| Does hindsight affect prior years’ financial statements? |
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Hindsight means that you only understand an event or situation after it has happened.
Preparing financial statements is not always an exact science. Judgements and assumptions often need to be made about how to account for transactions and events. In preparing the financial statements, an entity uses information (a) available when the financial statements were authorised for issue; and (b) that could reasonably have been expected that it would be considered in preparing financial statements. If new information becomes known in a subsequent period, or an entity’s intention changes, the accounting would not necessarily be changed. This is particularly in the case of hindsight.
GRAP 3.55 indicates the following: “Hindsight should not be used when applying a new accounting policy to, or correcting amounts for, a prior period, either in making assumptions about what management’s intentions would have been in a prior period or estimating the amounts recognised, measured or disclosed in a prior period.” This means that an entity will not change prior year accounting because of new facts and circumstances that become known.
Consider the following examples: Classification of investment property – A municipality owns an office building which it uses in 20X0 as its head office. As a result, it classifies the building as property, plant and equipment. After the financial statements are authorised for issue, the municipality decides to lease the majority of the building to a provincial public entity. In 20X1, the building is classified as investment property. The classification of assets is based on their use (or intended use) at a point in time. As a result, the comparative information is not changed to reflect the different classification in 20X1.
Classification of loan receivable as current or non-current – A public entity provides a loan to a technology innovation start-up. The loan is repayable in equal monthly installments plus interest once the start-up achieves a certain level of profitability. The loan is callable (i.e. capital and interest becomes repayable on demand) if the entity’s solvency ratio reaches a specified level. In year 20X0, the public entity was of the view that the entity would only become profitable in 20X3 and classified the loan as non-current. In 20X1, there was an economic crisis, which meant that the start-up had to take on additional debt and the solvency ratio deteriorated. This resulted in the loan being called and repaid in full in 20X1. Although the loan was settled in 20X1, this does not mean that the classification as non-current in 20X0 was incorrect. For more, read GRAP 3 on Accounting Policies, Changes in Accounting Estimates and Errors here.
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