Question

PalEx a Palestinian listed company issued its financial statements on the 31st of December 2019. The company does not issue comparative statements. The company Audit report in 2018 was qualified due to material departure from IFRS in accounting for inventory. The company now Accounts for their inventory using FIFO. You are an auditor PalEx asked to review the financial statements. Required: - Can you conduct a review Explain your answer? - Based on your answer what would you advise PalEX do - If they accept your advise and you performed all your procedures write the report

Answer 1

Changes in accounting are of three types. They are changes in accounting principle, changes in accounting estimates, and changes in reporting entity. Accounting errors result in accounting changes too. Changes in accounting principle and changes in reporting should be accounted for retrospectively, whereas changes in accounting estimates should be accounted for prospectively. Errors correction depends on the period they are recovered in and if comparative statements are issued.

To start off, changes in accounting principle come about when a company adopts a new generally accepted accounting principle for the prior years’ generally accepted accounting principle. For example, a company might decide to account for its inventory based on FIFO instead of LIFO method or change its depreciation method from straight line to accelerated depreciation method. Even though switching from one generally accounting principle to another generally accounting principle is allowed, FASB requires companies to account for the changes retrospectively. Following this approach, companies adjust their prior years’ financial statements as if they were prepared using the new principle. Beginning balance of the retained earnings of the earliest year presented is adjusted for any cumulative effects. In doing so, FASB contends that financial statements are easy to compare from one year to another, and thus, the information provided therein is more useful to the financial statement users.

In addition, changes in estimates are simply restatement of accounting assumptions. At end of year, companies make estimates to prepare their financial statements. These estimates are not always correct. For example, a company assumes at first that the life of an equipment would be five years and salvage value five thousands. After two years, the company might decide the life of the equipment to be seven years and salvage value only two thousands. Consequently, the company has to account for changes in estimate. Accounting for changes in estimate is done prospectively. Under this approach, the company need not restate its prior years financial states, rather it should account for the changes in current and future years. The rationale for adopting prospective approach for accounting changes in estimates is that estimates are normal and recurring corrections and adjustments.