Accounting changes: Overview, definition, and example
What are accounting changes?
Accounting changes refer to modifications or adjustments made to a company's financial reporting practices, accounting principles, or methodologies. These changes can involve the adoption of new accounting standards, modifications to existing accounting policies, or changes in how transactions are recorded or reported in financial statements. Accounting changes can be voluntary (such as a company choosing to adopt a new accounting standard) or required (such as changes mandated by regulators or accounting boards). Such changes must often be disclosed in financial reports to ensure transparency and provide stakeholders with clear, updated information about the company's financial status.
Why are accounting changes important?
Accounting changes are important because they can significantly impact a company’s financial statements and how its financial performance and position are perceived by stakeholders, including investors, creditors, and regulators. Changes in accounting policies, estimates, or principles may lead to different revenue recognition, asset valuation, or expense allocation. These changes can affect profitability, tax liabilities, and financial ratios, influencing business decisions, investment strategies, and regulatory compliance. Proper disclosure of accounting changes ensures that stakeholders can accurately compare financial performance over time and understand the reasons behind shifts in the company's reported results.
Understanding accounting changes through an example
Imagine a company, Company A, switches from using the cash basis of accounting to the accrual basis of accounting. Under the cash basis, Company A records revenues and expenses when cash is received or paid. Under the accrual basis, revenues and expenses are recorded when they are earned or incurred, regardless of when cash transactions occur. This accounting change would likely impact the company's income statement and balance sheet, as revenues and expenses are now recognized differently. As a result, Company A would disclose this change in its financial statements, explaining how it affects the reported financial position and performance.
In another example, a company decides to update its method for depreciating assets. Previously, it used the straight-line method (where the same amount of depreciation expense is recognized each year), but now it switches to an accelerated method (where more depreciation is recognized in the earlier years of an asset's life). This accounting change would affect the company’s income statement by increasing depreciation expenses in the early years and decreasing taxable income. The company would need to disclose this change in its financial reports, explaining the impact on financial results and its reasons for the change.
An example of accounting changes clause
Here’s how an accounting changes clause might appear in a contract:
“The Parties agree that any changes in the accounting policies or practices that affect the calculation of financial statements, including the adoption of new accounting standards or changes in the method of recognition, measurement, or presentation, will be disclosed in the financial statements and will not affect the financial performance or obligations outlined in this Agreement, except as specifically outlined in this section.”
Conclusion
Accounting changes are important adjustments made to a company’s financial reporting practices and can have significant implications for how the company’s financial health and performance are perceived. These changes might involve shifts in accounting policies, estimates, or methodologies and must be disclosed transparently to ensure stakeholders have accurate and up-to-date information. By understanding and properly disclosing accounting changes, companies help maintain trust with investors, regulators, and other stakeholders while ensuring compliance with accounting standards.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.