TOP CONTRIBUTORS

Adam Farren

Effect of accounting changes appear on a company's financial statements whenever accounting principles change and impact net income from previous reporting periods.

Effect of accounting changes is relevant only to a company's financial statements and the reporting of its net income or net loss. When a company changes or updates the accounting principles it uses to calculate its income, this can affect the company's reported income in previous reporting periods.

In order to allow meaningful evaluation of a company's current and prior revenues, companies must disclose the effect of changes in accounting principles on their balance sheet. The cumulative effect of accounting changes is most often disclosed in a footnote that explains its financial effect, allowing readers to evaluate the current accounting period's net income against prior periods.

A cumulative effect of accounting change is seen after a change in:

1. Accounting principles, such as a new method of calculating Amortization or Depreciation
2. Accounting estimates - for example, a revised projection of Accounts Receivable
3. Reporting entity - for example, in a merger or acquisition, the new company now includes an entirely new group of assets

Example

In 1970, Chrysler changed from LIFO "Last In, First Out" accounting to FIFO "First In, First Out" accounting principles. This change created a cumulative effect of $53.5 million in the company's net income, and if it had been disclosed as part of net income on the company's financial statement the company would have reported a net income of $45.9 million. But instead, it reported previous income statements using the new principle, which led to a more accurate reported net loss of $7.6 million.^[1]

References

1. ↑ The CPA Journal, "Cumulative Effect of a Change in Accounting Principle: Remove It from the Income Statement," January 2003