Definition
A change in accounting principle switches from one acceptable method to another, for example from FIFO to average cost, and requires that the new method be preferable. Under ASC 250 it is applied retrospectively to all prior periods unless impracticable, with an adjustment to opening retained earnings, and with disclosure. A change in accounting estimate results from new information, such as revising an asset's useful life or the uncollectible rate, and is applied prospectively in the current and future periods. If it is hard to distinguish, a change in estimate effected by a change in principle is treated as an estimate. Adopting a new standard follows the standard's own transition.
Why it matters in an audit or review
Auditors ask for management's analysis of why the new principle is preferable, test that it was applied correctly, and evaluate whether an estimate change is hiding an error or smoothing income.
Example
(Illustrative, no salvage value) An asset cost $100,000 is depreciated over 10 years and has 4 years of depreciation taken ($40,000), leaving $60,000. Management now estimates 8 remaining years. New annual depreciation is $60,000 / 8 = $7,500, versus $10,000 before, with no restatement of prior years.
Common mistakes
- Restating for an estimate change.
- No support for why the new principle is preferable.
Sources
- FASB ASC 250-10-45, Accounting Changes and Error Corrections (changes in principle, preferability, estimates, estimate effected by a change in principle)
- FASB ASC 250-10-50, disclosures
- AICPA, AU-C Section 540, Auditing Accounting Estimates and Related Disclosures
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error