One area where the Fair Accounting Standards Board, the FASB, and the International Accounting Standards Board, the IASB, converge is with the treatment of accounting changes. SFAS 154, Accounting Changes and Error Correction, documents how companies should treat changes in accounting principles and changes in accounting estimates, two related but different concepts.
Change in Accounting Principle
Accounting principles are general guidelines that govern the methods of recording and reporting financial information. When an entity chooses to adopt a different method from the one it currently employs, it is required to record and report that change in its financial statements. A good example of this is a change in inventory valuation; for example, a company might switch from a FIFO method to a specific-identification method. According to the FASB, an entity should only change an accounting principle when it is justifiably preferable to an existing method or when it is a necessary reaction to a change in accounting framework.
Change in Accounting Estimate
Accountants use estimates in their reports when it is impossible or impractical to provide exact numbers. When these estimates prove to be incorrect, or new information allows for a more accurate estimation, the entity should record the improved estimate in a change in accounting estimate. Examples of commonly changed estimates include bad-debt allowance, warranty liability and the service life of an asset. There are different and less stringent reporting requirements for changes in accounting estimates than for accounting principles. In some cases, a change in accounting principle leads to a change in accounting estimate; in these instances, the entity must follow standard reporting requirements for changes in accounting principles.