Change in Accounting Estimate

Many figures in accounts rely on estimates, such as the useful life of equipment, the amount of customer debts that will not be paid, warranty costs and the value of inventory. As circumstances change, estimates are updated.

A change in estimate is applied from the current period onwards. Earlier years are not restated, because the original estimate was reasonable based on the information available at the time.

For example, a company bought a machine for 100,000 expecting a ten-year life, depreciating it at 10,000 a year. After four years, with 60,000 left to depreciate, it decides the machine will last only three more years. From now on, it depreciates 20,000 a year.

This treatment differs from a change in accounting policy, which is usually applied to earlier years as well, and from the correction of a prior-period error, which requires restating past figures. Companies must disclose significant changes in estimates. Frequent or convenient changes in estimates can be a warning sign of earnings management.