Definition of Change in Accounting Principle
Change in Accounting Principle
A change from one generally accepted accounting principle to another generally accepted accounting principle—for example, a change from capitalizing expenditures
to expensing them. A change in accounting principle is accounted for in most instances
as a cumulative-effect–type adjustment.
Related Terms:
The change in earnings of previous years
based on the assumption that a newly adopted accounting principle had previously been in use.
The cumulative, after-tax, prior-year effect of a change in accounting
principle. It is reported as a single line item on the income statement in the year of the
change in accounting principle. The cumulative-effect-type adjustment is the most common accounting
treatment afforded changes in accounting principle.
The change in the value of a firm's foreign currency denominated accounts due to a
change in exchange rates.
Earnings of a firm as reported on its income statement.
Total liabilities exceed total assets. A firm with a negative net worth is insolvent on
the books.
The ease and quickness with which assets can be converted to cash.
The second-largest stock exchange in the United States. It trades
mostly in small-to medium-sized companies.
The average project earnings after taxes and depreciation divided by the average
book value of the investment during its life.
General term for a document demanding payment.
Sources of funds internally provided from operations that alter a company's
cash flow position: depreciation, deferred taxes, other sources, and capital expenditures.
A not-for-profit corporation owned by its members. Its primary
functions are to provide a location for trading futures and options, collect and disseminate market information,
maintain a clearing mechanism and enforce trading rules.
The location of five New York futures exchanges: Commodity
Exchange, Inc. (COMEX), the New York Mercantile exchange (NYMEX), the New York Cotton Exchange,
the Coffee, Sugar and Cocoa exchange (CSC), and the New York futures exchange (NYFE). common size
statement A statement in which all items are expressed as a percentage of a base figure, useful for purposes of
analyzing trends and the changing relationship between financial statement items. For example, all items in
each year's income statement could be presented as a percentage of net sales.
Convertible preferred stock that may be exchanged, at the
issuer's option, into convertible bonds that have the same conversion features as the convertible preferred
stock.
The exchange of information electronically, directly from one firm's
computer to another firm's computer, in a structured format.
The marketplace in which shares, options and futures on stocks, bonds, commodities and indices
are traded. Principal US stock exchanges are: New York Stock Exchange (NYSE), American Stock Exchange
(AMEX) and the National Association of Securities Dealers (NASDAQ)
The Exchange
A nickname for the New York stock exchange. Also known as the Big Board. More than
2,000 common and preferred stocks are traded. The exchange is the oldest in the United States, founded in
1792, and the largest. It is located on Wall Street in New York City.
Exchange controls
Governmental restrictions on the purchase of foreign currencies by domestic citizens or
on the purchase of the local domestic currency by foreigners.
Exchange of assets
Acquisition of another company by purchase of its assets in exchange for cash or stock.
Exchange of stock
Acquisition of another company by purchase of its stock in exchange for cash or shares.
Exchange offer
An offer by the firm to give one security, such as a bond or preferred stock, in exchange for
another security, such as shares of common stock.
Exchange rate
The price of one country's currency expressed in another country's currency.
Exchange Rate Mechanism (ERM)
The methodology by which members of the EMS maintain their
currency exchange rates within an agreed upon range with respect to other member countries.
Exchange rate risk
Also called currency risk, the risk of an investment's value changing because of currency
exchange rates.
Exchange risk
The variability of a firm's value that results from unexpected exchange rate changes or the
extent to which the present value of a firm is expected to change as a result of a given currency's appreciation
or depreciation.
Exchangeable Security
Security that grants the security holder the right to exchange the security for the
common stock of a firm other than the issuer of the security.
Fixed-exchange rate
A country's decision to tie the value of its currency to another country's currency, gold
(or another commodity), or a basket of currencies.
Floating exchange rate
A country's decision to allow its currency value to freely change. The currency is not
constrained by central bank intervention and does not have to maintain its relationship with another currency
in a narrow band. The currency value is determined by trading in the foreign exchange market.
Foreign exchange
Currency from another country.
Foreign exchange controls
Various forms of controls imposed by a government on the purchase/sale of
foreign currencies by residents or on the purchase/sale of local currency by nonresidents.
Foreign exchange dealer
A firm or individual that buys foreign exchange from one party and then sells it to
another party. The dealer makes the difference between the buying and selling prices, or spread.
Foreign exchange risk
The risk that a long or short position in a foreign currency might have to be closed out
at a loss due to an adverse movement in the currency rates.
Foreign exchange swap
An agreement to exchange stipulated amounts of one currency for another currency
at one or more future dates.
Forward exchange rate
Exchange rate fixed today for exchanging currency at some future date.
Generally Accepted Accounting Principals (GAAP)
A technical accounting term that encompasses the
conventions, rules, and procedures necessary to define accepted accounting practice at a particular time.
Gold exchange standard
A system of fixing exchange rates adopted in the Bretton Woods agreement. It
involved the U.S. pegging the dollar to gold and other countries pegging their currencies to the dollar.
Historical exchange rate
An accounting term that refers to the exchange rate in effect when an asset or
liability was acquired.
Insurance principle
The law of averages. The average outcome for many independent trials of an experiment
will approach the expected value of the experiment.
London International Financial Futures Exchange (LIFFE)
A London exchange where Eurodollar futures
as well as futures-style options are traded.
London International Financial Futures Exchange (LIFFE)
London exchange where Eurodollar futures as well as futures-style options are traded.
Net change
This is the difference between a day's last trade and the previous day's last trade.
New York Stock Exchange (NYSE)
Also known as the Big Board or The Exhange. More than 2,00 common
and preferred stocks are traded. The exchange is the older in the United States, founded in 1792, and the
largest. It is lcoated on Wall Street in New York City
Nominal exchange rate
The actual foreign exchange quotation in contrast to the real exchange rate that has
been adjusted for changes in purchasing power.
Organized exchange
A securities marketplace wherein purchasers and sellers regularly gather to trade
securities according to the formal rules adopted by the exchange.
Philadelphia Stock Exchange (PHLX)
A securities exchange where American and European foreign
currency options on spot exchange rates are traded.
Purchase accounting
Method of accounting for a merger in which the acquirer is treated as having purchased
the assets and assumed liabilities of the acquiree, which are all written up or down to their respective fair
market values, the difference between the purchase price and the net assets acquired being attributed to goodwill.
Real exchange rates
Exchange rates that have been adjusted for the inflation differential between two countries.
Regulatory accounting procedures
accounting principals required by the FHLB that allow S&Ls to elect
annually to defer gains and losses on the sale of assets and amortize these deferrals over the average life of the
asset sold.
Securities & Exchange Commission
The SEC is a federal agency that regulates the U.S.financial markets.
SIMEX (Singapore International Monetary Exchange)
A leading futures and options exchange in Singapore.
Spot exchange rates
Exchange rate on currency for immediate delivery. Related: forward exchange rate.
Stand-alone principle
Investment principle that states a firm should accept or reject a project by comparing it
with securities in the same risk class.
Statement of Financial Accounting Standards No. 8
This is a currency translation standard previously in
use by U.S. accounting firms. See: Statement of accounting Standards No. 52.
Statement of Financial Accounting Standards No. 52
This is the currency translation standard currently
used by U.S. firms. It mandates the use of the current rate method. See: Statement of Financial accounting
Standards No. 8.
Stock exchanges
Formal organizations, approved and regulated by the Securities and Exchange Commission
(SEC), that are made up of members that use the facilities to exchange certain common stocks. The two major
national stock exchanges are the New York Stock Exchange (NYSE) and the American Stock Exchange (ASE
or AMEX). Five regional stock exchanges include the Midwest, Pacific, Philadelphia, Boston, and Cincinnati.
The Arizona stock exchange is an after hours electronic marketplace where anonymous participants trade
stocks via personal computers.
Systematic risk principle
Only the systematic portion of risk matters in large, well-diversified portfolios.
The, expected returns must be related only to systematic risks.
Accounting
A collection of systems and processes used to record, report and interpret business transactions.
Accounting equation
The representation of the double-entry system of accounting such that assets are equal to liabilities plus capital.
Accounting period
The period of time for which financial statements are produced – see also financial year.
Accounting rate of return (ARR)
A method of investment appraisal that measures
the profit generated as a percentage of the
investment – see return on investment.
Accounting system
A set of accounts that summarize the transactions of a business that have been recorded on source documents.
Accruals accounting
A method of accounting in which profit is calculated as the difference between income when it is earned and expenses when they are incurred.
Cash accounting
A method of accounting in which profit is calculated as the difference between income
when it is received and expenses when they are paid.
Financial accounting
The production of financial statements, primarily for those interested parties who are external to the business.
Management accounting
The production of financial and non-financial information used in planning for the future; making decisions about products, services, prices and what costs to incur; and ensuring that plans are implemented and achieved.
Strategic management accounting
The provision and analysis of management accounting data about a business and its competitors, which is of use in the development and monitoring of strategy (Simmonds).
Accounting equation
The formula Assets = Liabilities + Equity.
accounting
A broad, all-inclusive term that refers to the methods and procedures
of financial record keeping by a business (or any entity); it also
refers to the main functions and purposes of record keeping, which are
to assist in the operations of the entity, to provide necessary information
to managers for making decisions and exercising control, to measure
profit, to comply with income and other tax laws, and to prepare financial
reports.
accounting equation
An equation that reflects the two-sided nature of a
business entity, assets on the one side and the sources of assets on the
other side (assets = liabilities + owners’ equity). The assets of a business
entity are subject to two types of claims that arise from its two basic
sources of capital—liabilities and owners’ equity. The accounting equation
is the foundation for double-entry bookkeeping, which uses a
scheme for recording changes in these basic types of accounts as either
debits or credits such that the total of accounts with debit balances
equals the total of accounts with credit balances. The accounting equation
also serves as the framework for the statement of financial condition,
or balance sheet, which is one of the three fundamental financial
statements reported by a business.
accrual-basis accounting
Well, frankly, accrual is not a good descriptive
term. Perhaps the best way to begin is to mention that accrual-basis
accounting is much more than cash-basis accounting. Recording only the
cash receipts and cash disbursement of a business would be grossly
inadequate. A business has many assets other than cash, as well as
many liabilities, that must be recorded. Measuring profit for a period as
the difference between cash inflows from sales and cash outflows for
expenses would be wrong, and in fact is not allowed for most businesses
by the income tax law. For management, income tax, and financial
reporting purposes, a business needs a comprehensive record-keeping
system—one that recognizes, records, and reports all the assets and liabilities
of a business. This all-inclusive scope of financial record keeping
is referred to as accrual-basis accounting. Accrual-basis accounting
records sales revenue when sales are made (though cash is received
before or after the sales) and records expenses when costs are incurred
(though cash is paid before or after expenses are recorded). Established
financial reporting standards require that profit for a period
must be recorded using accrual-basis accounting methods. Also, these
authoritative standards require that in reporting its financial condition a
business must use accrual-basis accounting.
double-entry accounting
See accrual-basis accounting.
generally accepted accounting principles (GAAP)
This important term
refers to the body of authoritative rules for measuring profit and preparing
financial statements that are included in financial reports by a business
to its outside shareowners and lenders. The development of these
guidelines has been evolving for more than 70 years. Congress passed a
law in 1934 that bestowed primary jurisdiction over financial reporting
by publicly owned businesses to the Securities and Exchange Commission
(SEC). But the SEC has largely left the development of GAAP to the
private sector. Presently, the Financial accounting Standards Board is
the primary (but not the only) authoritative body that makes pronouncements
on GAAP. One caution: GAAP are like a movable feast. New rules
are issued fairly frequently, old rules are amended from time to time,
and some rules established years ago are discarded on occasion. Professional
accountants have a heck of time keeping up with GAAP, that’s for
sure. Also, new GAAP rules sometimes have the effect of closing the barn
door after the horse has left. accounting abuses occur, and only then,
after the damage has been done, are new rules issued to prevent such
abuses in the future.
internal accounting controls
Refers to forms used and procedures
established by a business—beyond what would be required for the
record-keeping function of accounting—that are designed to prevent
errors and fraud. Two examples of internal controls are (1) requiring a
second signature by someone higher in the organization to approve a
transaction in excess of a certain dollar amount and (2) giving customers
printed receipts as proof of sale. Other examples of internal
control procedures are restricting entry and exit routes of employees,
requiring all employees to take their vacations and assigning another
person to do their jobs while they are away, surveillance cameras, surprise
counts of cash and inventory, and rotation of duties. Internal controls
should be cost-effective; the cost of a control should be less than
the potential loss that is prevented. The guiding principle for designing
internal accounting controls is to deter and detect errors and dishonesty.
The best internal controls in the world cannot prevent most fraud
by high-level managers who take advantage of their positions of trust
and authority.
Securities and Exchange Commission (SEC)
The federal agency that
oversees the issuance of and trading in securities of public businesses.
The SEC has broad powers and can suspend the trading in securities of a
business. The SEC also has primary jurisdiction in making accounting
and financial reporting rules, but over the years it has largely deferred to
the private sector for the development of generally accepted accounting
principles (GAAP).
stockholders' equity, statement of changes in
Although often considered
a financial statement, this is more in the nature of a supporting schedule
that summarizes in one place various changes in the owners’ equity
accounts of a business during the period—including the issuance and
retirement of capital stock shares, cash dividends, and other transactions
affecting owners’ equity. This statement (schedule) is very helpful
when a business has more than one class of stock shares outstanding
and when a variety of events occurred during the year that changed its
owners’ equity accounts.
accounting rate of return (ARR)
the rate of earnings obtained on the average capital investment over the life of a capital project; computed as average annual profits divided by average investment; not based on cash flow
cost accounting
a discipline that focuses on techniques or
methods for determining the cost of a project, process, or
thing through direct measurement, arbitrary assignment, or
systematic and rational allocation
Cost Accounting Standards Board (CASB)
a body established by Congress in 1970 to promulgate cost accounting
standards for defense contractors and federal agencies; disbanded
in 1980 and reestablished in 1988; it previously issued
pronouncements still carry the weight of law for those
organizations within its jurisdiction
electronic data interchange (EDI)
the computer-to-computer transfer of information in virtual real time using standardized formats developed by the American National Standards Institute
engineering change order (ECO)
a business mandate that changes the way in which a product is manufactured or a
service is performed by modifying the design, parts,
process, or even quality of the product or service
financial accounting
a discipline in which historical, monetary
transactions are analyzed and recorded for use in the
preparation of the financial statements (balance sheet, income
statement, statement of owners’/stockholders’ equity,
and statement of cash flows); it focuses primarily on the
needs of external users (stockholders, creditors, and regulatory
agencies)
management accounting
a discipline that includes almost
all manipulations of financial information for use by managers
in performing their organizational functions and in
assuring the proper use and handling of an entity’s resources;
it includes the discipline of cost accounting
Management Accounting Guidelines (MAGs)
pronouncements of the Society of Management Accountants of
Canada that advocate appropriate practices for specific
management accounting situations
Pareto principle
a rule which states that the greatest effects
in human endeavors are traceable to a small number of
causes (the vital few), while the majority of causes (the
trivial many) collectively yield only a small impact; this
relationship is often referred to as the 20:80 rule
responsibility accounting system
an accounting information system for successively higher-level managers about the performance of segments or subunits under the control
of each specific manager
Statement on Management Accounting (SMA)
a pronouncement developed and issued by the Management
accounting Practices Committee of the Institute of Management
Accountants; application of these statements is
through voluntary, not legal, compliance
Rho - The rate of change in a derivative’s price relative to the underlying
security’s risk-free interest rate.
Accounting change
An alteration in the accounting methodology or estimates used in
the reporting of financial statements, usually requiring discussion in a footnote
attached to the financial statements.
Accounting entity
A business for which a separate set of accounting records is being
maintained.
Accrual accounting
The recording of revenue when earned and expenses when
incurred, irrespective of the dates on which the associated cash flows occur.
Constant dollar accounting
A method for restating financial statements by reducing or
increasing reported revenues and expenses by changes in the consumer price index,
thereby achieving greater comparability between accounting periods.
Generally accepted accounting principles
The rules that accountants follow when processing accounting transactions and creating financial reports. The rules are primarily
derived from regulations promulgated by the various branches of the AICPA Council.
Matching principle
The process of linking recognized revenue to any associated
costs, thereby showing the net impact of all transactions related to the recognition
of revenue.
exchange rate
Amount of one currency needed to purchase one unit of another.
expectations theory of exchange rates
Theory that expected spot exchange rate equals the forward rate.
forward rate of exchange
Exchange rate for a forward transaction.
generally accepted accounting principles (GAAP)
Procedures for preparing financial statements.
Securities and Exchange Commission (SEC)
Federal agency responsible for regulation of securities markets in the United
States.
spot rate of exchange
Exchange rate for an immediate transaction.
Effective Exchange Rate
The weighted average of several exchange rates, where the weights are determined by the extent of our trade done with each country.
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