Change in Accounting Principle
The term change in accounting principle refers to the adoption of an accounting method that differs from that used in the past. When an alternate accounting method is chosen, the impact on the company’s financial statement must be shown in the current accounting period as well as retrospectively.
There are several categories of irregular items that may appear directly in the company’s financial statements or as footnotes to them. When a company adopts a different accounting method, the choice can have a material effect on the company’s financial position. For this reason, prior financial statements need to reflect this change. This allows analysts, investors, and creditors to make accurate comparisons when evaluating the historical performance of a company.
Examples of such changes include switching from a FIFO inventory valuation method to LIFO, or changing the company’s depreciation method from declining balance to straight line. These changes are frequently looked upon with suspicion by the financial community, since they can be used by management to inflate earnings.
Disclosure of such changes in accounting principles includes both notes to the current financial statement as well as tables demonstrating the impact of the change on prior periods.
Company A changed their depreciation method from declining balance to straight line. The cumulative effect of this change (net of income taxes) is $30,000. Before this change, Company A’s financial statement indicated net income of $2,500,000. The impact of this change on Company A’s income statement would be:
|Income Before Changes in Accounting Principles||$2,500,000|
|Cumulative Effect of a Change in Depreciation Method||$30,000|
Note: Cumulative effects of a change in accounting methods would appear in the income statement after any Extraordinary Items.
income statement, materiality, financial statements, extraordinary items, unusual gains or losses, intraperiod tax allocation, prior period adjustments, changes in accounting estimates, change in reporting entity, accounting changes, correction of errors