AS 5 - Change in Accounting Policy vs Change in Accounting Estimate

# Changes in Accounting Policy vs Changes in Accounting Estimate (AS 5)

A frequent exam trap is the boundary between (a) a change in accounting policy, (b) a change in accounting estimate, and (c) the adoption of a NEW policy that is neither.

## A. Change in Accounting Policy

A change should be made only if:

• Required by statute, OR
• Required by an accounting standard, OR
• The change would result in a more appropriate presentation of the financial statements.

### Examples of change in accounting policy

• Change from Cost model to Revaluation model for PPE
• Change in cost formula used in measuring cost of inventories (e.g., FIFO ↔ Weighted Average)
• Change in basis of valuation of investments

### What is NOT a change in accounting policy

• Adoption of a policy for events/transactions that differ in substance from previously occurring events/transactions – example: replacing ad-hoc ex-gratia retirement payments with a formal gratuity scheme
• Adoption of a new policy for events/transactions which did not occur previously, or that were immaterial – example: introducing a pension scheme that did not exist earlier

### Disclosure of change in policy

• The change and its impact (if material and ascertainable) should be disclosed in the period of change
• If impact not ascertainable, the fact should be indicated
• A change in policy having no material effect in current period but expected to have a material effect in later periods should also be appropriately disclosed

## B. Change in Accounting Estimate

Estimates may be revised when:

• Circumstances on which the estimate was based change, OR
• New information/experience emerges, OR
• Subsequent developments take place.

### Examples of change in accounting estimate

• Change in rate of provision for doubtful debts (e.g., 2% → 3% or 2.5% → 8%)
• Change in useful life of PPE (e.g., furniture from 5 years to 3 years)
• Change in depreciation method (e.g., SLM → WDV) – treated as a change in estimate per AS 5
• Actual bad debts turning out to be more than provision
• Difference between provision and actual expense (e.g., Rs. 7 lakh provision vs Rs. 9 lakh actual)
• Revision of staff welfare provision (e.g., Rs. 7.5 lakhs → Rs. 10 lakhs in same year)

### Treatment

The effect of a change in accounting estimate should be:

• Classified using the same classification in the P&L as was previously used for the estimate, AND
• Recognized in the current period (and future periods if affected) – not retrospectively.

### Disclosure

If material, the nature and amount of a change in accounting estimate that has a material effect in the current period (or expected to have material effect in subsequent periods) should be disclosed.

## Quick Decision Tree