The preparation of financial statements requires frequent use of estimates for such items as asset service lives, salvage values, lease residuals, asset impairments, collectibility of accounts receivable, warranty costs, pension costs, etc. Future conditions and events that affect these estimates cannot be estimated with certainty. Therefore, changes in estimates will be inevitable as new information and more experience is obtained. FAS 154 requires that changes in estimates be recognized currently and prospectively, as did APB 20, the predecessor standard. The effect of the change in accounting estimate is accounted for in “(a) the period of change if the change affects that period only or (b) the period of change and future periods if the change affects both.” The reporting entity is precluded from retrospective application, restatement of prior periods, or presentation of pro forma amounts as a result of a change in accounting estimate.
For example, on January 1, 2008, a machine purchased for $10,000 was originally estimated to have a ten‐year useful life and a salvage value of $1,000. On January 1, 2013 (five years later), the asset is expected to last another ten years and have a salvage value of $800. As a result, both the current period (the year ending December 31, 2008) and subsequent periods are affected by the change. Annual depreciation expense over the estimated remaining useful life is computed as follows:
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