Changes 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:

• Alters the subsequent accounting for existing or future assets or liabilities.
• Affects the carrying amount of an existing asset or liability.

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.

Applying changes in accounting policies

(i) An entity shall account for a change in accounting policy resulting from the initial application of an Ind AS in accordance with the specific transitional provisions, if any, in that Ind AS; and

(ii) when an entity changes an accounting policy upon initial application of an Ind AS that does not include specific transitional provisions applying to that change, or changes an accounting policy voluntarily, it shall apply the change retrospectively.

Examples of Changes in Accounting Estimate

All of the following are situations where there is likely to be a change in accounting estimate:

• Reserve for obsolete inventory
• Allowance for doubtful accounts
• Changes in the useful life of depreciable assets
• Changes in the amount of expected warranty obligations
• Changes in the salvage values of depreciable assets

Changes in accounting estimates

As a result of the uncertainties inherent in business activities, many items in financial statements cannot be measured with precision but can only be estimated. Estimation involves judgements based on the latest available, reliable information. For example, estimates may be required of:

(a) Bad debts

B) Inventory obsolescence

(c) The fair value of financial assets or financial liabilities

(d) The useful lives of, or expected pattern of consumption of the future economic benefits embodied in, depreciable assets

 (e) Warranty obligations.

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.

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. However, 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.