Change in Accounting Policy-Meaning,Example,Accounting for a Change in Accounting Policy (Commerce Achiever)

What is a Change in Accounting Policy?

A business develops accounting policies in order to ensure that relevant and reliable financial informations is created. In particular, the policies should yield unbiased information that reflects the economic substance of transaction, and which faithfully represent the financial performance, position, and cash flows of a business.

In general, accounting policies are not changed, since doing so alters the comparability of accounting transactions over time. Only change a policy when the update is required by the applicable accounting framework, or when the change will result in more reliable and relevant information.

Accounting for a Change in Accounting Policy

If the initial application of an accounting standard mandates that a business change an accounting policy, account for the change under the transition requirements stated in the new standard. When there are no transition requirements that accompany an accounting standard, apply the change retrospectively. Retrospective application means that the accounting records be adjusted as though the new accounting policy had always been in place, so that the opening equity balance of all periods presented incorporates the effects of the change.

There are cases where it may be impracticable to determine the retrospective effect of a change in accounting policy. If so, apply the new policy to the carrying amounts of affected assets and liabilities as of the beginning of the earliest period to which the policy can be applied, along with the offsetting equity account. If the effect of a policy change cannot be determined for any prior period, then do so from the earliest date on which it is practicable to apply the new policy. When making policy changes, adjust all other affected information in the notes that accompany the financial statements.

Change in Accounting Policy:

Accounting Policies refer to the specific principles, rules, conventions and practices employed by an entity in the preparation and presentation of financial statements. The entity shall select and apply the accounting policies consistently unless interpretation or by other reasons, it is required to change to different accounting policies. Various accounting policies happen in transactions related to:

• Valuation of Inventory
• Valuation of fixed assets
• Valuation of investments
• Treatment of goodwill
• Treatment of contingent liabilities

As a general rule, the changes in the accounting policies must be applied retrospectively in the financial statements. It means the company must adjust all the comparative amounts of prior years in the current year due to such change in the financial statement.

The change in accounting policies is required if:

• It is required by the statute
• It results into a better and appropriate presentation
• The change will provide more useful, relevant and reliable information of financial statements about the effects of transactions, events, financial performance, etc

When there is a change in accounting policy, the company has to disclose the following facts:

• Disclose the changes that would have a material effect in this period or upcoming periods
• In case of the material effect of the change in this period, calculate and disclose the amount by

which any item in the books of account is affected by such change

• Nature of change
• Reasons for change
• Where the retrospective application is impracticable, the reasons for such impracticability.

If change is due to a new standard, transitional provisions should be applied. If transitional provisions are not given, the new policy should be applied retrospectively. This standard state that the significant accounting policies adopted by the company should form part of the financial statements.

Accounting policy	Accounting principles
Inventory costing	Weighted average methodFirst In First Out methodLast in First out
Method of depreciation	Straight-line methodWritten down methodProduction unit’s method
Valuation of Fixed assets	Acquisition priceRevaluation

When the change in accounting policy is applied with retrospective effect, the company shall adjust the opening balance of each affected component e.g., depreciation as the policy has been applied from the very beginning. When it is impracticable to determine the cumulative effect due to the change in accounting policy, the entity shall adjust the transactions in a manner to apply the changes prospectively from the earliest time possible.

Sample of fixed assets accounting policy:

                                                                    ABC Ltd.

                                                     Fixed Assets Accounting Policy

• Purpose: This policy establishes the procedure of recording the newly purchased fixed assets and old fixed assets information and it elaborates the process of determining the valuation of the fixed assets at the historical price in the annual financial statements of ABC Ltd.
• Fixed Assets Definition: It is defined as part of the property which has a useful life of more than 12 months and was purchased for a cost of Rs. 75000 or more. Such assets must be depreciated at the rate of 20 % per annum.
• Register of Fixed Assets: The list of all the fixed assets of the organization should be entered in the fixed assets register and it shall be reviewed half-yearly by the Board of Directors.

The register must include the following information:

• Code number of the asset
• Description of the asset
• Asset class
• Asset’s cost price
• Asset’s useful life
• Asset’s salvage value if any

• The threshold value for capitalization:

Any fixed asset with a cost of Rs 75000 or more shall be included in fixed assets. The fixed assets with a value less than Rs 75000 will be charged to expenses in the financial accounts of the company.

• Useful life:

The useful life is the estimated period during which the assets provide benefits to the company. The factors such as depreciation, obsolescence, wear and tear are taken into account for the calculation of useful life. The policy has specified the following useful lives for the following fixed assets

Assets	Useful life
Computer	2 years
Furniture and fixtures	6 years
Office equipment	7 years
Vehicles	5 years

Adopted this the 5^th of December by board vote via teleconference: Yes/Approve: David, Leena & Pruthvi

No/Disapprove: None

Not Voting: None

Example

Let us understand the change in accounting policy and its effect on the financial statement with the help of the following example:

On 1^st April 2019, Hari purchased a machine for Rs. 100,000. Depreciation was charged at 20% per annum on SLM. From 1^st April 2020, he decided to switch to WDV retrospectively. Calculate the effect of this change. (SLM – Straight Line method & WDV – Written down method)

Calculation of depreciation using SLM:

Depreciation= 100000* 20/100*3=60000

Calculation of depreciation using WDV

Depreciation for 15/16= 100000*20/100= 20000

WDV value= 100000-20000=80000

Depreciation for 16/17= 80000*20/100=16000

WDV value= 80000-16000= 64000

Depreciation for 17/18= 64000*20/100= 12800

WDV value= 64000-12800= 51200

Total depreciation as per WDV= 20000+ 16000+12800= 48800

Total depreciation as per SLM= 60000

So, the adjusting entry would be

Date	Particulars	Debit	Credit
	Profit and Loss A/C Dr	11200
	To Depreciation A/C		11200
	(To record adjusting entry for change