(ii) Books have been closed for 2002
PQ-7
The list of account balance of Perseus, a limited liability company, contains the following
items at 31st December 2000:
Dr. Cr.
Rs. Rs.
Opening inventory 3,850,000
Accounts receivable ledger balances 2,980,000 1,970
Accounts payable ledger balances 14,300 1,210,400
Prepayments 770,000
Cash at bank A 940,000
Overdraft at bank B 360,000
The closing inventory amounted to Rs. 4,190,000, before allowing for the adjustments
required by items (2) and (3) below.
In the course of preparing the financial statements at 31st December 2000, the need for a
number of adjustments emerged, as detailed below:-
(i) The opening inventory was found to have been overstated by Rs. 418,000 as a result
of errors in calculations of values in the inventory sheets.
(ii) Some items included in closing inventory at cost of Rs. 16,000 were found to be
defective and were sold after the balance sheet date for Rs. 10,400. Selling costs
amounted to Rs. 600.
(iii) Goods with a sales value of Rs. 88,000 were in the hands of customers at 31 st
December 2000 on a sale or return basis. The goods had been treated as sold in the
records and the full sales value of Rs. 88,000 had been included in trade receivables.
After the balance sheet date, the goods were returned in good condition. The cost of
the goods was Rs. 66,000.
(iv) Accounts receivable amounting to Rs. 92,000 are to be written off.
(v) An allowance for doubtful debts is to be set-up for 5% of the accounts receivable
total.
(vi) The manager of the main selling outlet of Perseus is entitled, from 1 st January 2000,
to a commission of 2% of the company’s profit after charging that commission. The
profit amounted to Rs. 1,101,600 before including the commission, and after
adjusting for items (1) to (5) above. The manager has already received Rs. 25,000 on
account of the commission due during the year ended 31st December 2000.
Required:
(a) (i) Explian how adjustment should be made for the error in the opening
inventory, according to IAS-8 (Assume that it consititute a material and
fundamental amount).
(ii) State two disclosure required by IAS-8 in the financial statements at 31 st
December 2000 for the adjustment in (i) above.
(b) Show how the final figures for current assets should be presented in the balance
sheet at 31st December 2000.

PQ-8
During the audit of Axis Industries Limited for the year ended 30 June 2000, you observed
that 1040 liters of palm- oil, which was already sold by the company during the year 1999,
was incorrectly included in closing inventory as at 30 June 1999. Such quantity carries a
financial impact of Rs. 52,000. Extracts from the accounts are as follows:
Year ending Year ending

30 June 2000 30 June 1999
(Rs.) (Rs.)
Sales 832,000 588,000
Cost of sales (Note 1) 692,000 428,000
Pretax profit 140,000 160,000
Income Tax @ 30% 42,000 48,000
Net profit after tax 98,000 112,000
Note 1:Cost of sales for the year ended 30 June 2000 contains the above mentioned error in
the opening inventory
Note 2:Retained earnings:
As at 30 June 1998 Rs. 160,000
As at 30 June 1999 Rs. 272,000
Required:
Draft the income statement and statement of retained earnings under the treatment specified
in lAS-8, for the relevant years.
PQ-9
Zahid, a chartered accountant, has recently joined DFL as deputy manager accounts.
Financial statements for the year ending June 30, 2014 are being finalized. Extracts of draft
statements are as follows:
Extracts – income statements

2013 2013
-----------------
Rs.’000-------------
Profit before interest and tax 33,200 24,500
Finance cost 3,200 2,250
Tax [30%] 9,000 6,675
Extracts – statement of changes in equity (retained earnings)

Rs.’000
Balance as at 01-07-12 82,250
Profit after tax 15,575
Balance as at 30-06-13 97,825
Profit after tax 21,000
Balance as at 30-06-14 118,825

Zahid has discovered that on July 1, 2011 DFL sold a machine to a bank for Rs. 20 million
and leased it back for its remaining life of 8 years. A gain on disposal of Rs. 4 million was
recognized immediately on disposal. Subsequently lease payments were accounted for as
operating lease. Relevant details are as follows:
- Rs. 3.749 million Payable annually in advance

- Rs. 2 million payable in respect of bargain purchase option at end of lease term
- Implicit rate on lease was 15%.
Kashif, senior manager accounts, who is also a chartered accountant, is asking Zahid to
ignore this matter. Although Kashif admits his mistake as he was not updated with
accounting standards, but he emphasizes to conceal this issue as it may affect his reputation
before top management. Furthermore Zahid’s job confirmation depends upon Kashif’s
recommendation.
Required:
(a) Prepare revised extracts of financial statements after correction of above error.
(b) Prepare a note on lease obligation for inclusion in financial statements (comparative
figures not required).
(c) Discuss the ethical issues involved in above situation and what actions are available
for Zahid.

Solution of Practice Questions
SOLUTION NO. PQ-1 Note: All figures are in million.

(a) Fine Fibre Limited
Retained earnings
Rs.
Balance at 1st July 2011 (105 – 82 + 15) 38
Add: Profit restated 2012 (W-2) 88
Less: Dividend (30 x 5 / 10) (15)
Balance at 30th June 2012 restated 111
Add: Profit 2013 92
Less: Dividend (30 x 4 / 10) (12)
Balance at 30th June 2013 191
(b) Correction of error note:

In the year 2012, depreciation was mistakenly accounted for as 21.8 million instead
of 12.8 million. Now it has been rectified by restating last year’s figures in
comparative column. Summary of changes made is as under:
Increase / (Decrease) in 2012

Rs.
Depreciation expenses (W-1) (9)
Deferred tax expenses (W-2) 3
Profit after tax 6
Retained earnings 6
Assembly plant (W-1) 9
Provision for deferred tax 3
{Working notes}
(W-1) Calculation of depreciation:
Details Actual Wrong Difference
Rs. Rs. Rs.
Assembly plant – Cost 80 80 -
Depreciation for 2011 (16) (16) -
64 64 -
Depreciation for 2012 12.8 21.8 9 Excess
51.2 42.2
Depreciation for 2013 10.24 8.44 1.8 Less
(W-2) Correction of profit:

Details 2012 2013
Rs. Rs.
Profit before tax (128 + 9) 137 (140 – 1.8) 138.2
Tax:
Current (36) (39)
Deferred (10 + 3.15) (13.15) (8 – 0.63) (7.37)
Corrected profit 87.85 91.83
Rounded 88 92

SOLUTION NO. PQ-2 Note: All figures are in million

Clay Pakistan Limited
for the year end 30 June 2011
Sh. capital Cap. res. Tran. res. Gen. res. Un-app. profit
Total
Balance on 01 July 2009 (vi) 9,400 3,210 750 8,905 5,410
27,675
Adjustment of changes in accounting policy (W-1) 14 14
Balance on 01 July 2009 restated 9,400 3,210 750 8,905 5,424
27,689
Revaluation surplus adjusted (iii) 1,769
1,769
Deferred tax on revaluation surplus (1,769 x 30%) (vii) (531)
(531)
Exchange difference on translation…. (i) 120 120
Net profit (W-1) 4,085
4,085
Transferred to general reserve (4,120 x 30%) (v) 1,236 (1,236) 0
Bonus shares issued (9,400 x 10%) (iv) 940 (940) 0
Dividend (9,400 x 25%) (iv) (2,350)
(2,350)
Balance on 30 June 2010 10,340 3,210 870 10,141 6,221
30,782
Revaluation surplus adjusted (iii) 1,483
1,483
Deferred tax on revaluation surplus (1,483 x 30%) (vii) (445)
(445)
Exchange difference on translation….. (i) 155 155
Net profit (W-1) 5,275
5,275
Transferred to general reserve (5,275 x 30%) (v) 1,583 (1,583) 0
Bonus shares issued (10,340 x 10%) (iv) 1,034 (1,034) 0
Final dividend for 2009-10 (10,340 x 20%) (iv) (2,068)
(2,068)
Interim dividend for 2010-11 (11,374 x 20%) (iv) (2,275)
(2,275)
Balance on 30 June 2011 11,374 3,210 1,025 11,724 5,574
32,907
{Working notes}
(W-1)
Effect on profit due to change in accounting policy:
30.06.2009 30.06.2010 30.06.2011
Increase by Rs. 20 million in year 30.06.2009 (ii) 20 (20)
Decrease by Rs. 30 million in year 30.06.2010 (ii) (30) 30
Increase by Rs. 20 million in year 30.06.2011 (ii) 20
Total profit effect 20 (50) 50
Tax deduction (30%) (vii) (6) 15 (15)
Total profit effect after tax 14 (35) 35
Profit after tax before adjustment (i) 4,120 5,240
Profit after tax after adjustment 4,085 5,275
SOLUTION NO.PQ-3

(i) Profit and Loss Account

2008 2007
Depreciation Expense (W-1) 1.03 1.40
Balance Sheet
2008 2007
Machine – Cost 10 10
Machine – Accumulated Depreciation (3.83) (2.80)
6.17 7.20
(ii) Profit & Loss Account
2008 2007
Depreciation Expense (W-2) 1.27 1.27
Balance Sheet
2008 2007
Machine – Cost 10 10
Machine – Accumulated Depreciation (W-2) (3.94) (2.67)
6.06 7.33
As the depreciation for 2007 has been recorded erroneously on the previous estimates, it
should be rectified by adjusting the comparative figures for 2007 only because error
occurred in that period. Therefore comparative figures for year 2007 have been restated as
per IAS -8 to rectify the error.
{Working notes}
(W-1)
10 - 3
Depreciation for a year = 5
= 1.40 per year
Depreciation for two years (2006 and 2007) = 1.40 x 2
= 2.80
Depreciation for 2008 (based on new estimates =
Cost - Accumulated Depreciation - New Salvage Value
Revised Life
10 - 2.8 - 1 *
= 6
= 1.03 per year
*(10 x 10 %) = 1
(W-2)
10 - 3
Dep. for first year (based on original estimates) = 5
= 1.40
Depreciation on new estimates =
Cost - Accumulated Depreciation - New Salvage Value
Revised Life
10 - 1.4 - 1 **
= 6
= 1.27 per year
**(10 x 10 %) = 0.86
SOLUTION NO.PQ-4
Mumtaz& Co.

Profit & Loss Account

For the Year Ended 2004
(Restated)
2004 2003
Rs. Rs.
Sales 1,200,000 850,000
Cost of sales (W-1) (910,000) (645,000)
Gross profit 290,000 205,000
Selling and Admin. Expense(180,000) (127,500)
Taxation @ 40% (44,000) (31,000)
Mumtaz& Co.
Statement of Retained Earnings
For the Year Ended 2004
Rs.
Balance as at year ended 2002450,000
Add: Profit for 2003 46,500
Balance as at year ended 2003496,500
Add: Profit for 2004 66,000
Balance as at year ended 2004 562,500
Disclosures:
(a) Method of valuation of cost of inventories has been changed from LIFO to FIFO for
better presentation of inventories.
(b) As a result of change in policy, the closing stock recorded for the years 2004 and
2003 has resulted in understatement of Rs. 25,000 and Rs. 35,000 respectively.
Therefore by increasing the stocks, the cost of goods sold for the current year has
been increased by Rs. 10,000 and for the last year has been decreased by Rs.
35,000.
(c) Comparative information has been restated.
SOLUTION NO.PQ-5
(a) Plastic Card (Pvt.) Limited

Fixed Assets Schedule
Plant and Office

Cost: Land Building Vehicles
Machinery Equipment
3,500,00
As onJuly1, 2002 1,000,000 56,000,000 1,680,000 1,000,000
0
Additions /(Deletions) _______- _______- ________- _______- _______-
3,500,00
As onJune 30, 2003 1,000,000 56,000,000 1,680,000 1,000,000
0
Rate % - 5 10 10 20
Accumulated
Depreciation:

As onJuly1, 2002 - 175,000 5,600,000 168,000 200,000

Adjustments - - - -
For the Year _______- 166,250 5,040,000 151,200 160,000
As onJune 30, 2003 _______- 341,250 10,640,000 319,200 360,000
3,158,75
Net Book Value 1,000,000 45,360,000 1,360,800 640,000
0
There were two errors in the schedule i.e. mark up paid on lease of vehicles were capitalized
and the method followed for charging depreciation in 2003 was straight line method instead
of reducing balance method.
(b) Plastic Card (Pvt.) Limited

Profit and Loss Account for the year ended 2003 (Partial)
2003 2002
Rs. Rs.
Profit before tax 5,650,000 4,560,000
Add: Expenses overcharged 599,824 -
Less: Expenses Undercharged - (66,382)
6,249,824 4,493,618
Less: Tax @ 43% (2002 @ 45 %) (2,687,424) (2,022,128)
Net profit after tax 3,562,400 2,471,490
Plastic Card (Pvt.) Limited

Rs.
Balance at June 30, 2001 -
Add: Profit for the year – 2002 2,471,490
Balance at June 30, 2002 2,471,490
Add: Profit for the year – 20033,562,400
Balance at June 30, 2003 6,033,890
{Working notes}
(W-1)
Accumulated Depreciation – Vehicles
2001 Balance b/d -
2002 Balance c/d 200,000 2002 Depreciation 200,000
200,000 200,000
2002 Balance b/d 200,000
2003 Balance c/d 360,000 2003 Depreciation 160,000
360,000 360,000
(W-2)
Calculation of Correct Expenses for Year 2002
Mark – up not charged rather capitalized 82,977
Less: Depreciation on Vehicles charged in Excess (216,595 – 200,000)
(16,595)
Expenses undercharged in 200266,382
(W-3)
Calculation of Correct Expenses for Year 2003
Depreciation on all assets charged in excess (6,170,176 – 5,517,450) 652,726

Less: Mark – up not charged rather capitalized (52,902)

Expenses overcharged in 2003599,824
SOLUTION NO.PQ-6
(i) Entries when books have not been closed for 2002:
Machinery 20,000
Accumulated depreciation 4,000
Retained Earnings 16,000
(Reversing the effect of charging machinery to expenses and also charging
depreciationexpense for year 2001 on straight line method.)
Depreciation 4,000
(Charging Depreciation for the year 2002 on straight line method)
(ii) Entries when books have been closed:
Machinery 20,000
Retained Earnings 12,000
(Rectification the effect of charging machinery to expenses and also charging
depreciationfor the years 2001 and 2002 on straight line.)
Note 1:Books closed means financial statements have been prepared and closing entries
have been recorded.
SOLUTION NO.PQ-7
(a) (i) The opening balance of retained earnings should be adjusted in the
statement of changes in equity. Comparative information should be restated,
unless it is impracticable to do so.
(ii) IAS 8 requires the disclosures of:
 The nature of the fundamental error;
 The amount of the correction for the current period and for each prior
period presented;
 The fact that comparative information has been restated or that it is
impracticable to do so.
(b) Current Assets:

Rs.
Inventory (W-1) 4,249,800
Trade receivable (W-2) 2,660,000
Debit balance of account Payable 14,300
Prepayments (W-3) 748,400
Cash 940,000
{Working notes}
(W-1)
Correct Valuation of Closing Inventory
Rs.
As per given before adjustments4,190,000
Less:Reduction to NRV (6,200)
Add:Goods on sale or return basis 66,000
Correct valuation of closing inventory 4,249,800

Journal Entries
Trading 6,200
Stock 6,200
(Stock costing 16,000 has been written down to NRV of 10,400 – 600 =
9,800)
Stock 66,000
Trading 66,000
(Goods on sale or return basis returned after balance sheet date)
(W-2)
Adjustments regarding Accounts Receivables
Rs. Rs.
As originally stated before adjustments 2,980,000
Less:Goods on sale or return basis (88,000)
Bad debts (92,000) (180,000)
2,800,000
Less:Provision for bad debts @ 5% of 2,800,000 (140,000)
2,660,000
Journal Entries
Sales 88,000
Accounts Receivables 88,000
(Goods on sales or return basis being reversed)
Bad debts 92,000
Trade Receivables 92,000
(Bad Debts being recorded)
Bad debts 140,000
Provision for doubtful debts 140,000
(Provision recorded @ 5% of Account Receivables)
(W-3)
Prepayments
As originally stated 770,000
Less: Commission Expenses (W-3.1) (21,600)
748,400
(W-3.1)
Profit bfore allowing commission
102
x2
Commission expense =
1,101,600
102
x2
=
= 21,600
Percentage
Note: We shall multiply the profit with fraction 100 + percentage when the
words “After Charging” are used.
Journal Entries
Commission expense 21,600
Prepayments 21,600
(Being the commission payable to manager recorded)
SOLUTION NO.PQ-8
Axis industries Limited

Income Statement (Extract)

30.06.2000 30.06.1999
Rs. Rs.
Sales 832,000 588,000
Cost of sales (Note-1) (640,000) (480,000)
Pretax profit 192,000 108,000
Income tax @ 30% (57,600) (32,400)
Net profit after tax 134,400 75,600
Note to the income Statement

1040 litres of palm oil which was sold by the company during year 1999, was incorrectly
included in the closing inventory as at June 30, 1999, such quantity carried a financial impact
of Rs. 52,000. The error has now been corrected by increasing cost of goods sold for the
year ending 1999 by 52,000 and by decreasing the cost of goods sold for the year ending
2000 by 52,000.
Axis industries Limited

Statement of Retained Earnings
Share Retained
capital Earnings Total
Rs. Rs. Rs.
Balance as at 30-06-1998 - 160,000 160,000
Profit as restated for year ending 30.6.99 - 75,600 112,000
Balance as at 30-06-1999 - 235,600 272,000
Profit as restated for year ending 30.6.00 - 134,400 134,400
Balance as at 30-06-2000 - 370,000 370,000
SOLUTION NO.PQ-9
(a)
INCOME STATEMENT - Extracts
2014 2013
------- Rs.'000 ------
Restated
PBIT (W-
1) 34,949 26,249
Finance cost (W-2) (5,215) (4,491)
PBT 29,734 21,758
Tax 30% (8,920) (6,527)
PAT 20,814 15,231
SOCE - Extracts
Rs.'000
Balance as at 01-07-
12 82,250

Adj. for prior year error (W-3) (3,282)

Balance as at 01-07-12 restated 78,968
PAT - restated 15,231
Balance as at 30-06-13 – restated 94,199
PAT 20,814
Balance as at 30-06-
14 115,013
W-1 PBIT 2014 2013

As per question 33,200 24,500
Gain on disposal [4,000 / 8] 500 500
Rental charged as expense 3,749 3,749
Depreciation on leased asset
[20,000 / 8] (2,500) (2,500)
34,949 26,249
W-2 Finance cost 2014 2013

As per question 3,200 2,250
finance charge [W-4] 2,015 2,241
5,215 4,491
W-3 Adj. for prior year error Rs.'000

Gain deferred (4,000)
Deferred gain amortized [4,000 /8] 500
Depreciation on leased asset
[20,000 / 8] (2,500)
Rental charged as expense 3,749
finance charge [W-4] (2,438)
(4,689)
Net of tax (3,282)
(b)
NOTES TO THE
ACCOUNTS
Lease obligation
Lease term is 8 years and instalment is payable annually on every July 1st. Implicit rate is
15%.
Reconciliation
PV of
MLP FC MLP
Not later than 1 year 3,749 2,015 1,734

Later than 1 year but not 16,996 5,298 11,698

later than 5 years

20,745 7,313 13,432
W-4 Lease schedule
Date Open. Bal. Payment Interest Principal Clos. Bal.
01-Jul-11 20,000 3,749 - 3,749 16,251
01-Jul-12 16,251 3,749 2,438 1,311 14,940
01-Jul-13 14,940 3,749 2,241 1,508 13,432
01-Jul-14 13,432 3,749 2,015 1,734 11,698
01-Jul-15 11,698 3,749 1,755 1,994 9,703
01-Jul-16 9,703 3,749 1,455 2,293 7,410
01-Jul-17 7,410 3,749 1,111 2,637 4,772
01-Jul-18 4,772 3,749 716 3,033 1,739
30-Jun-19 1,739 2,000 261 1,739 0

Past Papers
PP-1
The following information pertains to draft financial statements of Pak Ocean Limited (POL)
for the year ended 31 December 2014.
(i)
2014 2013
------ Rs. in million ------
Profit after tax 78 52
Other comprehensive income 12 (5)
Incremental depreciation on revaluation
of property, plant and equipment 1.5 2.3
(ii) Installation of an assembly plant was completed in December 2012 at a cost of Rs. 60
million and it was ready for use on 1 February 2013. However, depreciation for the
year ended 31 December 2013 amounting to Rs. 4.5 million was worked out from the
date of production i.e. 1 April 2013. The mistake was corrected by adjusting the profit
and loss account for the year ended 31 December 2014.
(iii) Shareholders' equity as at 1 January 2013 was as follows:
Rs. in million
Share capital (Rs. 100 each) 200
Retained earnings 4
On 30 November 2014, POL issued 25% right shares to its ordinary shareholders at Rs. 120
per share.
(iv) Cash dividend and bonuses declared/paid during the last three years:
For the year ended Final *Interim

Cash Bonus Cash Bonus
31 December 2012 – 15% 16% –
31 December 2013 18% – 20% –
31 December 2014 – 25% – 10%
*Declared with half yearly accounts
Required:
Prepare Statement of Changes in Equity for the year ended 31 December 2014 in
accordance with the requirements of the Companies Ordinance, 1984 and International
Financial Reporting Standards. (Ignore taxation) (Spring 15, Q-4, Marks-15)
PP-2
The following information has been extracted from the draft financial statements of Himalaya
Woods Limited (HWL) for the year ended 30 June 2015:

Statement of financial position as at 30 June 2015

Equity and liabilities 2015 2014 Assets 2015 2014
Rs. in million Rs. in million
Share capital (Rs. 100 2,500 2,500 Property, plant 4,261 3,773
each) and equipment
Retained earnings 2,450 2,058 Stock in trade 835 795
Trade and other payables 740 560 Trade debts - net 650 585
Taxation 70 52 Cash and bank 14 17
balances
5,760 5,170 5,760 5,170
Statement of comprehensive income for the year ended 30 June 2015

2015 2014
Rs. in million
Sales revenue 20,000 15,520
Cost of sales (14,000) (10,000)
Operating expenses (5,406) (4,764)
Taxation at 34% (202) (257)
Following matters are under consideration for finalisation of the financial statements:
(i) Previous year in June 2014, goods delivered on ‘sale or return basis’ were erroneously
recorded as sale at Rs. 35 million (cost plus 40%). In July 2014, 35% of these goods
were returned by the customers and debited to sales return account.
(ii) A customer owing Rs. 20 million as on 30 June 2015 was declared bankrupt on 1
August 2015. HWL estimates that 40% of the debt would be received on liquidation.
(iii) HWL maintains a provision for doubtful debts at 4% of trade debts.
(iv) Retained earnings balance as at 30 June 2013 amounted to Rs. 1,559 million.
Required:
In accordance with the requirements of International Financial Reporting Standards,

prepare the following:
(a) Statement of financial position as at 30 June 2015

(b) Statement of comprehensive income for the year ended 30 June 2015
(c) Statement of changes in equity for the year ended 30 June 2015 (Aut 15, Q-1, Marks-18)
(Show comparative figures. Ignore deferred tax implications and notes to the financial
statements)
PP-3
The following information has been taken from the financial statements of Asif Engineering
Limited (AEL) for the year ended 31 December 2015:
2015 (draft) 2014 2013

---------- Rs. in million ----------
Property, plant equipment 2,430 2,402 2,105
Stores and spares 73 80 70
Retained earnings as at 31 December 353 224 101
Net profit 129 123 112

In the above financial statements, AEL has recognised consumption of spare parts as
expense. AEL has now decided to change its above policy and classify consumption of
spares having useful life of more than one year as capital spares under property, plant and
equipment.
Following information pertains to capital spares consumed during the past three years:
Year ended Parts issued during the Useful life of the issued
year Rs. in million parts
31 December 2013 55 5 years
Depreciation on these parts is to be charged using straight line method over its useful life.
Required:
In accordance with the requirements of International Financial Reporting Standards, prepare

the revised extracts (including comparative figures) of the following:
(a) Statement of financial position as at 31 December 2015 (04)

(b) Statement of comprehensive income for the year ended 31 December 2015 (03)
(c) Statement of changes in equity for the year ended 31 December 2015 (03) (Ignore
taxation) (Spring 16, Q-7, Marks-10)
PP-4
Chand Paints Limited (CPL) is engaged in the manufacturing of chemicals and paints. In
April 2016 it was discovered that certain errors had been made in the financial statements
for the year ended 30 June 2015. The errors were corrected in 2016. The details are as
follows:
2016 (Draft) 2015 After 2015

correction Audited
of errors
-------- Rs. in million --------
Statement of comprehensive income
Sales tax, commission and discounts (7,939) (8,246) (7,916)
Cost of sales (45,508) (44,606) (44,633)
Selling and distribution expenses (2,940) (2,635) (2,441)
Administration expenses (2,356) (2,254) (2,149)
Other operating charges (495) (467) (515)
Other operating income 920 427 509
Profit for the year 4,089 3,723 4,359
Statement of financial position
Trade and other receivables 1,839 1,613 2,025
Trade and other payables 11,600 8,894 8,670
The share capital and un-appropriated profit of CPL as on 1 July 2014 was Rs. 10,400
million and Rs. 19,089 million respectively.

The details of dividend declared are as follows:
2016 2015
Cash dividend – Interim 10% 5%
– Final 15% 10%
Required:
(a) Prepare a correction of error note to be included in the financial statements for the year
ended 30 June 2016. (Ignore earnings per share and taxation) (10)
(b) Prepare the statement of changes in equity for the year ended 30 June 2016. (08)
(Aut 16, Q-4, Marks-18)
PP-5
Following information has been extracted from the draft financial statements of Marvellous
Limited (ML) for the year ended 30 June 2017:
Statement of financial position

2017 2016
Rs. in million
Property, plant and equipment 700 612
Retained earnings 275 240
Deferred tax liability 58 52
Provision for taxation 12 16
Statement of profit or loss
Profit before taxation 65 85

Taxation 30 25
The following matters are under consideration of the management:
It was identified that ML’s obligation to incur decommissioning cost related to a plant has not
been recognised. The plant was acquired on 1 July 2014 and had been depreciated on
straight line basis over a useful life of four years. The expected cost of decommissioning at
the end of the life is Rs. 50 million. Applicable discount rate is 8%.
In view of significant change in the expected pattern of economic benefits from an item of
the equipment, it has been decided to change the depreciation method from reducing
balance to straight line. The equipment was purchased on 1 July 2015 at a cost of Rs. 80
million having estimated useful life of 5 years and residual value of Rs. 16 million. The
depreciation at the rate of 27.5% on reducing balance method is included in the above draft
financial statements.
The following balances pertain to ML’s statement of financial position as on 30 June 2015:

Rs. in million
Property, plant and equipment 650
Retained earnings 180
Deferred tax liability 40
Provision for taxation 24
Applicable tax rate is 30%. Tax authorities consider decommissioning cost as an expense
when paid.
Required:
Prepare extracts from the following (including comparative figures) for the year ended
30 June 2017:
(a) Statement of financial position (08)
(b) Statement of profit or loss (03)
(c) Correction of error note (06) (Aut 17, Q-6, Marks-17)
PP-6
For the purpose of preparation of statement of changes in equity for the year ended 31
December 2017, Daffodil Limited (DL) has extracted the following information:
2017 2016 2015

Draft Audited Audited
Rs.in million
Transfer to general reserves 112 - 141
Transfer of incremental depreciation - 49 55
Final cash dividend - - 7.5%
2017 2016 2015
Draft Audited Audited
Transfer to general reserves 112 - 141
Transfer of incremental depreciation - 49 55
Final cash dividend - - 7.5%
Additional information:
(i) Details of share issues:

 25% right shares were issued on 1 May 2016 at Rs. 18 per share. The market price
per share immediately before the entitlement date was also Rs. 18 per share.
 A bonus issue of 10% was made on 1 April 2017 as final dividend for 2016.
 50 million right shares were issued on 1 July 2017 at Rs. 15 per share. The market
price per share immediately before the entitlement date was Rs. 25 per share.
 A bonus issue of 15% was made on 1 September 2017 as interim dividend.

(ii) After preparing draft financial statements, it was discovered that depreciation on a
plant costing Rs. 700 million has been charged @ 25% under reducing balance
method, from the date of commencement of manufacturing i.e. 1 July 2014. However,
the plant was available for use on 1 February 2014.
(iii) Share capital and reserves as at 31 December:
2015 2014
------ Rs. in million ------
Ordinary share capital (Rs. 10 each) 1,600 1,600
General reserves 1,850 1,709
Retained earnings 1,430 1,302
Required:
Prepare DL’s statement of changes in equity for the year ended 31 December 2017 along
with comparative figures. (Ignore taxation) (Spr 18, Q-1, Marks-14)
(a) Using the information given in Question no. 1 above, compute DL’s basic earnings per
share for the year ended 31 December 2017 along with the comparative figure. (08)
(b) Explain how dividend on preference shares is dealt with while computing basic EPS. (03)
(Spring 18, Q-2, Marks-08)

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Chapter - 9 IAS-8 Accounting policies, change in estimates and errors

IAS-8 Accounting policies, changes in estimates and errors

This IAS discusses three items:

(i) Accounting policies

(a) relevant to the economic decision-making needs of users; and

1.1 Consistency of accounting policies

1.2 Changes in accounting policies

An entity shall change an accounting policy only if the change:

(a) is required by an IFRS; or

1.3 The following are not changes in accounting policies

1.4 Applying changes in accounting policies

CAF-7 Financial accounting and reporting II 176 Anjum Maqsood - ACA

1.5 What is retrospective application

Retrospective application is applying a new accounting policy to transactions, other events

1.6 Limitations on retrospective application

When retrospective application is required, a change in accounting policy shall be applied

(a) the nature of the change in accounting policy;

2. Changes in accounting estimates

(a) bad debts;

CAF-7 Financial accounting and reporting II 177 Anjum Maqsood - ACA

(e) warranty obligations.

2.1 Effect of change in estimate

The effect of a change in an accounting estimate shall be recognised prospectively by

3.1 Limitations on retrospective restatement

When it is impracticable to determine the period-specific effects of an error on comparative

Corrections of errors are distinguished from changes in accounting estimates. Accounting

3.2 Disclosure of prior period errors

An entity shall disclose the following:

(a) the nature of the prior period error;

CAF-7 Financial accounting and reporting II 178 Anjum Maqsood - ACA

CAF-7 Financial accounting and reporting II 179 Anjum Maqsood - ACA

Statement of Comprehensive Income

Statement of Changes in Equity

(a) How would you describe the above matters.

Statement of Comprehensive Income

CAF-7 Financial accounting and reporting II 180 Anjum Maqsood - ACA

Statement of Changes in Equity

Statement of Financial Position

CAF-7 Financial accounting and reporting II 181 Anjum Maqsood - ACA

(i) Shareholders’ equity as at 1 January 2013:

Share capital (Rs. 10 each) Rs. 116 million

2013 2012 2011

*interim dividend was announced before the issue of right shares.

(vi) Applicable tax rate for the company is 34%.

CAF-7 Financial accounting and reporting II 182 Anjum Maqsood - ACA

Other relevant information is as under:

CAF-7 Financial accounting and reporting II 183 Anjum Maqsood - ACA

Year ended Impact on inventory valuation

Cash dividend Bonus

(vii) Tax rate applicable to the company is 30%.

CAF-7 Financial accounting and reporting II 184 Anjum Maqsood - ACA

CAF-7 Financial accounting and reporting II 185 Anjum Maqsood - ACA

(a) Redraft fixed assets schedule.

CAF-7 Financial accounting and reporting II 186 Anjum Maqsood - ACA

method on this asset.

CAF-7 Financial accounting and reporting II 187 Anjum Maqsood - ACA

Year ending Year ending