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30.4 Change in accounting principle
Publication date: 30 May 2022
us Financial statement presentation guide
ASC 250-10-20 defines a change in accounting principle.
Definition from ASC 250-10-20
A change from one generally accepted accounting principle to another generally accepted accounting principle when there are two or more generally accepted accounting principles that apply or when the accounting principle formerly used is no longer generally accepted. A change in the method of applying an accounting principle also is considered a change in accounting principle.
A change in accounting principle can be required by newly issued guidance or as the result of a decision by the reporting entity to adopt a different accounting principle on the basis that it is preferable.
New accounting guidance generally provides specific transition requirements (e.g., prospective application, full retrospective application, modified retrospective application, etc.). Accordingly, the provisions of ASC 250 do not apply when a reporting entity is adopting a new accounting pronouncement that specifies the manner of adopting the change. However, if transition requirements are not provided by the new accounting guidance, a change in accounting principle should be reported in accordance with ASC 250.
In certain situations, a reporting entity may elect to change its financial statement presentation from one acceptable alternative to another (e.g., a change from presenting accumulated depreciation and amortization on the face of the financial statements to the footnotes or changing from a “one-step” income statement to a “two-step” income statement). We believe a change in financial statement presentation does not constitute a change in accounting principle and thus would not require a preferability assessment. However, a reporting entity should have consistent presentation for all periods presented within the financial statements.
The adoption of accounting principles in certain situations are outside the scope of ASC 250.
Excerpt from ASC 250-10-45-1
Neither of the following is considered to be a change in accounting principle:
- Initial adoption of an accounting principle in recognition of events or transactions occurring for the first time or that previously were immaterial in their effect
- Adoption or modification of an accounting principle necessitated by transactions or events that are clearly different in substance from those previously occurring.
Some examples of scenarios that would not constitute a change in accounting principle under ASC 250-10-45-1a may include the selection of a date for the annual goodwill impairment test after completing a business combination that resulted in recording goodwill for the first time or conforming the accounting policies of an acquired business to those of the acquirer.
An example of a scenario that may not be deemed a change in accounting principle under ASC 250-10-45-1b is when changes in the contractual relationship between the reporting entity and other parties result in a conclusion that the reporting entity is no longer the principal in a revenue transaction and should present that revenue on a net basis.
Generally, accounting principles that are not material are not disclosed in the footnotes. Therefore, it would be unusual for an accounting principle that is disclosed in previously-issued financial statements to be deemed immaterial for the purpose of considering ASC 250-10-45-1a. However, in certain instances, reporting entities may have historically disclosed immaterial accounting principles for comparability with peers or for consistency with prior years. In these situations, reporting entities should perform an assessment of the materiality of the accounting principle that they are changing, the materiality of the change, and the preferability of the change to determine what level of disclosure, if any, is warranted. Even if a reporting entity concludes that a change is immaterial and retrospective application is not required (refer to FSP 30.4.2 and discussion of SAB Topic 5.F), if the change is disclosed, an SEC registrant may still be required to file a preferability letter from their independent registered public accountants. See FSP 30.4.1 and FSP 30.4.2.
Once an accounting principle is adopted, it should be applied consistently when accounting for similar events and transactions because the consistent use of accounting principles is critical to the utility of financial statements. A reporting entity that wants to voluntarily change an accounting principle must justify that the alternative accounting principle is preferable. For example, a change in a reporting unit’s annual goodwill impairment test date is a change in the method of applying an accounting principle requiring a preferability assessment (see BCG 9.5.1.2).
Preferability may vary depending upon the circumstances of the reporting entity. For example, one reporting entity may consider the LIFO inventory method to be preferable due to the nature of its inventory costs, while for others, FIFO may be preferable. The disclosure should include an explanation of why the newly adopted change is preferable.
SAB Topic 6.G.2.b, Reporting Requirements for Accounting Changes (codified in ASC 250-10-S99-4), provides guidance on assessing the justification for a change in accounting principle. It includes considerations such as whether an authoritative body has deemed an accounting principle preferable, how the change impacts business judgment and planning, and whether the change results in improved financial reporting.
Question FSP 30-1 discusses whether a preferability assessment is required when a private company changes accounting principles upon filing an IPO registration statement.
Question FSP 30-1
When a private company changes accounting principles to conform with public company accounting principles in connection with filing an IPO registration statement, does the change require a preferability assessment?
When a private company changes accounting principles to conform with public company accounting principles in connection with filing an IPO registration statement, does the change require a preferability assessment?
PwC response
No. When a private company is required to change accounting principles to conform with public company accounting requirements (e.g., discontinuing the application of the Private Company Council (PCC) goodwill alternative), a preferability assessment is not necessary. This is because such a change in accounting principle is not “voluntary” and is required by a regulator to conform to GAAP.
Question FSP 30-2 discusses whether a private company is required to perform a preferability assessment when adopting a PCC accounting alternative for the first time.
Question FSP 30-2
When a private company voluntarily adopts a PCC accounting alternative for the first time, is a preferability assessment required?
When a private company voluntarily adopts a PCC accounting alternative for the first time, is a preferability assessment required?
PwC response
No. Although the adoption of a PCC accounting alternative is a voluntary change in accounting principle, ASU 2016-03, Intangibles—Goodwill and Other (Topic 350), Business Combinations (Topic 805), Consolidation (Topic 810), Derivatives and Hedging (Topic 815), allows private companies to forgo a preferability assessment the first time they elect any of the PCC accounting alternatives within the scope of the ASU. However, after the initial election of a PCC accounting alternative, any future accounting changes require a preferability assessment, except when a private company changes accounting principles to conform with public company accounting principles in connection with filing an IPO registration statement (see Question FSP 30-1).
30.4.1 Preferability letters (change in accounting principle)
For public reporting entities (except for foreign private issuers) that make material accounting changes, the registrant’s independent accountant is required to provide a letter, commonly referred to as a “preferability letter.” The preferability letter indicates whether or not the change to an alternative principle is, in the accountant’s judgment, preferable under the circumstances. S-X 10-01(b)(6) and S-K Item 601 provide guidance on the form and content of preferability letters.
If there has been a material change in an accounting principle or its method of application, the auditor is required to discuss the change in an explanatory paragraph in the auditor’s report. The explanatory paragraph must identify the nature of the change and refer to the financial statement footnote that discusses it.
30.4.2 Presentation and disclosure considerations (change in accounting principle)
ASC 250-10-45-5 requires that a change in accounting principle be reported through retrospective application, unless impracticable. Retrospective application requires the following:
- The cumulative effect of the change to the accounting principle on periods prior to those presented should be reflected in the carrying amounts of assets and liabilities as of the beginning of the earliest period presented.
- The effect, if any, must be reflected in the opening balance of retained earnings (or other appropriate components of equity or net assets) for the earliest period presented.
- Financial statements for prior periods presented should be adjusted to reflect the period-specific effects of applying the new accounting principle.
SAB Topic 5.F, Accounting Changes Not Retroactively Applied Due to Immateriality (codified in ASC 250-10-S99-3), provides the SEC staff’s view when an accounting change that is required to be adopted by retrospective application is considered to be immaterial to prior period financial statements. The SEC staff believes the amount should be reflected in the results of operations for the period in which the change is made, unless the cumulative effect is material to current operations or to the trend of the reported results of operations. In this case, the individual income statements of the earlier years should be retrospectively adjusted. See SAB 99, Materiality, for evaluating materiality.
ASC 250-10-50-1 requires specific financial statement disclosures with respect to a change in accounting principle.
Excerpt from ASC 250-10-50-1
An entity shall disclose all of the following in the fiscal period in which a change in accounting principle is made:
- The nature of and reason for the change in accounting principle, including an explanation of why the newly adopted accounting principle is preferable.
- The method of applying the change, including all of the following:
- A description of the prior-period information that has been retrospectively adjusted, if any.
- The effect of the change on income from continuing operations, net income (or other appropriate captions of changes in the applicable net assets or performance indicator), any other affected financial statement line item, and any affected per-share amounts for the current period and any prior periods retrospectively adjusted. Presentation of the effect on financial statement subtotals and totals other than income from continuing operations and net income (or other appropriate captions of changes in the applicable net assets or performance indicator) is not required.
- The cumulative effect of the change on retained earnings or other components of equity or net assets in the statement of financial position as of the beginning of the earliest period presented.
Financial statements of subsequent periods need not repeat the disclosures required by this paragraph. If a change in accounting principle has no material effect in the period of change but is reasonably certain to have a material effect in later periods, the disclosures required by (a) shall be provided whenever the financial statements of the period of change are presented.
ASC 250-10-50-1 indicates that the disclosure generally does not need to be repeated in subsequent period financial statements. However, when an accounting change occurs and prior periods are not retrospectively adjusted due to impracticability, the disclosures should be included in subsequent periods until all periods are prepared using the new principle.
SAB Topic 6.I.3, Net of Tax Presentation (codified in ASC 740-10-S99-1), clarifies that when cumulative effect adjustments related to changes in accounting principle are reported on a net of tax basis, additional disclosure of the nature of the tax component should be provided. This is accomplished by reconciling the tax component associated with the cumulative effect adjustment to the applicable statutory income tax rate.
Question FSP 30-3 illustrates the effect of a retrospective change in accounting principle on column labels in financial statements.
Question FSP 30-3
Do the columns in the financial statements need to be labelled “As adjusted” when there has been a retrospective change in accounting principle?
Do the columns in the financial statements need to be labelled “As adjusted” when there has been a retrospective change in accounting principle?
PwC response
No. Although the example in ASC 250-10-55-10 illustrating a retrospective change in accounting principle uses the label “As adjusted,” ASC 250 does not require such labeling in the financial statements. However, use of the “As adjusted” label is encouraged as a best practice. Additionally, when there has been a retrospective change in accounting principle, the financial statements should include clear disclosure about the effect of the change on the affected financial statement line items and any per-share amounts as required by ASC 250-10-50-1.
The “As restated” label should generally be used only when the financial statements reflect the correction of a material error.
30.4.2.1 Impracticability (change in accounting principle)
In certain scenarios, it may not be practical for reporting entities to determine the retrospective impact of an accounting change (e.g., due to lack of available information). ASC 250-10-45-9 acknowledges this complication and provides criteria that a reporting entity must meet to consider retrospective application impracticable.
It shall be deemed impracticable to apply the effects of a change in accounting principle retrospectively only if any of the following conditions exist:
- After making every reasonable effort to do so, the entity is unable to apply the requirement.
- Retrospective application requires assumptions about management’s intent in a prior period that cannot be independently substantiated.
- Retrospective application requires significant estimates of amounts, and it is impossible to distinguish objectively information about those estimates that both:
- Provides evidence of circumstances that existed on the date(s) at which those amounts would be recognized, measured, or disclosed under retrospective application
- Would have been available when the financial statements for that prior period were issued.
Sometimes it may be impracticable to determine the period-specific effects of a change on all prior periods presented, even when the cumulative effect can be determined. In these situations, the carrying amounts of assets and liabilities as of the beginning of the earliest period to which the new accounting principle can be applied should be adjusted for the cumulative effect of the change. Any offsetting adjustment should be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position).
If it is impracticable to determine the cumulative effect of applying a change in accounting principle, then the new accounting principle should be applied prospectively as of the earliest date practicable. In this scenario, the disclosures discussed in FSP 30.4.2 are still required.
30.4.2.2 Indirect effects of a change in accounting principle
ASC 250 indicates that retrospective application should include only the direct effects of a change in accounting principle, including any related income tax effects. Indirect effects (e.g., a royalty payment that is based on a reported amount such as revenue or net income) that would have been recognized if the newly adopted accounting principle had been followed in prior periods should not be included in the retrospective application. If indirect effects are actually incurred, they should be reported in the period in which the accounting change is made. Specific disclosures relating to the indirect effects of changes in accounting principles are outlined in ASC 250-10-50-1(c).
If indirect effects of a change in accounting principle are recognized both of the following shall be disclosed:
- A description of the indirect effects of a change in accounting principle, including the amounts that have been recognized in the current period, and the related per-share amounts, if applicable.
- Unless impracticable, the amount of the total recognized indirect effects of the accounting change and the related per-share amounts, if applicable, that are attributable to each prior period presented. Compliance with this disclosure requirement is practicable unless an entity cannot comply with it after making every reasonable effort to do so.
Example FSP 30-1 illustrates an indirect effect of an accounting change.
EXAMPLE FSP 30-1
Indirect effect of an accounting change
Indirect effect of an accounting change
FSP Corp changes to a preferable accounting principle in 20X2. The retrospective application of the change results in an increase in reported net income for 20X1. FSP Corp’s bonus plan is tied to reported net income, and the 20X1 bonus payment would have been higher if the new accounting principle had been adopted in 20X1. Though not required to do so under the bonus plan, FSP Corp elects to pay the incremental bonus amount in 20X2.
Should FSP Corp report the incremental bonus payment in the retrospective application of the change in accounting principle?
Analysis
No. The incremental bonus payment is an indirect effect of the accounting change and would not be included in the retrospective application in 20X1. Instead, the additional bonus expense should be recognized and reported in 20X2. Had FSP Corp chosen not to pay the incremental bonus, there would be no impact on 20X1 or 20X2.
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