What Is an Accounting Change?

An accounting change is a change in accounting principles, accounting estimates, or the reporting entity. A change in accounting principles is a change in a method used, such as using a different depreciation method or switching between LIFO (Last In, First Out) to FIFO (First In, First Out) inventory valuation methods.

Key Takeaways

  • An accounting change is a change in accounting principles, accounting estimates, or the reporting entity.
  • A change in accounting principles is a change in a method used, such as using a different depreciation method or switching between LIFO to FIFO inventory valuation methods.
  • Accounting changes require full disclosure in the footnotes of the financial statements to describe the justification and financial effects of the change.
  • Security analysts, portfolio managers, and activist investors watch carefully for changes in accounting principles, as these are often early warning signs of deeper issues.
  • As business environments change, accounting methods and principles will in turn change to keep pace with innovation.

Understanding an Accounting Change

An example of an accounting estimate change could be the recalculation of the machine's estimated lifetime due to wear and tear or technology devices and systems due to faster obsolescence. The reporting entity could also 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, such as management, partners, and security analysts to analyze the changes appropriately, ideally to help them make more informed decisions about a business's operations, future prospects, and investment-related matters.

A company generally needs to restate past statements to reflect a change in accounting principles. However, a change in accounting estimates 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 analysts, 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 the state of business has changed due to globalization, the digitization of business models, and shifting consumer preferences. To keep interested stakeholders well informed, public relations 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 as well. 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.