Question:
What is meant by a change in accounting principle? Describe the accounting treatment for a voluntary
change in accounting principle.
Answer:
GAAP permit alternative treatments for similar transactions. Common examples are the choice among
FIFO, LIFO, and average cost for the measurement of inventory and the choice among alternative
revenue recognition methods. A change in accounting principle occurs when a company changes from
one generally accepted treatment to another.
In general, we report voluntary changes in accounting principles retrospectively. This means revising all
previous periods’ financial statements as if the new method were used in those periods. In other words,
for each year in the comparative statements reported, we revise the balance of each account affected.
Specifically, we make those statements appear as if the newly adopted accounting method had been
applied all along. Also, if retained earnings is one of the accounts whose balance requires adjustment
(and it usually is), we revise the beginning balance of retained earnings for the earliest period reported in
the comparative statements of shareholders’ equity (or statements of retained earnings if they’re presented
instead). Then we create a journal entry to adjust all account balances affected as of the date of the
change. In the first set of financial statements after the change, a disclosure note would describe the
change and justify the new method as preferable. It also would describe the effects of the change on all
items affected, including the fact that the retained earnings balance was revised in the statement of
shareholders’ equity along with the cumulative effect of the change in retained earnings.
An exception is a change in depreciation, amortization, or depletion method. These changes are
accounted for as a change in estimate, rather than as a change in accounting principle. Changes in
estimates are accounted for prospectively. The remaining book value is depreciated, amortized, or
depleted, using the new method, over the remaining useful life.
What is meant by a change in accounting principle? Describe the accounting treatment for a voluntary
change in accounting principle.
Answer:
GAAP permit alternative treatments for similar transactions. Common examples are the choice among
FIFO, LIFO, and average cost for the measurement of inventory and the choice among alternative
revenue recognition methods. A change in accounting principle occurs when a company changes from
one generally accepted treatment to another.
In general, we report voluntary changes in accounting principles retrospectively. This means revising all
previous periods’ financial statements as if the new method were used in those periods. In other words,
for each year in the comparative statements reported, we revise the balance of each account affected.
Specifically, we make those statements appear as if the newly adopted accounting method had been
applied all along. Also, if retained earnings is one of the accounts whose balance requires adjustment
(and it usually is), we revise the beginning balance of retained earnings for the earliest period reported in
the comparative statements of shareholders’ equity (or statements of retained earnings if they’re presented
instead). Then we create a journal entry to adjust all account balances affected as of the date of the
change. In the first set of financial statements after the change, a disclosure note would describe the
change and justify the new method as preferable. It also would describe the effects of the change on all
items affected, including the fact that the retained earnings balance was revised in the statement of
shareholders’ equity along with the cumulative effect of the change in retained earnings.
An exception is a change in depreciation, amortization, or depletion method. These changes are
accounted for as a change in estimate, rather than as a change in accounting principle. Changes in
estimates are accounted for prospectively. The remaining book value is depreciated, amortized, or
depleted, using the new method, over the remaining useful life.
