Accounting estimates include the estimated salvage value and the estimated useful life of depreciable assets, estimated percentage of bad debts expense, estimated percentage of units to be repaired or replaced during a warranty period, and routine estimates of monthly expenses for utilities and other expenses. When a change is needed to one of these estimates, the change can affect the current and future periods only. Previous periods are not restated for changes in estimates. (Corrections of errors require a restatement of a prior period amount.)
An accounting principle is a general guideline to follow when recording and reporting financial transactions. There is a change in accounting principle when:
- There are two or more generally accepted accounting principles that apply to a particular situation, and you shift to the other principle; or
- When the accounting principle that former applied to the situation is no longer generally accepted; or
- You change the method of applying the principle.
A direct effect of a change in accounting principle is a recognized change in an asset or liability that is required in order to effect the change in principle. For example, if you change from theFIFO to the specific identification method of inventory valuation, the resulting change in the recorded inventory cost is a direct effect of a change in accounting principle.
An indirect effect of a change in accounting principle is a change in an entity's current or future cash flows from a change in accounting principles that you are applying retrospectively. Retrospective application means that you are applying the change in principle to the financial results of previous periods, as if the new principle had always been in use.
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