CHAPTER 10
ACCOUNTING CHANGES
CHANGE IN ACCOUNTING
ESTIMATE
By: Ann Jhennett Y. Tiglao, CPA
CATEGORIES OF
ACCOUNTING CHANGE
Change in accounting estimate
Change in accounting policy
Accounting changes can have a great impact on an entity's reported
earnings.
Thus, it is critically important that users of financial statements
understand the nature and effect of accounting changes and must not
rely solely on the bottom line which is the net income or loss.
Change in accounting estimate
PAS 8, paragraph 5, defines a change in accounting estimate as an
adjustment of the carrying amount of an asset or a liability, or the
amount of the periodic consumption of an asset that results from the
assessment of the present status and expected future benefit and
obligation associated with the asset and liability.
Simply stated, a change in accounting estimate is a normal recurring correction or
adjustment of an asset or liability which is the natural result of the use of an
estimate.
The use of reasonable estimate is an essential part of the preparation of financial
statements and does not undermine - their reliability.
An estimate may need revision if occur regarding the circumstances on which the
estimate was based or as a result of new information, more experience or
subsequent development.
By very nature, the revision of the estimate does not relate to prior periods and is
not a correction of an error.
A change in measurement basis is a change in accounting policy and not a change
in accounting estimate.
Sometimes it is difficult to distinguish a change in accounting estimate and a
change in accounting policy.
In such a case, the change is treated as a change in accounting estimate, with
appropriate disclosure.
EXAMPLES OF ACCOUNTING ESTIMATE
As a result of uncertainties in business activities, many items in the financial statements cannot be
measured with precision but can only be estimated.
Estimation involves judgment; based on the latest available and reliable information, estimates may
be required for the following:
a.
Doubtful accounts
b.
Inventory obsolescence
c.
Useful life, residual value, and expected pattern of consumption of benefit of depreciable asset
d.
Warranty cost
e.
Fair value of financial assets and financial liabilities
How to report change in accounting estimate
The effect of a change in accounting estimate shall be recognized currently and
prospectively by including it in income or loss of:
a. The period of change if the change affects that period only.
b. The period of change and future periods if the change affects both.
To the extent that a change in accounting estimate gives rise to changes in assets
and liabilities, or relates to item of equity, it shall be recognized by adjusting the
carrying amount of the related asset, liability or equity in the period of change.
A change in an accounting estimate shall not be accounted for by
restating amounts reported in financial statements of prior periods.
Changes in accounting estimates are to be handled currently and
prospectively, if necessary.
Prospective recognition of the effect of a change in accounting means
that the change is applied to transactions, other events and conditions
from the date of change in estimate.
ILLUSTRATION
For example, a depreciable asset costing P500,000 is estimated to have a life of 5 years. At
beginning of third year, the original life is changed to 8 years. Thus, the asset has a remaining life
of 6 years.
The procedure is not to correct past depreciation. Instead, the remaining carrying amount of
P300,000 (P500,000 minus P200,000 depreciation for 2 years) is now allocated over 6 years or a
subsequent annual depreciation of P50,000.
Thus, the entry to record the annual depreciation starting the third year is:
Depreciation 50,000
Accumulated depreciation
50,000
CHANGE IN DEPRECIATION METHOD
A change in depreciation method is accounted for as a change in accounting estimate.
ILLUSTRATION
An entity decided to change from the sum of years' digit method to the straight line
method of depreciation on January 01, 2019.
The asset originally has a cost of P1,000,000 acquired on January 1, 2017 and is
estimated to have a four-year life.
Cost — January 1, 2017
1,000,000
Accumulated depreciation:
2017 (4 /10 x 1,000,000)
2018 (3/ 10 x 1,000,000)
Carrying amount — January 1, 2019
400,000
300,000
(700,000)
300,000
The procedure is simply to allocate the carrying amount of P300,000
over the remaining life of 2 years using the new depreciation method
which is the straight line.
Accordingly, the depreciation for 2019 is recorded as follows:
Depreciation (300,000 / 2)
Accumulated depreciation
150,000
150,000
QUESTIONS
1. What are the two main categories of accounting changes?
2. Define a change in accounting estimate.
3. Give examples of items in the financial statements that may require
estimate.
4. How is a change in accounting estimate reported?
5. Explain a change in depreciation method.
PROBLEMS
Problem 10-1 (AICPA Adapted)
On January 1, 2016, Flair company purchased a machine for P2,640,000 and depreciated it by the
straight line using an estimated life of 8 years with no residual value.
On January 1, 2019, the entity determined that the machine had a useful life of 6 years from the
date of acquisition with a residual value of P240,000.
What is the accumulated depreciation on December 31, 2019?
a. 1,460,000
b. 1,540,000
c. 1,600,000
d. 1,760,000
Problem 10-1 Answer A
Cost
2,640,000
Accumulated Depreciation
(990,000)
Carrying amount - January 1, 2019 (2,640,000 / 8 x 3)
1,650,000
Accumulated Depreciation- January 1, 2019
990,000
Depreciation for 2019 (1,650,000 - 240,000 / 3)
470,000
Balance - December 31, 2019
1,460,000
Problem 10-2 (IFRS)
On January 1, 2015, Roma Company purchased equipment for P4,000,000. The equipment has a useful life of
10 years and a residual value of P400,000.
On January 1, 2019, the entity determined that the useful life of the equipment was 12 years from the date of
acquisition and the residual value was P480,000.
1. What is the carrying amount of the equipment on January 1, 2019?
a. 2,560,000
b. 2,920,000
c. 2,400,000
d. 2,800,000
2. What is the depreciation of the equipment for 2019?
a. 175,000
b. 260,000
c. 360,000
d. 300,000
Problem 10-2
Question 1 Answer A
Cost - January 1, 2015
4,000,000
Accumulated Depreciation - January 1, 2019 (4,000,000 - 400,000 / 10 x
4)
(1,440,000)
Carrying amount - January 1, 2019
2,560,000
Question 2 Answer B
Carrying amount - January 1, 2019
2,560,000
Residual value
(480,000)
Depreciable amount
2,080,000
Depreciation for 2019 (2,080,000 / 8 years)
260,000
Revised useful life
Expired
Remaining useful life
12 years
(4)
8 years
Problem 10-3 (AICPA Adapted)
Dawn company purchased a machine on January 1, 2016 for P3,000,000. At the date of acquisition,
the machine had a life of six years with no residual value. The machine is being depreciated on a
straight line basis. On January 1, 2019, the entity determined that the machine had a useful life of
five years from the date of acquisition with residual value of P100,000.
What is the depreciation for 2019?
a. 700,000
b. 500,000
c. 750,000
d. 600,000
Problem 10-3 Answer A
700,000
Problem 10-4 (AICPA Adapted)
On January 1, 2017, Zee Company purchased for P2,400,000 a machine with a useful of ten years
and no residual year. The machine was depreciated by the double declining balance method and the
carrying amount of the machine was P1,536,000 on December 31, 2018. The entity changed to the
straight line method on January 1, 2019.
What is the depreciation for 2019?
a. 153,600
b. 307,200
c. 240,000
d. 192,000
Problem 10-4 Answer D
Straight line depreciation for 2019 (1,536,000/8)
192,000
Problem 10-5 (AICPA Adapted)
On January 1, 2018, Kevin Company purchased a machine for P2,750,000. The machine was
depreciated using the sum of years’ digits method based on a useful life of 10 years with no residual
value. On January 1, 2019, the entity changed to the straight line method of depreciation.
What is the depreciation for 2019?
a. 180,000
b. 220,000
c. 250,000
d. 275,000
Problem 10-5 Answer C
SYD (1+2+3+4+5+6+7+8+9+10)
55
Cost - January 1, 2018
2,750,000
Accumulated Depreciation - January 1, 2019 (10 / 55 x 2,750,000)
Carrying amount - January 1, 2019
(500,000)
2,250,000
Straight line depreciation for 2019 (2,250,000/ 9 years remaining)
250,000
Problem 10-9 (IAA)
On January 1, 2018, London Company purchased a large quantity of personal computers. The cost of these
computers was p6,000,000.
On the date of purchase, the management estimated that the computers would last approximately four years
and would have a residual value at that time of P600,000. The entity used the double declining balance
method.
During January 2019, the entity realized that technological advancements had made the computers virtually
obsolete and that they would have to be replaced. The management changed the remaining useful life of the
computers to two years.
What is the depreciation expense for 2019?
a. 3,000,000
b. 2,400,000
c. 1,500,000
d. 1,200,000
Problem 10-9 Answer B
Fixed rate (100% / 4 x 2)
50%
Cost
6,000,000
Depreciation for 2018 (50% x 6,000,000)
Carrying amount - January 1, 2019
3,000,000
3,000,000
Residual value
(600,000)
Maximum depreciation in 2019
2,400,000
Fixed rate in 2019 (100% / 2 x 2)
This means that the computers should be fully depreciation in 2019. Since there is a residual value of
P600,000,
the maximum depreciation for 2019 is equal to the carrying amount of P3,000,000 minus the
residual value of P600,000 or P2,400,000.
100%
ACTIVITY 1
Problem 10-6 (AICPA Adapted)
Turtle Company purchased equipment on January 1, 2017 for P5, 000,000. The equipment had an
estimated 5-year service life. The policy for 5-year assets is to use the 200% double declining
balance method for the first two years and then switch to the straight line depreciation method.
What amount should be reported as accumulated depreciation on December 31, 2019?
a. 3,000,000
b. 3,800,000
c. 3,920,000
d. 4,200,000
Problem 10-7 (IAA)
Xavier Company purchased a machinery on January 1, 2016 for P7,200,000. The machinery has a
useful life of 10 years with no residual value and was depreciated using the straight line method. In
2019, a decision was made to change the depreciation method from straight line to sum of years'
digits. The estimate of useful life and residual value remained unchanged.
What is the depreciation for 2019?
a. 1,260,000
b. 1,440,000
c. 916,360
d. 720,000
Problem 10-8 (AICPA Adapted)
On January 1, 2017, Brazilia Company purchased for P4,800,000 a machine with a useful life of
ten years and a residual value of P200,000. The machine was depreciated by the double declining
balance.
The entity changed to the straight line method on January 1, 2019. The residual value did not
change.
What is the accumulated depreciation on December 31, 2019?
a. 1,728,000
b. 2,087,000
c. 1,380,000
d. 2,112,000
Problem 10-10 (IAA)
Canyon Company decided at the beginning of 2019 to decrease the estimated useful life of the patent from 10
years to 8 years.
The patent was purchased on January 1, 2014 for P3,000,000 with estimated residual value of zero.
The entity decided on January 1, 2019 to change the depreciation method from accelerated method to straight
line.
On January 1, 2019, the cost of the equipment is P8,000,000 and the accumulated depreciation is P3,400,000.
The remaining useful life of the equipment on January 1, 2019 is 10 years and the residual value is P200,000.
What is the total charge against 2019 income as a result of the accounting changes?
a. 940,000
b. 960,000
c. 627,500
d. 647,500
Problem 10-11 Multiple Choice (AICPA Adapted)
1. A change in the periods benefited by a deferred cost because additional information has been obtained is.
a. an accounting change that should be reported in the period of change and future periods if the change affects both
b. an accounting change that should be reported by restating the financial statements of all prior periods presented
c. a correction of an error
d. not an accounting change
2. A change in the residual value of an asset arising because additional information has been obtained is
a. An accounting change that should be reported in the period of change and future periods if the change affects both
b. An accounting change that should be reported by restating the financial statements of all prior periods presented
c. A correction of an error
d. Not an accounting change
3. Which statement in relation to a change in accounting estimate is true?
a. Change in accounting estimate is accounted for retrospectively.
b. Change in accounting estimate results from new information or new development.
c. By very nature, the revision of an estimate relates to prior periods and is accounted for as a correction of an
error.
d. All of these statements are true in relation to a change in accounting estimate.
4. The effect of a change in accounting policy that is inseparable from the effect of a change in accounting
estimate should be reported
a. by restating the financial statements of all prior periods presented.
b. as a correction of an error
c. as a component of income from continuing operations in the period of change and future periods if the
change affects both.
d. as a separate disclosure after income from continuing operations in the period of change and future periods if
the change affects both.
5. When an entity changed the expected service life of an asset because additional
information has been obtained, which of the following should be reported?
a. Cumulative effect of change in accounting policy
b. Proforma effect of retroactive application
c. Prior period error
d. An accounting change that should be reported in the period of change and future
periods if the change affects both
Problem 10-12 Multiple Choice (IAA)
1. Which is not classified as an accounting change?
a. Change in accounting policy
b. Change in accounting estimate
c. Error in the financial statements
d. All of these are classified as an accounting change
2. Which of the following is the proper time period to record the effect of a change in accounting
estimate?
a. Current period and prospectively
b. Current period and retrospectively
c. Retrospectively
d. Current period
3. Why is retrospective treatment of change in accounting estimate prohibited?
a. A change in accounting estimate is a normal recurring correction or adjustment.
b. The retrospective treatment is not allowed.
c. Retrospective treatment of a change in accounting estimate is required by IFRS.
d. IFRS does not prohibit retrospective treatment of change in accounting estimate.
4. Which of the following is required for a change from sum of years' digits to straight line method
of depreciation?
a. The cumulative effect on prior years is reported in the statement of retained earnings
b. Retrospective restatement
c. Recomputation of depreciation for current and future years
d. All of these are required
5. Which of the following is not a justification for a change in depreciation
method?
a. A change in the estimated useful life
b. A change in the pattern of estimated future benefit
c. To conform with the depreciation method prevalent in a particular industry
d. A change in the future benefit from the asset
THANK YOU FOR LISTENING!
Reference:
Intermediate Accounting 3 Volume 2019 by Conrado T. Valix, Jose T. Peralta and Christian Aris M.
Valix