When accountants need to make reporting changes in financial statements, they usually classify them into one of three categories. These include a change in accounting principle, change in accounting entity, or change in accounting estimate. This article will provide a brief overview of what each of these items mean.
Changes in accounting principles are simply a change in rule, from one method of reporting for an item to another, either under domestic standards such as GAAP or international standards such as IFRS. The reason accountants change principles is to better present financial information, to make things more clear to users. Typically the change is required to avoid improper disclosure, and it only applies to past information. Change in accounting principle does not have a prospective application.
A change in accounting entity occurs when a corporation consolidates with a parent or simply provides combined reporting with another company instead of reporting on its own operations. When this change occurs, all prior comparative statements need to be revised to take the change into account in order to better reflect the current position of the company.
Changes in accounting estimates are the only changes that are prospective. They include changing the lives of assets for purposes of depreciation, writing down obsolete inventory, and making adjustments to salary expenses. These changes typically don’t have to be fully disclosed unless they are material. However, any time an estimate is made, accountants usually fully disclose the changes if they will have an impact on future reporting periods. This is in contrast to the prior two methods of accounting changes, but also the one that occurs most frequently.
In summary, changes in accounting reporting can have material impacts if not properly categorized or disclosed. Sometimes these changes can make a company look profitable even though it really isn’t. It’s up to investors to do their due diligence in researching the reasons behind the changes.
Source:
HUD.gov “Accounting Changes and Prior Period Adjustments
http://portal.hud.gov/hudportal/documents/huddoc?id=DOC_23196.pdf