A change in accounting principle is the term used when a business selects between different generally accepted accounting principles or changes the method with which a principle is applied. Changes can occur within accounting frameworks for either generally accepted accounting principles, or GAAP, or international financial reporting standards, or IFRS. American companies use GAAP.
For investors or other users of financial statements, changes in accounting principles can be confusing to read and understand. The adjustments look very similar to error corrections, which often have negative interpretations. Changing an accounting principle is different from changing an accounting estimate or reporting entity. Accounting principles impact the methods used, whereas an estimate refers to a specific recalculation. An example of a change in accounting principle occurs when a company changes its system of inventory valuation, perhaps moving from LIFO to FIFO.
Recording and Reporting Change in Accounting Principle
Whenever a change in principle is made by a company, the company must retrospectively apply the change to all prior reporting periods, as if the new principle had always been in place, unless it is impractical to do so. This is known as "restating." Keep in mind that these requirements only impact direct effects, not indirect effects.
If the adoption of a new accounting principle results in a material change in an asset or liability, the adjustment must be reported to the retained earnings' opening balance. Additionally, the nature of any change in accounting principle must be disclosed in the footnotes of financial statements, along with the rationale used to justify the change. The FASB issues statements about accounting changes and error corrections that detail how to reflect changes in financial reports.