Definition
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.
Explanation
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.
Example
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 |
Net Income | $2,530,000 |
Note: Cumulative effects of a change in accounting methods would appear in the income statement after any Extraordinary Items.
Related Terms
The term materiality refers to an accounting constraint that is used to determine the relative importance or value of an item to one of the company's financial statements. If an item is not deemed significant enough to influence the decision-making process of an individual examining the company's financial statements, then that item is not considered material.
Moneyzine EditorFebruary 8th, 2024
The accounting term financial statement refers to a series of documents that reflect the collection and summary of accounting data. Financial statements include the balance sheet, income statement, cash flow statement, and the statement of retained earnings.Moneyzine EditorJanuary 18th, 2024
The financial accounting term extraordinary items refers to gains or losses appearing on a company's income statement that are both unusual and occur infrequently. These are items that can materially affect the company's financial statements, but are not considered part of the company's normal business operations.Moneyzine EditorJanuary 17th, 2024- The financial accounting term unusual gains or losses refers to line items appearing on a company's income statement that are unusual or occur infrequently. These are costs or revenues that would materially affect the company's financial statement, and are considered part of the company's normal business operation.Moneyzine EditorSeptember 21st, 2023
The financial accounting term intraperiod tax allocation refers to the distribution of income taxes to specific irregular items appearing in a financial statement. Intraperiod tax allocations occur within a given accounting period and allow the reader to understand the income tax implication of the irregular item.Moneyzine EditorJanuary 22nd, 2024- The financial accounting term prior period adjustments refers to either a correction to a prior period's financial statement, or the realization of a tax benefit resulting from an operating loss of a subsidiary before it was acquired.Moneyzine EditorSeptember 21st, 2023
The term changes in accounting estimates referrers to those estimations 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; and are corrected prospectively in the financial statements of a company.Moneyzine EditorJanuary 11th, 2024.png)
The financial accounting term changes in reporting entity refers to a switch from one type of reporting entity to another. Changes in reporting entity can fall into several categories, including a change in subsidiaries, the number of companies combined into a consolidated report, as well as the mix of companies appearing in a consolidated report.Moneyzine EditorJanuary 11th, 2024
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.Moneyzine EditorDecember 12th, 2023
The financial accounting term correction of an error in financial reports refers to the rectification of a mistake caused by a transaction that was recorded incorrectly or omitted. Accounting principles require the retrospective restatement of financial statements that were incorrect.Moneyzine EditorJanuary 12th, 2024
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