FAR: Example of Treatment of a Change in Estimation (Depreciation)

Here is a simple multiple choice question from the Wiley TestBank that pertains to the treatment of accounting changes and error correction. 

Cory Company acquired some machinery on January 2, year 2. Cory was using straight-line depreciation with an estimated life of 15 years with no salvage value for this machinery. On January 2, year 6, Cory estimated that the remaining life of this machinery was 6 years with no salvage value. How should this change be accounted for by Cory?

A)     Revising future depreciation per year to equal the book value of January 2, year 6, divided by 6.

B)      Making a prior period adjustment and changing to an accelerated depreciation method that will compensate for under-depreciation in prior years.

C)      Estimating the effect of the change on each year’s net earnings, but maintaining the method of depreciation as originally determined.

D)     Revising future depreciation per year to equal the original cost divided by 6.

Revising future depreciation per year to equal the book value of January 2, year 6, divided by 6 is correct. Cory Company’s change of depreciation is considered a change in estimate. A change in estimate is treated prospectively by revising the remaining years’ depreciation expense. Book value of the asset at the time of change should be divided by 6, the estimated remaining life.

The key thing to remember here is that whenever an issuer changes depreciation methods because their estimation was off, they have to account for the change in the current year and future years. Estimations are just that, estimations. So, there were no mathematical errors really. The book value, not the historical or original cost, would be used to recalculate the new depreciation expenses for each remaining year.