Connect with us

Change In Accounting Estimates and Reporting Entity

Published

on

On the previous post, I have discussed about Changes and Correction of Errors Journal Entry, there are three areas where changes may occur in the accounting ; (a) in the principle; (b) in the estimates; and (c) in the reporting entity. The change in accounting principle has been included on the previous post. Therefore I come with the rest through this post.

Advertisement

Change In Accounting Estimates

There are a number of situations in accounting that require the use of estimates. Examples include un-collectibility of accounts receivable, liabilities for estimated warranty costs, and the salvage values and lives of plant assets.

If often happens that estimates need to be revised as a result of new information. Such changes in accounting estimates are handled differently from changes in accounting principles. Prior statements are not revised, correction entries are not made, and the cumulative effect of the change is not recorded. Instead, the change affects only the future (and this period if the revision is made before the end of the period). In short, this change is neither retroactive nor current, but “prospective” in nature.

The reason why the accounting profession prescribed this treatment is that such changes occur frequently, and would thus require continual retroactive or catch-up entries. This would make the financial statements difficult to read and interpret.

If a change is made in the estimated useful life or residual value of a plant asset, then for the future, the new depreciation would be calculated based on the following:

New Depreciation Formula

Result: No adjustment or correction entries would be made for the depreciation taken so far.

Example:

Royal bali Corp. purchased a machine on January 1, 19X1, for $100,000. At that time it was thought the machine would have a life of 10 years and a residual value of $10,000.

Thus the annual depreciation taken was $9,000 [($100,000 – $10,000) / 10].

Early in 19X5 the company realizes that the total life of the machine is only 8 years and the residual value is only $8,000. Since 4 years have already passed (19X1–19X4), there are another 4 years still remaining. The book value at this time is $64,000, as indicated by the following T-accounts:

Change in Accounting Es

The annual depreciation for 19X5, 19X6, 19X7, and 19X8 is:

Annual Depreciation Example

Result: No correction entries are made to correct the depreciation of prior years.

If a change has to be made and it is unclear if it is a change in principle or a change in estimate, it should be considered a change in estimate.

[Info_Box]The treatment just discussed for changes in estimates only applies if the original estimate was calculated with proper care. It does not apply if the estimate was determined without proper care or in bad faith. In such cases, the change is considered to be a correction of an error, which requires different treatment. Correction of errors is discussed later in this post.[/Info_Box]

Changes In Reporting Entity

Some accounting changes result in financial statements that are the statements of a new or different entity. Examples include presenting consolidated statements instead of statements for each individual company, changing the specific subsidiaries that make up a consolidated group, and accounting for a pooling of interests.

The financial statements in the year of the change should describe the nature of the change and the reason for the change, and the statements for all prior periods presented should be restated to reflect this new entity.

The effect of the change on net income and earnings per share should be disclosed for all periods presented.

Up-coming post: Journal Entry for Correction of Errors and counterbalancing

Click to comment

Leave a Reply

Your email address will not be published. Required fields are marked *




Are you looking for easy accounting tutorial? Established since 2007, centre-potential.ru hosts more than 1300 articles (still growing), and has helped millions accounting student, teacher, junior accountants and small business owners, worldwide.

Trending


Related pages


cpa far examexamples of cash outflowrecapture of depreciationbep break even pointcashbreak compromisary note templatemanagement representation letter examplehow to prepare closing entries in accountingatm fee rebatesauditing frauds casesmethods of calculating goodwillirs car depreciation calculatorcpa exam sample questions and answersdifference between verification and valuationcompleteness assertion for accounts payablemeaning of deferred tax liabilitiesaccounting notes payable journal entriesjob description of treasury managerppmt formula in excelstockholders equity equationretained earnings stockholders equityquickbook pro 2010 free downloadaccrued taxes payableassociative forecasting definitionchargeable income formulafair value journal entriesias 16 depreciation methodsauditing and attestationirs response letter templateformula for diminishing value depreciationfeatures of good forecasting methodsjournal entries depreciationwhat is uncollectible accountstypes of budgets in management accountingit outsourcing advantages and disadvantagesfraud examination and forensic accountingwarranty accounting treatmentsample audit program for accounts receivablehow to test goodwill for impairmentallowance for loan losses journal entriesclassified balance sheet templatemulti step income statement excel templatefinancial ledger definitionwhat is accounting entityuseful life of vehicles for depreciationfixed asset capitalizationexamples of cash inflowgeneral ledger entriesinventory management economic order quantityasc 740 valuation allowancestraight line method of amortization formularequest for abatement of penalties letterjournal entries for bank reconciliationexpense recognition ifrsa compound journal entry involvesmanufacturing accounting basicsaging of receivables methodmasters in accounting starting salaryprepaid expense meaningindirect cash flow statement exampledays sales outstanding calculationdisadvantage of standard costinggoodwill on income statementsample promissory note templateppe financial termjoint venture ifrshow to record accrued expensepromissory note journal entrybreak even tax rate formulaformulas of cost accountingcapital lease vs operating lease accountingfreight terms cifcompleted contract method revenue recognitionwhen cpa exam score releasecontingent liabilities accountingis depreciation a sunk costforward exchange contract journal entriesspare parts inventory accountingimputed equity