Definition
The term changes in accounting estimates referrers to those estimations that require revision based on the availability of new and better information in the current accounting period. Changes in accounting estimates can involve revenues, expenses, liabilities and assets; and are corrected prospectively in the financial statements of a company.
Explanation
Also known as normal, recurring corrections and adjustments, changes in accounting estimates occur when better information becomes available. Accountants as well as business specialists are required to estimate expenses and revenues in addition to the value of assets and liabilities appearing in the financial statements of the company. The change in the useful life of an asset, bad debt, pension obligations, and inventory values are some examples of estimates that can materially affect the income statement or balance sheet.
Changes in accounting estimates is one of several categories of irregular items that may appear as line items or notes to one or more of the company's financial statements. Unlike errors that require prior period adjustments, corrections to these estimates are made prospectively if better information is available; this means such changes can impact both the current as well as future accounting periods. In addition to not being considered an error, a change to an estimate does not meet the definition of an extraordinary item.
Example
Company A purchased a machine for $200,000 with a useful life estimated at ten years and no residual value. In Year 7, it was determine the machine needed to be replaced in Year 8. Company A used straight line depreciation of $20,000 per year in Years 1 through 6. To account for this change in the estimated useful life of the asset, Company A would depreciate the balance of the asset's value in Year 7 and 8 as shown below:
Depreciation Expense | Accumulated Depreciation | Book Value | |
Year 0 | $200,000 | ||
Year 1 | $20,000 | $20,000 | $180,000 |
Year 2 | $20,000 | $40,000 | $160,000 |
Year 3 | $20,000 | $60,000 | $140,000 |
Year 4 | $20,000 | $80,000 | $120,000 |
Year 5 | $20,000 | $100,000 | $100,000 |
Year 6 | $20,000 | $120,000 | $80,000 |
Year 7 | $40,000 | $160,000 | $40,000 |
Year 8 | $40,000 | $200,000 | $0 |
Related Terms
The income statement is a financial accounting report that demonstrates how net income, or profit, is derived from revenues. The main categories appearing on an income statement include revenues, cost of goods sold, operating expenses, non-recurring items and net income.
Moneyzine EditorNovember 6th, 2024
The term materiality refers to an accounting constraint that is used to determine the relative importance or value of an item to one of the company's financial statements. If an item is not deemed significant enough to influence the decision-making process of an individual examining the company's financial statements, then that item is not considered material.Moneyzine EditorFebruary 8th, 2024
The financial accounting term extraordinary items refers to gains or losses appearing on a company's income statement that are both unusual and occur infrequently. These are items that can materially affect the company's financial statements, but are not considered part of the company's normal business operations.Moneyzine EditorNovember 6th, 2024
The financial accounting term depreciation is sometimes defined as a decline in tangible plant's service potential. Depreciation is a method of allocating the cost of a tangible asset in a systematic manner to those time periods that benefit from the use of the asset.Moneyzine EditorJanuary 16th, 2024- The financial accounting term unusual gains or losses refers to line items appearing on a company's income statement that are unusual or occur infrequently. These are costs or revenues that would materially affect the company's financial statement, and are considered part of the company's normal business operation.Moneyzine EditorSeptember 21st, 2023
The financial accounting term intraperiod tax allocation refers to the distribution of income taxes to specific irregular items appearing in a financial statement. Intraperiod tax allocations occur within a given accounting period and allow the reader to understand the income tax implication of the irregular item.Moneyzine EditorJanuary 22nd, 2024- The financial accounting term prior period adjustments refers to either a correction to a prior period's financial statement, or the realization of a tax benefit resulting from an operating loss of a subsidiary before it was acquired.Moneyzine EditorSeptember 21st, 2023
The term change in accounting principle refers to the adoption of an accounting method that differs from that used in the past. When an alternate accounting method is chosen, the impact on the company's financial statement must be shown in the current accounting period as well as retrospectively.Moneyzine EditorJanuary 11th, 2024.png)
The financial accounting term changes in reporting entity refers to a switch from one type of reporting entity to another. Changes in reporting entity can fall into several categories, including a change in subsidiaries, the number of companies combined into a consolidated report, as well as the mix of companies appearing in a consolidated report.Moneyzine EditorNovember 6th, 2024
The term accounting changes is used to describe three categories of changes disclosed in the financial statements of a company. Accounting changes can include: a change in accounting principal, accounting estimates, and reporting entities. Disclosures should include a description of the change as well as its effect on financial statements.Moneyzine EditorNovember 6th, 2024
The financial accounting term correction of an error in financial reports refers to the rectification of a mistake caused by a transaction that was recorded incorrectly or omitted. Accounting principles require the retrospective restatement of financial statements that were incorrect.Moneyzine EditorNovember 6th, 2024
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