Change in Accounting Policy
Contents
A change in accounting policy refers to a voluntary alteration by a company in the specific principles, methods, or practices adopted in preparing and presenting its financial statements. Unlike changes in accounting estimates, which are driven by new information or conditions, changes in accounting policy are usually made to provide more reliable and relevant financial information to users of the financial statements.
Changes in accounting policy are implemented when a company believes that the new policy will result in a better representation of its financial affairs and performance.
This can occur due to changes in accounting standards, regulations, or upon realization that an alternative policy will more accurately reflect the company’s operations and financial status.
Such changes are applied retrospectively, with adjustments made to prior periods’ financial statements to ensure consistency and comparability over time.
Example of a Change in Accounting Policy
“Global Tech Ltd.” decides to change its accounting policy for recognizing revenue from software sales. Previously, revenue was recognized at the point of sale; now, the company opts to recognize revenue over the period the software is provided to the customer, reflecting the ongoing obligations and benefits more accurately.
Before Change: Revenue recognized at point of sale.
After Change: Revenue recognized over the service period.
Adjustment Required: Restate previous financial statements to reflect revenue recognition over the service period for consistency.
In this scenario, “Global Tech Ltd.” makes a strategic decision to change its revenue recognition policy to better align with the delivery of services over time, rather than at the point of sale.
This change requires the company to adjust its previously issued financial statements to apply the new policy retroactively.
This ensures that the financial statements present a consistent basis for comparison across reporting periods, allowing stakeholders to make more informed decisions based on comparable and relevant financial information.
Significance for Investing & Finance
The significance of a change in accounting policy includes:
Enhanced Transparency and Relevance: By adopting more appropriate accounting policies, companies can provide financial statements that more accurately reflect their operations and financial status.
Comparability: Retrospective application of new accounting policies ensures that financial statements remain comparable across periods, aiding stakeholders in their analysis and decision-making processes.
Compliance with Standards: Changes are often made to comply with new or revised accounting standards, helping companies maintain regulatory compliance and uphold high standards of financial reporting.
Impact on Financial Statements: Such changes can significantly impact reported assets, liabilities, equity, income, and expenses, necessitating clear disclosure to explain the effects on the company’s financial position and performance.
In summary, a change in accounting policy is a deliberate shift in how a company applies accounting principles and practices in its financial reporting.
This process, governed by strict accounting standards and regulations, requires careful consideration, transparent disclosure, and retrospective adjustment to maintain the integrity, relevance, and comparability of financial statements. Through these changes, companies strive to present their financial information in the most accurate light, supporting the needs of investors, regulators, and other stakeholders.
FAQ
What necessitates a company to change its accounting policy?
A company may change its accounting policy to comply with new accounting standards, enhance the relevance and reliability of its financial statements, or better reflect its financial performance and position.
How should a company disclose a change in accounting policy in its financial statements?
A company must fully disclose the nature of the change, the reasons for the change, and the impact of the change on its financial statements, including adjustments made to prior period figures, in the notes to the financial statements.
Can a company change its accounting policy anytime it wants?
A company can change its accounting policy only if the change is required by an accounting standard or if it provides more reliable and relevant information to the users of the financial statements; arbitrary changes are not permitted to ensure consistency and comparability.
Does a change in accounting policy affect the current year’s financial statements only?
No, a change in accounting policy is applied retrospectively, meaning it affects the current year’s financial statements and is also applied to all prior periods presented, to ensure comparability and consistency across all reporting periods.