How to Account for a Change in Accounting Estimate:
Changes in estimates, such as the estimated useful like for a tangible asset or the bad debt allowance percentage, are accounted for on a prospective basis. This means that the current and future financial statements must reflect the change, but the company does not need to change historical periods. Instead, the change will be made prospectively. This means that the change will be made in the current period and all future periods.
Changes in Accounting Estimates: Treated Prospectively:
Management will often create estimates for components of their financial statements. Keep in mind, these will also include changes in accounting principle that are considered inseparable from a change in accounting estimate such as changes in depreciation methodology and changes in inventory methods to last in, first out (LIFO). Other changes in accounting estimate that are often seen on the CPA exam are as follows: such as:
- Warranty obligations
- Bad debts/estimates of uncollectible receivables
- Changes in the useful lives of their fixed assets
- Obsolete inventory
- Pending litigation that has been settled
- Changes in accounting principle that is inseparable from a change in accounting estimates (e.g. depreciation method and change in inventory to LIFO)
When companies experience changes in accounting estimates, they will prospectively change their estimates on the financial statements. This means that the changes will be made in the current and future years only.
Below is an example of changes in accounting estimate, courtesy of Universal CPA Review:
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