Accounting Principle vs. Accounting Estimate: What’s the Difference?

Accounting Principle Change vs. Accounting Estimate Change

The one area in which FASB and its more recent rival, the International Accounting Standards Board (IASB), agree is on the treatment of accounting changes.

SFAS 154, Accounting Changes and Error Correction, in other words, explains how private companies should treat two related, but distinct concepts. An accounting principle dictates the reporting of information. An accounting estimate approximates it.

Key Takeaways

An accounting change is made when the organisation changes the basis on which its financial figures are calculated (an accounting change in policy), and when the organisation changes the actual financial numbers for some of the transactions it has been involved in (an accounting change in estimate).

Some of these changes were due to accounting principle changes, such as inventory valuation or revenue recognition changes, while the rest involved changes to estimates (eg, depreciation or bad-debt allowances).

Principle changes are applied retrospectively – which means that any financial statements produced prior to the change will be amended (ie, ‘restated’) while estimate changes are not.

Il y a certaines situations où il n’y a pas besoin de faire des restatements (avec des modifications de principe) ni de desrevelures (avec modifications d’estimation).

Accounting Principle Change

Generally accepted accounting principles are, well, general. An entity has booked its sales the wrong way. It has to recognise and report that.

Inventory valuation, for instance, is an accounting handle often involved in restatements. Say the company changes its inventory valuation method from FIFO (first in, first out) to specific-identification. According to the FASB, an entity may change an accounting principle only when the new method is preferable to the prior method and, absent a change in GAAS, it cannot be applied unless it is preferable (and it is).

Other examples of relevant accounting principles that might change could include ones dealing with the matching principle, the going concern principle, revenue recognition principles, and other principles.

Accounting Estimate Change

Professional standards require such estimates. For instance, an accountant writing a report might well accept that certain items are either ‘impossible or impracticable to measure or estimate with precision’ and therefore need to provide estimates of an approximation. Should those have proven wrong – new information making it now possible to determine the figure with better precision, as it were – the entity will record that improved estimate in a change in accounting estimate. For instance, bad-debt allowances, warranty liability, and depreciation are among the typical figures that will change estimation practices.

Key Differences

Accounting principles changes can also be incurred when older principles no longer seem proper, or when the method of application changes. When estimating the impact of an accounting change, the convention is to apply it retrospectively (that is, accurately presented financial statements must be restated).

Line items that are directly impacted then need to be re-stated. There are a few other instances where retroactive application is not required, such as where the entity made ‘all reasonable efforts’ to do so, which can include trying to make certain subjective significant estimates or having been required to know management’s intent.

Changes in accounting estimates are changes in the carrying values of assets or liabilities which arise from a change in an accounting estimate. The change is recognised in the period of the change: changes in accounting estimates do not require that the carrying amount of assets or liabilities in the statement of financial position at the beginning of the previous period, or in any subsequent period, be restated. If the financial statement line items affected by the change in accounting estimate are not material, no disclosure of the change is required.

The Bottom Line

Requirements for reporting changes in accounting estimates are less stringent than those for changes in accounting principles. A change in accounting principle can result in a change in accounting estimate, and this requires that the reporting requirements for changes in accounting principle be followed.