Change in Accounting Policy (Explanation and Examples)

Financial Accounting

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.

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Accounting policyAccounting principles
Inventory costingWeighted average methodFirst In First Out methodLast in First out
Method of depreciationStraight-line methodWritten down methodProduction unit’s method
Valuation of Fixed assetsAcquisition 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:
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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

AssetsUseful life
Computer2 years
Furniture and fixtures6 years
Office equipment7 years
Vehicles5 years

Adopted this the 5th 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 1st April 2015, Hari purchased a machine for Rs. 100,000. Depreciation was charged at 20% per annum on SLM. From 1st April 2018, 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

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DateParticularsDebit ($)Credit ($)
 Profit and Loss A/C Dr  11200 
            To Depreciation A/C            11200
 (To record adjusting entry for change  

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