Cumulative Effect of Accounting Changes
Accounting standards generally require that a company choose and apply its methods consistently from year to year. Occasionally, new accounting standards or other circumstances (for example, a change in business processes such as the handling of inventory) necessitate that a company change its accounting policies. These changes are permitted and sometimes required. However, the effects of any such change must be disclosed to enable the reader to evaluate the impact on the financial statements.
Under U.S. GAAP, the cumulative effect of the change to the new accounting method as of the beginning of the current fiscal year is shown at the bottom of the income statement for that period, net of related income taxes. The new method is used in determining earnings for the current period. This does result in some incomparability for the current period.
AT&T reported a net gain from the cumulative effect of accounting changes in 2003. Its footnote explains:
2003 includes cumulative effect of accounting changes of $2,541: a $3,677 benefit related to the adoption of Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations” (FAS 143); and a $1,136 charge related to the January 1, 2003 change in the method in which we recognize revenues and expenses related to publishing directories from the “issue basis” method to the “amortization” method.
In years past, AT&T would recognize all of the revenue and expenses associated with directory publications at the time of publication. However, it changed its accounting practice to reflect the fact that the directories are used for a period of time. It now amortizes both the revenue and the expense over the expected time the directory will be in use.
The analyst can also evaluate the impact on prior earnings by examining the cumulative impact of the change. In the case of AT&T, the after-tax cumulative impact on net income was $2.5 billion. Net earnings for previous years would have been $2.5 billion higher on a cumulative basis if the new standards had always been used.
For more information, see all articles on: Accounting, Financial Statement Analysis, Fundamental Analysis See also:
The Intelligent Investor: The Classic Text on Value Investing
Financial Statement Analysis: A Practitioner's Guide, 3rd Edition
Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series)
