Is change in inventory valuation method is a change in accounting estimate or an accounting policy?

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Before we establish whether it is a change in accounting policy or a change in accounting estimate, lets understand what constitutes a change in accounting policy and accounting estimate.

According to IAS 8 a change in accounting estimate is:

An adjustment in the following that results from the assessment on the basis of present and expected future conditions:

  • the carrying amount of an asset or a liability; or
  • the amount of the periodic consumption of an asset, that results

The reasons for changes in estimates can be any of the following:

  • changes occured in the circumstances on which the estimate was based
  • new information gathered
  • more experience gained

However, IAS 8 has not defined specifically a change in accounting policy just like a change in accounting estimate has been defined specifically. However, we do know what is accounting policy, as this has been defined, and we can this definition to understand the change in accounting policy.

According to IAS 8 accounting policies are:

the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements.

In simple words accounting policies are principles, bases, conventions, rules and practices applied by an entity to portray the financial effects of business transactions and other events. This requires selection of:

  • recognition criteria
  • measurement basis
  • presentation format

Every element of the financial statements requires rules for at least these three aspects and this is what accounting policies are. Accounting policies tell how an element will be recognized, measured and presented in the financial statement.

So, we can understand from this analysis that any change in any of the above three aspects will constitute a change in accounting policy.

Now coming back to the answer which you might already know by now is that change in inventory valuation method is a change in measurement base and it is not just an adjustment in the carrying amount of the inventory thus it is a change in accounting policy.

If company changes its inventory valuation method from FIFO to weighted average method then it is basically changing the principle of valuation as FIFO follows a particular cost flow assumption whereas weighted average method uses weighted average of the cost at which inventory was held at the beginning of the period and cost of the goods bought during the period. So, both methods use different basis to value the closing inventory.

Summary
A change in inventory valuation method, for example from FIFO to weighted average or otherwise, is a change in measurement basis. Therefore, it is a change in accounting policy

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