An accounting change is a change in accounting principles, accounting estimates, or the reporting entity. A change in an accounting principle is a change in a method used, such as using a different depreciation method or switching between LIFO to FIFO inventory valuation methods. An example of an accounting estimate change could be the recalculation of the machine's estimated life due to wear and tear. The reporting entity could change due to a merger or a breakup of a company.
Accounting changes require full disclosure in the footnotes of the financial statements to describe the justification and financial effects of the change. This allows readers of the statements to analyze the changes appropriately, ideally to help them make more informed decisions about a business's operations.
Breaking Down Accounting Change
A company generally needs to restate past statements to reflect a change in accounting principle. However, a change in accounting estimate does not require prior financial statements to be restated. In the case of an accounting change, users of the financial statements should examine the footnotes closely to understand what any changes mean and if they affect the true value of the company.
Security analyst, portfolio managers, and activist investors watch carefully for changes in accounting principles, as these are often early warning signs of deeper issues. A change in an accounting principle can be fairly routine; especially as business has changed with globalization, the digitization of business models, and shifting consumer preferences. To keep interested stakeholders well informed, PR and strategic communications teams often help explain the rationale behind a change in accounting methods—which can often make perfect finance and accounting sense.
Like artificial intelligence, the Internet of Things and digital methods increasingly alter business performance measurement; it's to be expected, accounting methods and principles will in turn change to keep pace with innovation. An example would include businesses using more intangible assets and less tangible assets of a traditional variety.