3.5 Changes in Accounting Principles
The presumption that an entity should not change an accounting principle, once
adopted, in accounting for events and transactions
of a similar type is basic to the preparation of
financial statements. An entity may change an
accounting principle only if management can
justify that the newly adopted accounting
principle is both acceptable and preferable.
Factors that may justify that an accounting
treatment is preferable include authoritative
literature, changes in the structure and economics
of principal transactions, industry practice,
business judgment, and business planning. However,
industry practice, in and of itself, may not
always demonstrate that an alternative principle
is preferable. Ultimately, whether a change is
preferable depends on the entity’s facts and
circumstances, and the burden of justification
rests with the reporting entity.
Once a company is public, a change in accounting principle generally also
results in the need for a preferability letter. A preferability letter is a letter
issued by the entity’s independent auditors and included in an SEC filing stating
that the auditor has also concluded that the accounting change is preferable. If a
change in accounting is made in conjunction with an IPO, the preferability letter is
not required because the entity was not yet public on the date the change was made.
The determination of whether a change in accounting policy is a change in accounting
principle involves judgment and careful consideration of the facts and
circumstances.