Crash Course in Accounting and Financial Statement Analysis, Second Edition

Accounting Changes

Accounting changes represent changes in a company’s accounting methodology governing the reporting of its financial statements, and are reported net of taxes on a separate line item following extraordinary items (Exhibit 5.10).

Exhibit 5.10. Accounting Changes Represent Changes in a Company’s Accounting Methods

Source: Used with permission of McDonald’s Corporation. 2005 Annual Report, © McDonald’s Corporation, 2005.

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Types of accounting changes include:

• Changes Applied to New Transactions

  • New transactions occur only after the accounting change takes place.

  • No adjustments to current financial statements are required.

  • Example: Applying a different depreciation method to new assets.

• Changes in Estimates

  • Can be associated with useful lives and salvage value of depreciable assets as well as value of uncollectible revenue (e.g., Bad Debt Expense is an estimate).

  • Changes are made only in the affected (present and/or future) period(s); past results remain as originally reported.

• Retroactive Changes in Accounting Principles

  • If the company chooses to apply newly adopted accounting principles retroactively (to the past results), the impact of this change on prior periods is shown as a separate item on the income statement called “Cumulative Effect of the Accounting Change on Prior Periods.”

Certain events are not expected to recur, and their placement on ...