Enquiry:

This is with reference to two different views over change in inventory valuation method (cost formula) from weighted average to first-in first-out (FIFO) basis or vice versa.

In this connection, one of view is that change in cost formula from weighted average to FIFO or vice versa is a change in accounting estimate as International Accounting Standard (lAS) 2, ‘Inventories’ (“IAS-2 “) do not state that the selection of a cost formula under IAS-2 falls under the ambit of accounting policies. Therefore, change in the cost formula would not be attributed as change in accounting policy. To support this view, following paras (32 to 37) of lAS 8, ‘Accounting Policies, Changes in Accounting Estimates and Errors’ (“IAS-8 “) are relevant:

“32.     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 judgments 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 Benefit embodies in depreciable assets; and
e)                 warranty obligations

33.    The use of reasonable estimates is an essential part of the preparation of   financial statements and does not undermine their reliability.

34.    An estimate may need revision if changes occur in the circumstances on which the estimate was based or as a result of new information or more experience. By its nature, the revision of an estimate does not relate to prior periods and is not the correction of an error.

35.    A change in the measurement basis applied is a change in an accounting policy, and is not a change in an accounting estimate. When it is difficult to distinguish a change in an accounting policy from a change in an accounting estimate, the change is treated as a change in an accounting estimate.

36.     The effect of a change in an accounting estimate, other than a change to which paragraph 37 applies, 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.

37.    To the extent that a change in an accounting estimate gives rise to changes in assets and liabilities, or relates to an item of equity, it shall be recognised by adjusting the carrying amount of the related asset, liability or equity item in the period of the change. ”

Another view in this regard is that the change in inventory valuation method from weighted average to FIFO or vice versa is a change in accounting policy instead of change in accounting estimate. Basis for this view are given as under:

• The change of cost formula does not fall under the definition of ‘ change in accounting estimate’, defined below, as it cannot be construed as the assessment of the present status of, and expected future benefits of assets. Therefore, the change of cost formula of inventory valuation is to be considered as change in accounting policy under IAS-8. However, it falls under the definition of accounting policies defined below.
• Moreover, change in measurement basis is a change in accounting policy rather a change In accounting estimate.

Para 35 of the IAS-8 states that;

“A change in the measurement basis applied is a change ill an accounting policy and is not a change in an accounting estimate. When it is difficult distinguish a change in an accounting policy from a change in an accounting estimate, the change is treated as a change in an accounting estimate. ”

In chapter 18, ‘Accounting Policies, Estimates and Errors’ of Gripping IFRS (Pakistan Edition 2008), in the last paragraph of the overview section, it is clearly stated that change in inventory valuation method will be a change in accounting policy. The referred para from the book is reproduced below:

“It should be noted, however, that a change in measurement basis is considered to be a change in policy and not a change in estimate (e.g. with respect to inventories, a change from the FIFO method to the WA method would be a change in accounting policy rather a change in estimate). ”

Change in accounting estimate and accounting policies have been defined in IAS-8 as follows:

“A change in accounting estimate is an adjustment of the carrying amount of an asset or a liability, or the amount of the periodic consumption of an asset, that results from the assessment of the present status o[ and expected future benefits and obligations associated with assets and liabilities. Changes in accounting estimates result from new information or new developments and accordingly are not corrections of errors.”

“Accounting policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements.”

Your valuable opinion is solicited as to whether the change of cost formula of inventory valuation from FIFO to Weighted Average or vice versa will be a change is accounting policy or change in accounting estimate.

Opinion:

The Committee considered your enquiry and in the absence of any specific guidance to  the contrary in the standards and based on practices generally followed for treatment of changes in methods of determining cost of inventory, agrees with the second view described in note 3 of your letter that change in the cost formula from a weighted average cost formula to FIFO-based cost formula or vice versa is a change in accounting policy.

The change in a cost formula represents a change in the bases on which the value of the inventory has been determined. Therefore, a change in the cost formula represents a change in specific bases and hence will be treated as a change in accounting policy.

(March 19, 2014)