When accounting for business transactions, there will be times when an estimate must be used. In some cases, those estimates prove to be incorrect, in which case a change in accounting estimate is warranted. A change in estimate is needed when there is a change that:
- Affects the carrying amount of an existing asset or liability, or
- Alters the subsequent accounting for existing or future assets or liabilities.
Changes in estimate are a normal and expected part of the ongoing process of reviewing the current status and future benefits and obligations related to assets and liabilities. A change in estimate arises from the appearance of new information that alters the existing situation. Conversely, there can be no change in estimate in the absence of new information.
Examples of Changes in Accounting Estimate
All of the following are situations where there is likely to be a change in accounting estimate:
- Allowance for doubtful accounts
- Reserve for obsolete inventory
- Changes in the useful life of depreciable assets
- Changes in the salvage values of depreciable assets
- Changes in the amount of expected warranty obligations
When there is a change in estimate, account for it in the period of change. If the change affects future periods, then the change will likely have an accounting impact in those periods, as well. A change in accounting estimate does not require the restatement of earlier financial statements, nor the retrospective adjustment of account balances.
If the effect of a change in estimate is immaterial (as is usually the case for changes in reserves and allowances), do not disclose the alteration. However, disclose the change in estimate if the amount is material. Also, if the change affects several future periods, note the effect on income from continuing operations, net income, and per share amounts.