Determining whether a change is a change in accounting principle, a change in estimate, or the correction of an error can be difficult and require judgment.
In several areas of US GAAP, reporting entities can elect from more than one acceptable accounting principle. As defined in ASC 250-10-20, a change in accounting principle is a change from one acceptable accounting principle to another when there are two or more generally accepted accounting principles. Examples include changing the accounting method for amortizing actuarial gains and losses in net periodic pension expense and changing the method of inventory valuation.
In contrast, as defined in ASC 250-10-20, a change in accounting estimate results from incorporating new information or modifying the estimating techniques affecting the carrying amount of assets or liabilities as of the date the change is made. Changing inputs for estimating uncollectible receivables based on new information is an example of a change in the estimating technique.
The distinction between a change in accounting principle and a change in accounting estimate is important because a change in accounting principle is generally applied retrospectively (by recasting prior periods), while a change in accounting estimate is applied prospectively, affecting only current and future periods. In addition, reporting entities cannot change accounting principles unless the new method is preferable.
Distinguishing a change in accounting estimate from the correction of an error is also important and can be challenging. While a change in accounting estimate results from new information since a previous financial reporting date, an error reflects the misapplication of information that was available at a previous financial statement reporting date. If the information was known, or could have been known, as of the prior period, it is generally indicative of an error in the previous accounting. ASC 250-10-20 includes examples of errors in previously issued financial statements, such as mathematical mistakes, mistakes in the application of GAAP principles, or oversight or misuse of facts that existed at the time the financial statements were issued. Additionally, a change from an accounting principle that is not generally accepted to one that is generally accepted is the correction of an error.
Reporting entities should consider the following questions to help differentiate among a change in accounting principle, a change in estimate, or the correction of an error:
  • What was the rationale for the accounting change?
  • Did the estimation model change, or just the inputs?
  • Why did the inputs to the estimation model change and when was the change in inputs supportable?
  • Is the reporting entity applying the accounting principle to a new business, new balances, or new transactions, or is the accounting principle applicable to balances and transaction streams to which it should have been applied in the past?
  • If the accounting results have changed significantly, can the changes be substantiated by developments in the business?
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