A company has depreciated a piece of equipment on a straight-line basis, originally estimating a 10-year useful life and no salvage value. At the start of year 6, based on updated maintenance and usage data, management revises its estimate of the equipment's remaining useful life to 3 additional years (rather than the 5 originally remaining) and revises its salvage value estimate to $9,000. Under US GAAP, how should this revision be accounted for?
- Retrospectively, by restating the depreciation expense reported in each of the first five years as if the revised 3-year remaining life and $9,000 salvage value had been used from the date of acquisition
- As a correction of an error, requiring a prior-period adjustment to beginning retained earnings for the cumulative effect of the difference between the depreciation actually recorded and the amount that would have been recorded under the revised estimate
- By recognizing a cumulative catch-up adjustment in the current period's income statement for the difference between total depreciation recorded to date and the amount that would have been recorded under the revised estimate, with no change to future depreciation
- Prospectively, as a change in accounting estimate: the equipment's remaining undepreciated cost, less the revised $9,000 salvage value, is spread over the revised 3-year remaining useful life, with no restatement of prior periods
Why D? And why not the others?
Correct answer: D. Prospectively, as a change in accounting estimate: the equipment's remaining undepreciated cost, less the revised $9,000 salvage value, is spread over the revised 3-year remaining useful life, with no restatement of prior periods
A revision of an asset's estimated useful life or salvage value is a change in accounting estimate, not the correction of an error and not a retrospective restatement event, because the original estimates were reasonable when made and the revision simply reflects new information about the asset's remaining service potential. ASC 250-10-45-17 requires changes in accounting estimate to be accounted for prospectively: the equipment's remaining undepreciated cost at the start of year 6, reduced by the revised $9,000 salvage value, is spread evenly over the newly estimated 3-year remaining life, and depreciation already recorded in years 1 through 5 is left untouched. Restating the first five years' depreciation as if the new estimate had applied from acquisition improperly treats an estimate change as if it were a retrospective accounting policy change. Treating this as an error correction with a retained-earnings adjustment is wrong because nothing about the original 10-year, no-salvage estimate was mistaken at the time it was made — it simply reflects updated information now, which is the defining feature of an estimate change rather than an error. A one-time cumulative catch-up recognized entirely in the current period's income statement is also incorrect, since prospective treatment spreads the adjusted remaining cost over the remaining periods rather than dumping the full effect into a single year.
Source: FASB ASC 250-10-45-17 (changes in accounting estimate, including useful life and salvage value of a depreciable asset, accounted for prospectively)