The term accounting changes is used to describe three categories of changes disclosed in the financial statements of a company. Accounting changes can include: a change in accounting principal, accounting estimates, and reporting entities. Disclosures should include a description of the change as well as its effect on financial statements.
While the accounting profession is provided guidance by the Financial Accounting Standards Board when it develops Generally Accepted Accounting Principles, oftentimes these professionals have several options from which to choose. For example, a company could change the method they’re using for depreciating an asset or valuing inventory. Accountants may also be required to generate estimates based on the best information available at that time.
Accounting estimates and reporting entities can change as better information becomes available, or companies change their operating structure. It’s also possible to change accounting methods; although investor-analysts should carefully examine these changes, since they can materially affect the perceived profitability of a company.
The profession has established three categories into which all changes fall:
- Change in Accounting Principal: refers to the adoption of an accounting method that differs from that used in the past.
- Change in Accounting Estimate: referrers to those forecasts that require revision based on the availability of new and better information in the current accounting period. Changes in accounting estimates can involve revenues, expenses, liabilities and assets; these are corrected prospectively in the financial statements of a company.
- Change in Reporting Entity: refers to changes in subsidiaries, consolidations, or the way individual companies or consolidated reports appear in the financial statements of a company.
When an alternate accounting method is chosen, the impact on the company’s financial statemenst must be shown in the current accounting period as well as retrospectively. A change in reporting entity also requires the restatement of prior financial statements. A change in estimates only needs to be disclosed.