Change in accounting estimate definition
/What is a Change in Accounting Estimate?
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.
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Accounting Changes and Error Corrections
Examples of Changes in Accounting Estimate
All of the following are situations where there is likely to be a change in accounting estimate:
Changes in the useful life of depreciable assets
Changes in the salvage values of depreciable assets
Changes in the amount of expected warranty obligations
Accounting for a Change in Accounting Estimate
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. This is a highly practical approach, since there are many changes in accounting estimate, which would otherwise require you to make endless changes to the financial statements for prior periods.
Disclosure of a Change in Accounting Estimate
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 in the footnotes that accompany the financial statements. However, you should 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 in the footnotes.
A sample disclosure for a change in accounting estimate is as follows:
During the fiscal year ended December 31, 2023, Alpha Corporation revised its estimate for warranty liabilities based on updated historical data and anticipated future warranty costs. The change in estimate was necessitated by increased product quality claims observed over the past two years and updated cost projections related to repairs and replacements.
The revised estimate increased the warranty liability as of December 31, 2023, by $3.5 million, from $12.0 million to $15.5 million. The impact of this change in estimate is reflected in the warranty expense recorded during the period, which increased by $3.5 million compared to the prior estimate.
This change in estimate is accounted for prospectively, as required under generally accepted accounting principles (GAAP). The increase in warranty expense reduced net income for the year ended December 31, 2023, by $2.6 million (net of tax). Basic and diluted earnings per share were reduced by $0.05 as a result of the change.
Management will continue to monitor warranty claims trends and revise estimates as necessary.