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Imagine you are the senior accountant at your organization, and management is not sure of the difference between a change in accounting estimate and a change in accounting principle. Briefly discuss the difference between a change in accounting estimate and a change in accounting principle, and outline the impact the changes will have on the company’s financial statements. Give your opinion on why a company should avoid reporting changes in accounting principles and changes in accounting estimates. Provide a rationale for your response.
Expert Answer
Change in accounting estimate:
i. It occurs when estimations made for accounting are no longer suitable in the existing situations.
ii. For example, management has estimated the useful life of an asset as 8 years, but after 3 years the remaining life is 3 more years. So the earlier estimate of 8 years is no longer suitable.
Change in accounting principle:
i. A change in accounting principle cannot be easily done. There has to be a proper justification for it or the statute must require such a change.
ii. For example, Generally Accepted Accounting Principles (GAAP) allow both straight line and reducing balance method for calculating depreciation on fixed assets. Changing from straight line to reducing balance is an example of change in accounting principle.
The impact of both change in accounting estimate and accounting principle have retrospective implication on the financial statements. The impact needs to be calculated retrospectively and disclosed in the financial statements.
A company cannot avoid reporting changes in accounting estimates and changes in accounting principle. It can avoid making changes in accounting estimate and accounting principles as these have a significant impact on the profitability of the Company and the shareholders may be surprised because of such change.
