Wize University Introduction to Financial Accounting Textbook > Long-Term Assets
Changes in Estimates
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Changes in Estimates
When an asset is first acquired, the estimates of the useful life and residual value determine the rate at which the asset will depreciate. When these estimates change during an asset's life, the depreciation over the remaining life must be adjusted to reflect these changes.
What Causes a Change in Estimate?
- Change in cost due to additional capital expenditures.
- Change of residual value
- Change of useful life
- Change of depreciation method
Steps to perform a change in estimate
- Determine the new cost of the asset by adding any additional capital expenditures.
- Determine the carrying value by subtracting any existing accumulated depreciation.
- Depreciate the carrying value over the remaining useful life of the asset.
Wize Concept
Changes in estimates are not retroactive, meaning that any previous depreciation will not be affected, only future depreciation changes.
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Example: Changes in Estimates
Ten years ago, Wize Corp. purchased a building for $400,000. The building had an estimated useful life of 40 years and residual value of $40,000 at the time of the purchase. Today the company is renovating the building at a cost of $250,000. It is expected that the building's useful life will be extended by 15 years and its residual value will increase to $100,000. The company depreciates its buildings using the straight-line method.
How much depreciation expense should the company record at the end of this year?
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Example: Changes in Estimates
JK Inc. has always used the straight-line method to depreciate its equipment. Management has decided that moving forward it would be switching to the double-declining balance method. The company owns a piece of large equipment that it purchased for $90,000 on July 1st, 2018. At the time of purchase, the equipment's estimated useful life was 6 years and its residual value was $5,000.
Today is January 1st, 2020, the company has stated that the initial estimates of useful life and residual value have not changed.
Determine the depreciation expense to be recorded on December 31st, 2020.
Practice: Changes in Estimates
On April 1st, 2020, Wize Corp. purchased a used machine to use in its operations by signing a 5-year, $500,000 note at 5% interest. Closing fees for the transactions totalled $5,000 which included (notary fees and brokerage). The purchase was also subject to 10% sales tax which was paid in cash at the time of purchase. Wize Corp. paid $10,000 to a shipping company to delivery and install the machine at the company's facility, and spent another $6,000 repairing the machine's defects prior to putting it in use. The company's fiscal year ends December 31st.
The acquisition cost of the machine totalled $521,000, the company estimates that it will be used for 10 years and have a residual value of $11,000. Machines are depreciated using the double-declining balance method.
The depreciation expense for 2020 and 2021 was $78,150 and $88,570 respectively. On January 1st, 2022, Wize Corp. spent $123,000 overhauling the machine. The company's business model is changing and the machine needed to be adapted to it. The result of the overhaul is that the machine's useful like would be extended by 3 years, but the residual value would decrease to $5,000.
What is the depreciation expense that should be recorded on December 31st, 2022? Round your final answer to the nearest dollar.
Practice: Changes in Estimates
Mattel Inc. manufactures a wide range of children's toys and games and is headquartered in El Segundo, California. On July 1st, 2020, the company spent $220,000 renovating the building that houses the company's head office. The building was purchased for $1,250,000 on January 1st, 2006. At the time of purchase, the building had a residual value of $50,000 and an estimated useful life of 40 years.
From the date of the renovation, the company estimates that the building can be used for another 40 years and would have a residual value of $75,000. What is the annual amount of depreciation to be reported in 2020? The company depreciates buildings using the straight-line method.