Final answer:
The cumulative effect of a change in accounting principle is adjusted in the opening balance of retained earnings to ensure consistency and comparability in comparative financial statements. Companies apply changes retrospectively, adjusting prior periods' financial data as if the new principle was always used.
Step-by-step explanation:
The cumulative effect of a change in accounting principle refers to the adjustment of the opening balance of retained earnings to report the impact of a change in accounting principle on prior periods. When comparative financial statements (FS) are presented, companies must retrospectively apply the new accounting principle to all prior periods, unless it is impracticable. This retrospective application ensures consistency and comparability across the presented periods. If the change affects periods before those presented, a company adjusts the opening balance of retained earnings for the earliest period presented.
For instance, if the Principles of Macroeconomics textbook had a change in its economic data assumptions or models that would significantly affect its calculations, it would be akin to changing an accounting principle. The revised edition would then need to reflect how the new calculations would have affected past data if the new approach had been used all along. Similarly, in the financial world, when an entity changes its accounting principle, it must also disclose the nature of the change, the reasons for it, and the effect on the income statement and earnings per share.