Change in accounting policy

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What is an Accounting Policy?

An accounting policy is a rule used by an entity to ensure that transactions are recorded properly and financial statements produced correctly. Accounting policies ensure that accounting activities are handled consistently over time. The main types of accounting policies are as follows:

  • Recognition policies. Contains rules for determining when and how an item is recognized in the financial statements, e.g., recognizing revenue when it is earned.

  • Measurement policies. Contains guidelines on how to measure assets, liabilities, income, and expenses, e.g., at historical cost, fair value, or amortized cost.

  • Presentation policies. Contains rules for presenting financial information in a structured and understandable manner, e.g., the format of financial statements.

  • Disclosure policies. Contains requirements for providing additional information in notes to the financial statements to ensure transparency and completeness.

What is a Change in Accounting Policy?

A business develops accounting policies in order to ensure that relevant and reliable financial information is created. In particular, the policies should yield unbiased information that reflects the economic substance of transactions, and which faithfully represent the financial performance, position, and cash flows of a business.

In general, accounting policies are not changed, since doing so alters the comparability of accounting transactions over time. Only change a policy when the update is required by the applicable accounting framework, or when the change will result in more reliable and relevant information.

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Accounting for a Change in Accounting Policy

If the initial application of an accounting standard mandates that a business change an accounting policy, account for the change under the transition requirements stated in the new standard. When there are no transition requirements that accompany an accounting standard, apply the change retrospectively. Retrospective application means that the accounting records be adjusted as though the new accounting policy had always been in place, so that the opening equity balance of all periods presented incorporates the effects of the change.

There are cases where it may be impracticable to determine the retrospective effect of a change in accounting policy. If so, apply the new policy to the carrying amounts of affected assets and liabilities as of the beginning of the earliest period to which the policy can be applied, along with the offsetting equity account. If the effect of a policy change cannot be determined for any prior period, then do so from the earliest date on which it is practicable to apply the new policy. When making policy changes, adjust all other affected information in the notes that accompany the financial statements.