Accounting

Changing Your (Accounting) Principles May Actually Be a Sign of Strength

Financial executives that make “voluntary changes in accounting principle” are not necessarily trying to game the balance sheet in order to hit a number and please investors, but are more likely trying to fix their financial reporting methods after discovering a weakness, according to a new study.

A report from researchers from the University of Dayton finds that a majority of changes in accounting principle made between 2004 and 2013 we driven by companies that discovered a material weakness, and that voluntary change were likely part of a strategy to improve financial reporting processes and policies.

“The results suggest that [material weakness] companies that report voluntary changes do not appear to do so for opportunistic reasons,” the study states. “Instead, these companies appear to be executing a strategy to improve financial reporting quality after the disclosure of a [material weakness] and using voluntary changes either to facilitate remediation efforts [or] as part of this overall strategy.”

Voluntary changes in accounting principle allow a company to alter their accounting methodology — such as switching depreciation methods — as long as it meets current standards, is disclosed and gets the blessing of the external auditors.

That blessing, in the form of auditor “preferability letter” have fluctuated between high of 108 in 2000 to a low of 57 in 2007, according to Audit Analytics.

When a change in accounting principle is made it often catches the eye of investors and the media and is sometimes spun as a way to manage earnings.

However, according to the recent study, voluntary changes in accounting methods are trying to fix a newly discovered material weakness and make sure their financial reporting methods are accurate going forward.

The researchers said that managers are more likely to report voluntary changes in the same year, or year following, a material weakness disclosures and that those companies are associated with higher accruals quality when compared to other companies reporting a material weakness.

“These results suggest that [material weakness] companies likely report voluntary changes as part of a strategy to improve financial reporting processes and policies,” the study concludes.