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Cumulative Effect of a Change in Accounting Principle

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Definition of Cumulative Effect of a Change in Accounting Principle

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Cumulative Effect of a Change in Accounting Principle

The change in earnings of previous years
based on the assumption that a newly adopted accounting principle had previously been in use.

Related Terms:


A collection of systems and processes used to record, report and interpret business transactions.


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

Accounting and Auditing Enforcement Release (AAER)

Administrative proceedings or litigation releases that entail an accounting or auditing-related violation of the securities laws.

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 earnings

Earnings of a firm as reported on its income statement.

Accounting entity

A business for which a separate set of accounting records is being

Accounting equation

The representation of the double-entry system of accounting such that assets are equal to liabilities plus capital.

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Accounting equation

The formula Assets = Liabilities + Equity.

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.

Accounting Errors

Unintentional mistakes in financial statements. Accounted for by restating
the prior-year financial statements that are in error.

Accounting exposure

The change in the value of a firm's foreign currency denominated accounts due to a
change in exchange rates.

Accounting insolvency

Total liabilities exceed total assets. A firm with a negative net worth is insolvent on
the books.

Accounting Irregularities

Intentional misstatements or omissions of amounts or disclosures in
financial statements done to deceive financial statement users. The term is used interchangeably with fraudulent financial reporting.

Accounting liquidity

The ease and quickness with which assets can be converted to cash.

Accounting period

The period of time for which financial statements are produced – see also financial year.

Accounting Policies

The principles, bases, conventions, rules and procedures adopted by management in preparing and presenting financial statements.

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 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

Accounting system

A set of accounts that summarize the transactions of a business that have been recorded on source documents.

Accrual accounting

The recording of revenue when earned and expenses when
incurred, irrespective of the dates on which the associated cash flows occur.

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.

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.

Aggressive Accounting

A forceful and intentional choice and application of accounting principles
done in an effort to achieve desired results, typically higher current earnings, whether the practices followed are in accordance with generally accepted accounting principles or not. Aggressive
accounting practices are not alleged to be fraudulent until an administrative, civil, or criminal proceeding takes that step and alleges, in particular, that an intentional, material misstatement
has taken place in an effort to deceive financial statement readers.

American Stock Exchange (AMEX)

The second-largest stock exchange in the United States. It trades
mostly in small-to medium-sized companies.

Antidilutive effect

Result of a transaction that increases earnings per common share (e.g. by decreasing the
number of shares outstanding).

Average accounting return

The average project earnings after taxes and depreciation divided by the average
book value of the investment during its life.

Bill of exchange

General term for a document demanding payment.

Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees

A committee formed in response to SEC chairman Arthur Levitt's initiative to improve the financial
reporting environment in the United States. In a report dated February 1999, the committee
made recommendations for new rules for regulation of financial reporting in the United States that
either duplicated or carried forward the recommendations of the Treadway Commission.

Calendar effect

The tendency of stocks to perform differently at different times, including such anomalies as
the January effect, month-of-the-year effect, day-of-the-week effect, and holiday effect.

CARs (cumulative abnormal returns)

a measure used in academic finance articles to measure the excess returns an investor would have received over a particular time period if he or she were invested in a particular stock.
This is typically used in control and takeover studies, where stockholders are paid a premium for being taken over. Starting some time period before the takeover (often five days before the first announced bid, but sometimes a longer period), the researchers calculate the actual daily stock returns for the target firm and subtract out the expected market returns (usually calculated using the firm’s beta and applying it to overall market movements during the time period under observation).
The excess actual return over the capital asset pricing model-determined expected return market is called an ‘‘abnormal return.’’ The cumulation of the daily abnormal returns over the time period under observation is the CAR. The term CAR(-5, 0) means the CAR calculated from five days before the
announcement to the day of announcement. The CAR(-1, 0) is a control premium, although Mergerstat generally uses the stock price five days before announcement rather than one day before announcement as the denominator in its control premium calculation. However, the CAR for any period other than (-1, 0) is not mathematically equivalent to a control premium.

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.

Change in Accounting Estimate

A change in accounting that occurs as the result of new information
or as additional experience is acquired—for example, a change in the residual values
or useful lives of fixed assets. A change in accounting estimate is accounted for prospectively,
over the current and future accounting periods affected by the change.

Change in Accounting Estimate

A change in the implementation of an existing accounting
policy. A common example would be extending the useful life or changing the expected residual
value of a fixed asset. Another would be making any necessary adjustments to allowances for
uncollectible accounts, warranty obligations, and reserves for inventory obsolescense.

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.

Change in Reporting Entity

A change in the scope of the entities included in a set of, typically, consolidated financial statements.

Changes in Financial Position

Sources of funds internally provided from operations that alter a company's
cash flow position: depreciation, deferred taxes, other sources, and capital expenditures.

Chicago Mercantile Exchange (CME)

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.

Clientele effect

The grouping of investors who have a preference that the firm follow a particular financing
policy, such as the amount of leverage it uses.

Coinsurance effect

Refers to the fact that the merger of two firms decreases the probability of default on
either firm's debt.

Commodities Exchange Center (CEC)

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.

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.

Contract Accounting

Method of accounting for sales or service agreements where completion
requires an extended period.

Contribution Principle

This is the principle which specifies the factors that must be taken into account when calculating dividends. At Canada Life, the key factors are: interest earnings, mortality, and operating expense.

Convertible exchangeable preferred stock

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

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

Creative Accounting Practices

Any and all steps used to play the financial numbers game, including
the aggressive choice and application of accounting principles, both within and beyond
the boundaries of generally accepted accounting principles, and fraudulent financial reporting.
Also included are steps taken toward earnings management and income smoothing. See Financial
Numbers Game.

Creative Acquisition Accounting

The allocation to expense of a greater portion of the price
paid for another company in an acquisition in an effort to reduce acquisition-year earnings and
boost future-year earnings. Acquisition-year expense charges include purchased in-process research
and development and an overly aggressive accrual of costs required to effect the acquisition.

Cumulative abnormal return (CAR)

Sum of the differences between the expected return on a stock and the
actual return that comes from the release of news to the market.

Cumulative dividend feature

A requirement that any missed preferred or preference stock dividends be paid
in full before any common dividend payment is made.

Cumulative-Effect Adjustment

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.

Cumulative Effect of Accounting Change

The change in earnings of previous years assuming
that the newly adopted accounting principle had previously been in use.

Cumulative preferred stock

Preferred stock whose dividends accrue, should the issuer not make timely
dividend payments. Related: non-cumulative preferred stock.

Cumulative probability distribution

A function that shows the probability that the random variable will
attain a value less than or equal to each value that the random variable can take on.

Cumulative Translation Adjustment (CTA) account

An entry in a translated balance sheet in which gains
and/or losses from translation have been accumulated over a period of years. The CTA account is required
under the FASB No. 52 rule.

Cumulative voting

A system of voting for directors of a corporation in which shareholder's total number of
votes is equal to his number of shares held times the number of candidates.

cumulative voting

Voting system in which all the votes one shareholder is allowed to cast can be cast for one candidate for the board of directors.

Dilutive effect

Result of a transaction that decreases earnings per common share.

double-entry accounting

See accrual-basis accounting.

Effective annual interest rate

An annual measure of the time value of money that fully reflects the effects of

effective annual interest rate

Interest rate that is annualized using compound interest.

Effective annual yield

Annualized interest rate on a security computed using compound interest techniques.

Effective Annual Yield

Annualized rate of return on a security computed using compound
interest techniques

Effective call price

The strike price in an optional redemption provision plus the accrued interest to the
redemption date.

Effective convexity

The convexity of a bond calculated with cash flows that change with yields.

Effective date

In an interest rate swap, the date the swap begins accruing interest.

Effective duration

The duration calculated using the approximate duration formula for a bond with an
embedded option, reflecting the expected change in the cash flow caused by the option. Measures the
responsiveness of a bond's price taking into account the expected cash flows will change as interest rates
change due to the embedded option.

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.

Effective Interest Rate

The rate of interest actually earned on an investment. It is
calculated as the ratio of the total amount of interest actually
earned for one year divided by the amount of the principal.

Effective margin (EM)

Used with SAT performance measures, the amount equaling the net earned spread, or
margin, of income on the assets in excess of financing costs for a given interest rate and prepayment rate

Effective rate

A measure of the time value of money that fully reflects the effects of compounding.

Effective spread

The gross underwriting spread adjusted for the impact of the announcement of the common
stock offering on the firm's share price.

Effective Tax Rate

The total tax provision divided by pretax book income from continuing


a measure of how well an organization’s goals
and objectives are achieved; compares actual output results
to desired results; determination of the successful accomplishment
of an objective

Electronic data interchange (EDI)

The exchange of information electronically, directly from one firm's
computer to another firm's computer, in a structured format.

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

Embodied Technical Change

Technical change that can be used only when new capital embodying this technical change is produced.

Engineering change

A change to a product’s specifications as issued by the engineering

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

Equation of Exchange

The quantity theory equation Mv = PQ.


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)

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

Amount of one currency needed to purchase one unit of another.

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, Nominal

The price of one currency in terms of another, in this book defined as number of units of foreign currency per dollar.

Exchange Rate, Real

The nominal exchange rate corrected for price level differences.

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.

expectations theory of exchange rates

Theory that expected spot exchange rate equals the forward rate.

Financial accounting

The production of financial statements, primarily for those interested parties who are external to the business.

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

Fisher effect

A theory that nominal interest rates in two or more countries should be equal to the required real
rate of return to investors plus compensation for the expected amount of inflation in each country.

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.

Fixed Exchange Rate

An exchange rate held constant by a government promise to buy or sell dollars at the fixed rate on the foreign exchange market.







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