You have plotted ten years of gross margin for a company and the chart has a clean step in it. Seven years sit in a band between 31% and 33%, then a single year jumps to 37% and stays there. You go looking for the operating cause — a product mix shift, a raw material collapse, a price increase — and there is nothing. Volumes grew steadily through the step. The competitor’s margin did not move. The company did not commission anything, buy anything or exit anything that year.
What did happen is in a note you have never read, and it is one of three things. A change in accounting policy, a change in accounting estimate, or a correction of a prior-period error. They sound like variations on the same idea. For someone keeping a series they are three different events, because each does something different to the year you are comparing against.
A sweet shop replaces its old brass balance with an electronic scale. The old one read about twenty grams heavy. From the day of the change every packet weighs less on paper, and the shop’s recorded output falls, and not one gram of sweet has changed. Whether the shop’s books make sense across the change depends entirely on one thing: whether it went back and restated last year’s records on the new scale, or simply started fresh from the day the scale arrived.
That is the whole of this lesson. Restate the comparative and the series stays comparable with a footnote. Start fresh from the date of the change and the series has a genuine step in it that will still be there in ten years, unlabelled, waiting for somebody to explain it as a business event.
The three changes, and what each does to last year
| What changed | Examples | How it is applied | What happens to the comparative |
|---|---|---|---|
| Accounting policy | The basis on which revenue is recognised; how a class of cost is treated; the method of measuring a category of asset | Retrospectively, as a rule — the accounts are prepared as though the new policy had always been in use | Restated. The step is smoothed out and disclosed, and your series stays usable |
| Accounting estimate | The useful life of plant; the residual value of an asset; the provision rate for doubtful debts or warranties | Prospectively — from the date of the change forward | Left exactly as it was. The step is real and permanent in the reported series |
| Prior-period error | Something that was wrong: an omission, a misapplication of a standard, a fraud discovered later | Retrospectively, by restating the comparative figures affected | Restated, and disclosed as a correction rather than a change of view |
The new standard, and the two ways to adopt it
When a new accounting standard arrives, every company in the country changes policy in the same year, which makes the step easy to spot and easy to underestimate. What is less well known is that a new standard usually offers a choice of how to get there, and different companies in the same industry may choose differently in the same year.
- Full retrospective adoption — the prior periods presented are restated as though the new standard had always applied. The series stays comparable; the transition note reconciles the old figures to the new.
- Modified or cumulative-effect adoption — the cumulative effect of the change is taken to opening retained earnings on the date of first application, and the comparatives are left exactly as previously reported. The current year is on the new standard and last year is on the old one.
Two tells that cost nothing to check
The first is the third balance sheet. When a company applies a policy retrospectively, restates a prior period or reclassifies items in a way that has a material effect, it is required to present a balance sheet as at the beginning of the preceding period as well — three balance sheets rather than two. That is an unusual sight and an entirely reliable signal. If an annual report opens with three balance sheet columns, something was restated, and the note explaining it is nearby.
The second is the line at the foot of the statements saying that previous year’s figures have been regrouped or reclassified to conform to the current year’s presentation. It looks like housekeeping and mostly it is. But regrouping moves amounts between lines — a cost out of "other expenses" and into "cost of materials consumed", say — and while profit after tax is untouched, any subtotal drawn between the two lines involved moves with it. That example changes gross margin and leaves EBITDA alone, because both lines sit above it; a cost moved from "other expenses" down into "finance costs" does the opposite. Which subtotals move depends entirely on which two lines the amount travelled between, so read the pair before deciding the sentence is harmless. If you track gross margin or EBITDA margin across a decade, this quiet line is the origin of a surprising number of steps.
Which one is it?
Three sentences you might find in the notes. Decide what each does to last year.
A company revised the remaining useful life of plant carried at ₹3,000 crore from fifteen years to twenty-five, cutting the annual depreciation charge from ₹200 crore to ₹120 crore. Profit after tax rose from ₹340 crore to ₹400 crore. What is the correct reading of the 17.6% profit growth?
Mithai wale ne purana peetal ka taraazu hata ke electronic laga liya. Purana bees gram bhaari tolta tha. Us din se har packet kaagaz pe halka — mithai mein ek dana farak nahi. Company ne machine ki bachi hui umar 15 saal se 25 saal maan li: depreciation ₹200 crore se ₹120 crore, PAT ₹340 crore se ₹400 crore, 17.6% "growth" aur cash flow mein ek rupaya nahi hila. Estimate badle toh pichla saal waisa hi rehta hai, isliye poora asar isi saal ke percentage mein aa jaata hai.
- A change in policy is applied retrospectively and the comparative is restated; a change in estimate is applied prospectively and the comparative is not.
- A prospective change puts its entire effect into one year’s growth rate while both years remain individually correct.
- A new standard usually offers full retrospective or cumulative-effect adoption, and peers in the same industry may pick differently in the same year.
- Three balance sheet columns instead of two means something was restated retrospectively.
- The "regrouped and reclassified" line leaves profit after tax alone and moves any subtotal drawn between the two lines the amount travelled between.
Mark it done to track your progress through the curriculum.
Common questions
Short, direct answers to what people ask about this topic.
- difference between change in accounting policy and change in accounting estimate
- A change in accounting policy changes the basis of accounting itself — how revenue is recognised, how a class of cost is treated — and as a rule it is applied retrospectively, so the comparative is restated and the step is smoothed out. A change in accounting estimate revises a judgement such as the useful life of plant or a provision rate for doubtful debts, and it is applied prospectively, so last year is left exactly as it was. Only the second leaves a permanent, unlabelled step in a long series.
- a change in an accounting estimate is applied
- Prospectively — from the date of the change forward. Nothing is restated, no comparative moves, and the disclosure is a paragraph in the notes. The reported growth rate for that year therefore carries the entire effect of the change, and the comparison against the prior year is not like-for-like even though both figures are correct on their own terms.
- why does an annual report show three balance sheets
- Because something material was restated. When a company applies an accounting policy retrospectively, restates a prior period or reclassifies items in a way that has a material effect, it must also present a balance sheet as at the beginning of the preceding period — three columns rather than two. It is an unusual sight and an entirely reliable signal that the note explaining the restatement is close by.
- what does previous year figures have been regrouped and reclassified mean
- It means amounts have been moved between lines of the prior year’s statements so the presentation matches this year’s. Profit after tax is untouched, but any subtotal drawn between the two lines involved moves with the amount: a cost shifted out of other expenses into cost of materials consumed changes gross margin and leaves EBITDA alone, while a cost moved down into finance costs does the opposite. Read which two lines the amount travelled between before deciding the sentence is harmless.
- is a change in the method of depreciation applied retrospectively
- No. Switching the method of depreciation — straight line to reducing balance or the other way round — feels like a policy change but is treated as a change in estimate and applied prospectively, so the comparative does not move. Older Indian practice went back and restated for this, so a long series can contain both treatments. Moving a class of asset from the cost model to the revaluation model is genuinely a policy change but is likewise exempted from the retrospective rule.