Financial statements are prepared over the basis of accounting principles. So, it is the entity’s responsibility to follow the same policies year by year. This ensures comparability concept of accounting is being followed in the preparation of financial statements.
Usually, entity cannot change its accounting policy without any solid reason. However, if the change in accounting policy will result in more accurate presentation of the performance of the activities of the entity, then such change is allowed with retrospective effect. IAS 8 (Accounting Policies, Changes in Accounting Estimates and Errors) and US GAAP ASC 250 provide complete guide for this.
Retrospective effect is one in which we have to make the changes from the past records. For example, if the entity is changing the depreciation method to WDV from straight line in year 2 of its acquisition, then it needs to calculate the depreciation in the year 1 using WDV method and has to adjust any difference in year 2.
Changes in Accounting Principles Example
Change is inventory valuation method from FIFO (First in First Out) to Weighted Average Method.
Change in depreciation method,
Change in revenue recognition method,
Exemption
However, there is no need to apply the changes with retrospective effect under the following circumstances:
- If effect of retrospective application is immaterial,
- If application of retrospective effect is impracticable,
- Change in accounting policy is required by law or IFRS.