Change in estimates

Two major areas where estimates are used in accounting for property, plant and equipment as well as intangibles are their useful lives and residual values. They are important mainly because although they are determined right from the initial recognition, unlike the cost value, they are subject to change when conditions do. The amount you paid in for the property shall rarely change and if so, it’s because you bought some additions to it. But for how long you’ll use the asset and what shall you actually get from selling it – they are subject to change in correlation with macro-economic performance as well as business-wise changes. It’s often ignored however and unintentionally I might add.

There are two sides to the story however. First off the management needs to determine and set their best estimates at the initial recognition. What are the sources of information to use? There is no right or wrong answer here. Usually the estimate for useful lives is done based on the previous experience, industry-wide knowledge and possibly for residual value you’d use the information available in selling ads or similar sources. So, pretending now that you have revisited those estimates (as you are supposed to do as a minimum annually), you understand that both or one of these values needs to be changed. Now what?

Now we have the change, but how shall you continue? One thing is clear and concise – the changes in estimates are never retrospective. If you either change the useful lives or the residual value, you always apply the change to the current year financial results. It’s however questionable in which month you should apply the change – should you apply it from the beginning or the month the change was discovered. Again, one and the other approach are used. In my opinion, a more fair and true view is given when the change is applied from the month it was discovered. As it happens however, it also depends on the subject of the matter and reasoning behind the change that may affect the proper period. More important than this is to however apply the change.