Reliable, comparable financial statements are a key component of high-quality financial reporting.  For financial statements to be considered reliable and comparable they must be free of material misstatements.  Accounting changes in previous financial statements reduce the reliability and comparability of the financial statements and they cannot be depended upon by users if they are not recorded correctly.  There are four types of accounting changes and guidance on the types of accounting changes and the proper accounting for each type is addressed in Accounting Standards Codification (ACC 250), Accounting Changes and Error Corrections.

Change in Accounting Principle

A change in accounting principle is a change in the accounting method used in reporting.  The change is from one generally accepted accounting principle to another generally accepted accounting principle when either (1) two different principles could apply to a situation or (2) a formerly used accounting principle is no longer accepted. A change can be required through an Accounting Standard Update or be elective because the change in principle is preferable. Some examples of changes in accounting principles include a change in accounting method used to account for inventory valuation, a change in the method used to value fixed assets, and a change in revenue recognition method.

Change in Accounting Estimate 

A change in accounting estimate is a change that has the effect of adjusting the carrying amount of an existing asset or liability or altering the subsequent accounting for existing or future assets and liabilities.  Changes in accounting estimates arise from new information received and evaluated by management. Management’s assessment of new information determines if a change in the current method of estimating needs adjustment.  Common types of change in accounting method arise from changes in the useful lives of property and equipment, estimates for the allowance for uncollectible accounts, provision for obsolete inventories, liability estimates for warranty obligations, and the life of goodwill.

Change in Reporting Entity

A change in reporting entity is defined as a change that results in financial statements that, in effect, are those of a different reporting entity.  The following types of change are considered changes in reporting entity:

1. Presenting consolidated or combined financial statements in the place of financial statements of individual entities,

2. Changing the entities included in combined financial statements,

3. Changing specific subsidiaries that make up the group of entities for which consolidated financial statements are presented.

The most frequent type of change in reporting entity is for significant restructuring activities and transactions.

Error Corrections

While the correction of an error is an accounting change, it is different from the accounting changes listed above because the other types of accounting changes do not originate from a mistake or issue that was not in line with generally accepted accounting principles.  An error in previously issued financial statements caused by a mathematical mistake, generally accepted accounting principles application issue, or oversight and misuse of facts at the time of preparation will create the need to identify, correct and disclose the error (depending upon the materiality of the error).  Once an error is identified, it must be assessed to see if it is material to the financial statements. Once the materiality is determined then the method of reporting and correcting in the financial statements. Some errors do not require correcting and disclosing (due to immateriality in current and prior financial periods) while other errors must be corrected through different types of restatements.