FASB Statement No. 154: Accounting Changes and Corrections

Guidance for how companies report changes in their accounting methods is found in the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 250, “Accounting Changes and Error Corrections.” This topic, which integrated the earlier FASB Statement No. 154, is the authoritative source for these matters. The objective of this standard is to improve the consistency and comparability of financial information over time and between different companies. By standardizing how changes are reported, it allows users of financial statements, like investors and lenders, to make more informed decisions.

The Mandate for Retrospective Application

A central requirement of ASC 250 is the use of retrospective application when a company voluntarily changes an accounting principle. Retrospective application means applying a new accounting policy to prior periods’ financial statements as if that policy had always been in use. This approach allows for a direct comparison of financial data across multiple years.

This method replaced the practice established by Accounting Principles Board (APB) Opinion No. 20. Under the old rules, companies reported the entire impact of a change in the current year’s income statement. This approach was known as the “cumulative effect” method and could distort the net income of the period of change.

Implementing a Change in Accounting Principle

When a company decides to voluntarily change an accounting principle, such as switching its inventory costing method from Last-In, First-Out (LIFO) to First-In, First-Out (FIFO), it must provide a justification for the change. The company must demonstrate that the new principle is preferable because it results in more reliable or relevant financial information.

Once justified, the company must apply the new principle retrospectively to all prior periods presented in the comparative financial statements. This involves recalculating financial statement line items for those years as if the new method had been used all along, which directly impacts the carrying amounts of assets and liabilities.

The next step involves adjusting the opening balance of retained earnings for the earliest prior period presented. This adjustment reflects the cumulative effect of the change on all periods before the first one being shown. For instance, if a company presents comparative financial statements for 2024 and 2025 and makes a change in 2025, it would adjust the January 1, 2024, retained earnings balance to reflect the total impact of the change on all years prior to 2024.

In some situations, it may be impracticable to determine the period-specific effects of a change. This can occur if the necessary data to restate prior periods cannot be reasonably estimated. In these limited cases, the company is required to apply the new principle to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is feasible. A corresponding adjustment is then made to retained earnings for that period.

Addressing Other Accounting Adjustments

Change in Accounting Estimate

Changes in accounting estimates are handled differently from changes in principles. These adjustments arise from new information or developments that lead to a revision of a previous estimate, like changing the useful life of a machine or updating the percentage of uncollectible accounts. These changes are accounted for prospectively, meaning the revision is applied only to the current and future periods. Prior periods are not restated, as the original estimate was based on the best information available at that time.

Change in Reporting Entity

A change in the reporting entity occurs when the group of companies included in a set of consolidated financial statements changes, such as when a company acquires a new subsidiary. This type of change requires retrospective application. The financial statements of all prior periods presented must be restated to show the financial information for the new, combined entity. This ensures that users can compare the financial performance of the entity as it is currently structured.

Correction of an Error

The correction of an error is distinct from a change in principle or estimate. Errors can result from mathematical mistakes, incorrect application of accounting principles, or the misuse of facts that existed when the financial statements were prepared. When a material error is discovered in previously issued financial statements, it must be corrected by restating those statements as a prior-period adjustment. The process involves correcting the error and adjusting the opening balance of retained earnings for the earliest period presented.

Financial Statement Disclosure Requirements

When a company makes a change in accounting principle, it must provide detailed disclosures in the notes to the financial statements. The company must describe the nature of the change and the reasons for it, including an explanation of why the newly adopted principle is preferable. The disclosures must also detail the method used to apply the change. An important part of the disclosure is quantifying the impact of the change on the financial statements, including the effect on income from continuing operations, net income, and all related per-share amounts for the current period and for every prior period retrospectively adjusted.

For other types of adjustments, specific disclosures are also required. If a change in an accounting estimate has a material effect on the financial statements, the nature and financial impact of the change must be disclosed. For the correction of an error, the company must disclose that previously issued financial statements have been restated, describe the nature of the error, and disclose the effect of the correction on each financial statement line item for all prior periods presented.