APB Opinion No. 20 was the U.S. accounting standard that governed how companies reported accounting changes from 1971 until FASB Statement No. 154 replaced it for fiscal years beginning after December 15, 2005.1Financial Accounting Standards Board. Status of Statement No. 154 Issued by the Accounting Principles Board, the predecessor to FASB, it sorted every accounting change into one of three categories and prescribed a different reporting method for each. Its defining feature was the cumulative effect adjustment: when a company voluntarily switched accounting principles, it generally reported the catch-up on the current year’s income statement rather than restating prior years. That default is gone under current GAAP, but the three-category framework it built survives in ASC 250.
The Three Categories It Created
APB 20 required every accounting change to be classified as one of three types, because the category dictated the accounting treatment.
A change in accounting principle meant switching from one generally accepted method to another, such as moving inventory valuation from FIFO to LIFO. A change in accounting estimate meant revising a judgment that had necessarily been made with incomplete information, such as adjusting an asset’s useful life or the allowance for doubtful accounts. A change in the reporting entity occurred when the financial statements effectively represented a different economic unit, for example when a company presented consolidated statements for the first time or added or removed a subsidiary from the consolidation group.
APB 20 also drew a line that still matters: correcting an error in previously issued statements is not an accounting change. Errors come from math mistakes, misapplied accounting principles, or facts overlooked when the original statements were prepared, and a switch from a non-GAAP method to a GAAP method counted as an error correction rather than a principle change.2Financial Accounting Standards Board. Financial Accounting Series – Exposure Draft Replacing APB Opinion 20 That mattered because errors triggered their own reporting treatment.
How Changes in Principle Were Reported
Under APB 20’s general rule, a company that voluntarily changed accounting principles did not go back and restate prior years. Instead, it computed a cumulative effect adjustment: the difference between what retained earnings actually were at the start of the current year and what they would have been if the new principle had always been in use. That single figure appeared on the income statement between extraordinary items and net income, net of tax. The new principle then applied going forward.
The approach was designed to avoid the cost of restating older statements. Its weakness was comparability: the current year and the prior years shown alongside it were prepared under different principles, which made year-over-year analysis harder. That weakness eventually drove FASB to replace the rule.
The Preferability Requirement
Management could not switch methods casually. APB 20 required the company to explain why the newly adopted principle was preferable to the old one. For public companies, the SEC added a second layer through Regulation S-X: the company’s independent auditors had to provide a preferability letter, filed as an exhibit with the next Form 10-Q, stating that in their judgment the new principle was preferable in the circumstances.
Exceptions That Required Restating Prior Years
The cumulative effect method was the default, not the universal rule. APB 20 carved out specific principle changes that had to be applied by restating prior-period statements as if the new principle had always been in place:
- A change from LIFO to another inventory method required restatement. A change to LIFO received a different treatment altogether, because the cumulative effect was generally impossible to calculate: beginning inventory in the year of change became the first LIFO layer, and the company applied LIFO from there forward.
- Changes in the method of accounting for long-term construction contracts, such as switching between percentage-of-completion and completed-contract, required restating prior periods.
- Switching to or from the full-cost method in extractive industries triggered retrospective treatment.
- When a company issued financial statements for the first time to raise equity capital, complete a business combination, or register securities, any principle changes in those statements had to be applied retrospectively.
Those exceptions reflected the APB’s view that, for certain high-impact changes, comparability was worth the cost of restatement.3Journal of Accountancy. The Change Game
How Changes in Estimate Were Reported
Estimate changes received the simplest treatment: strictly prospective. The revised estimate affected the current period and, where relevant, future periods. Prior statements were never restated, because the original estimate was not wrong when made; new information simply produced a better number.
Some events straddle both categories. If a company changed a depreciation method and at the same time revised the asset’s useful life, isolating the principle effect from the estimate effect was often impossible. APB 20 handled the overlap with a tiebreaker: when a change in principle is inseparable from a change in estimate, treat the whole event as an estimate change and apply it prospectively.4National Association of Insurance Commissioners. Statutory Issue Paper No. 3 – Accounting Changes
How Reporting-Entity Changes Were Reported
A change in the reporting entity required full retrospective restatement of every prior period presented. If a parent began consolidating a subsidiary that had previously been reported separately, it had to recalculate revenue, net income, total assets, and every other affected line as if the consolidated structure had always existed. The same applied when the consolidation group itself changed.
That treatment was labor-intensive, but there was no workable alternative. Without restatement, the current year would describe one entity and the comparative prior year would describe a fundamentally different one, and the columns would not be meaningful side by side.
Disclosure Under APB 20
For a principle change, the company disclosed the nature of and reason for the change, why the new principle was preferable, and the cumulative effect on income before extraordinary items and on net income, with the corresponding per-share amounts. For an estimate change, disclosure was required when the effect was material and had to describe the nature of the change and quantify the impact on income before extraordinary items, net income, and per-share amounts; if the estimate change was inseparable from a principle change, only the estimate disclosures were needed. For a reporting-entity change, the company explained the nature of and reason for the change, presented a schedule showing the effect on major financial statement lines for each restated period, and stated that prior periods had been restated.
What Replaced APB Opinion No. 20
FASB Statement No. 154, effective for fiscal years beginning after December 15, 2005, replaced APB 20 and is now codified as ASC Topic 250. The most consequential change was the elimination of the cumulative effect method for voluntary principle changes. Under ASC 250, a company that voluntarily changes an accounting principle must apply the new principle retrospectively to every prior period presented, unless doing so is impracticable. That means adjusting the carrying amounts of assets and liabilities as of the beginning of the earliest period shown, reflecting the cumulative effect in the opening balance of retained earnings for that period, and recasting the prior-period statements as if the new principle had always been in use.5Financial Accounting Standards Board. Summary of Statement No. 154
When retrospective application is impracticable for one or more individual prior periods, the company applies the new principle to asset and liability balances as of the beginning of the earliest period for which retrospective application is feasible, with a corresponding adjustment to opening retained earnings. When even the overall cumulative effect cannot be determined, the company applies the new principle prospectively from the earliest practicable date. A switch from FIFO to LIFO is a common example where full retrospective application is often impracticable because the historical inventory records needed do not exist.
SFAS 154 also reclassified one item from APB 20’s framework. A change in depreciation, amortization, or depletion method for long-lived nonfinancial assets is now treated as a change in accounting estimate effected by a change in principle, which means it is applied prospectively rather than by cumulative effect.5Financial Accounting Standards Board. Summary of Statement No. 154 Under APB 20, a depreciation method change was a principle change that triggered the cumulative effect treatment, so this is a meaningful simplification.
Changes in estimate and changes in the reporting entity kept essentially the treatment APB 20 gave them: prospective for estimates, full restatement for reporting-entity changes. The three-category framework itself came through intact, so a reader working through an older set of financial statements filed under APB 20 is still looking at the same three buckets used today, just with a different default answer for the principle-change bucket.