An accounting change is an alteration in how a company reports financial information. The most common categories are changes in accounting principle or estimate, or reporting entity. While other changes will exist beneath these categories, the term accounting change refers to major shifts in the application of national accounting principles. These changes must be reported to business stakeholders, primarily shareholders, banks or lenders, government agencies, and other groups financially vested in the organization.
A change in accounting principle often relates to depreciation or inventory valuation. For example, companies using a straight-line depreciation method will need to report a change to the double-declining balance method. Straight-line depreciation will decrease an asset’s book value by the same amount each month, whereas the double-declining balance method accelerates the depreciation in the early months, allowing companies to receive more benefits early on in the depreciation process.
An accounting change for inventory valuation is similar. The first in, first out (FIFO) method requires companies to sell older inventory first, whereas last in, first out (LIFO) is the opposite, selling newer inventory first. This change will affect net income, which is the reason for disclosure to outside stakeholders.
For accounting estimates, companies will often value assets at a certain dollar amount when recording the item in the general ledger. An accounting change results when companies re-value assets and need to make adjustments. For example, companies will may record a machine’s useful life at a specific dollar amount or estimate the goodwill from the purchase of another company. If auditors review this estimate and find it to be inaccurate or that it needs adjustments, companies must make an entry to correct the item and make a notation due to the accounting change.
A change in reporting entity occurs when a company merges with another, consolidates or dissolves operations from one or more business units. These changes will possibly result in a different reporting entity that will be responsible for gathering and creating financial information. National accounting standards typically have requirements for which entity reports financial information on a company’s statements, depending on ownership. In general, reporting requirements change at the ownership percentages of less than 25 percent, 26 to 50 percent, and 51 percent or higher. Each level will require a certain accounting change and disclosure, resulting in a different financial statement preparation method based on the merger or consolidation process.