Change in accounting estimate

There will be a situation during accounting for business transactions when an estimate has to be used. In some cases, those estimates turn out to be incorrect so the change in accounting estimates will be warranted. A change in estimate is necessary when:

• influences the carrying amount of liability or an existing asset, or
• alters the subsequent accounting for future or existing assets or liabilities.

The Changes in the accounting estimate determines an expected and normal part of the ongoing process which is looking through future benefits and the current status. Moreover, changes in the accounting estimate contain also obligations connected with liabilities and assets. A change in estimate appears with the outlook of new information which modifies the existing situation. Inversely, there might be no modification in estimate in the lack of new information.

The Examples of Changes in Accounting Estimate

All undermentioned situations in the change in accounting estimate presumably can appear:

• allowance for uncertain accounts,
• changes in the useful life of depreciable capitals,
• reserve for obsolete inventory,
• modifications in the salvage values of depreciable assets,
• modifications in the number of expected warranty obligations.

If a change in accounting estimate is established through a change in principle (for example, a change in depreciation method), it is considered as a change in estimate. An entity effects a change in estimate in cases changing an accounting principle, the footnote exposures needed by a change in accounting principle apply and need to be included in the notes to the budgetary statements.

Accounting estimates

Certain accounting works are based on management's judgment towards the use of estimates. Accounting estimates concern almost every position in the financial statements. Certain of the more common estimates concern those following one of:

• uncollectible accounts receivable,
• warranty usage,
• useful lives of assets,
• completion of projects,
• the in-process inventories.

Consequently, as management purchases additional information and have more experience with regarding such matters as: the agricultural life of plant and equipment property and probable uncollectible receivables, a modification in an accounting estimate might occur. Changes in accounting estimates commonly are reflected prospectively.

Change in accounting estimate affected through a change in accounting principle

A change in accounting estimate which is indissoluble from the effect of a connected change in accounting principle. For an example is a change in estimate effected through a change in principle is a modification in the method of amortization, depreciation or exhaustion for long-lived, nonfinancial assets.

Advantages of Change in accounting estimate

A change in accounting estimate can be beneficial to a business in certain situations. This includes the following advantages:

• Improved accuracy in financial statements: A change in estimate can help ensure that reported financial information is up to date and accurate. This can provide a more accurate picture of the company's financial standing and help investors make informed decisions.
• Increased transparency: As a result of increased accuracy in financial statements, a change in estimate can help to increase transparency in financial reporting. This can help investors and other stakeholders to better understand the company's financial performance and future prospects.
• Increased efficiency: A change in estimate can help to reduce the time and cost associated with preparing financial statements. This can save time and money that can be used for other areas of the business.
• Reduced risk: A change in estimate can help to reduce the risk of misstating financial information, which can lead to costly mistakes. This can help to protect the company's reputation and reduce the risk of costly legal action.

Limitations of Change in accounting estimate

The following are some of the limitations on such changes:

• Changes in estimates must be evaluated in terms of the risk of misstating the financial statements.
• Changes in estimates should be based on valid, verifiable evidence and not on the opinion or judgment of management.
• Changes in estimates should not be made to correct errors in the original accounting estimate.
• Changes in estimates should not be made to reflect changes in economic conditions.
• Changes in estimates should not be used to reflect changing expectations of future events.
• Changes in estimates should not be used to create an artificial profit or loss for the period.
• Changes in estimates should be made in a timely manner and should not be used to manipulate the financial results of the period.
• Changes in estimates should be recorded in the period in which they are made and should not be used to manipulate the financial results of prior periods.

Other approaches related to Change in accounting estimate

One approach to accounting for changes in estimates is to use a number of different techniques, including:

• Reassessment of the original estimate: This involves reviewing the original estimate to determine whether it is still accurate and relevant, or whether a different approach is needed.
• Comparison with past performance: Comparing current performance with past performance can help to identify areas where the original estimate was too high or too low.
• Review of the underlying assumptions: A review of the assumptions underlying the original estimate can help to identify potential discrepancies that may have led to an overestimate or underestimate.
• Use of market trends: Examining market trends can help to identify areas where the original estimate may be too conservative or overly optimistic.
• Use of independent estimates: It may be necessary to obtain an independent estimate from an external expert to ensure accuracy.

In summary, a change in accounting estimate may be necessary when the original estimate is no longer accurate or relevant, when past performance or underlying assumptions suggest a different approach is required, when market trends suggest a need for revision, or when an independent estimate should be obtained.

Footnotes

Change in accounting estimate — recommended articles

Accounting conservatism — Qualitative characteristics — Cost principle — Conservatism principle — Prudence concept — Substance over form — Matching principle — Fair value hedge — Materiality principle

References

• Braiotta L., Gazzaway J.R., Colson R., Ramamoorti S., (2010)., The Audit Committee Handbook, John Wiley and Sons
• Delaney P.R., Whittington O.R., (2011)., Wiley Cpa Examination Review, Outlines and Study Guides, John Wiley and Sons
• Flood J.M. (2014)., Wiley Gaap: Interpretation and Application of Generally Accepted Accounting Principles, John Wiley and Sons
• Jeffrey C. (2008)., Research on Professional Responsibility and Ethics in Accounting, Emerald Group Publishing

Author: Jakub Postawa