What must a company do if it decides to change an accounting estimate?

When a company decides to change an accounting estimate, it is required to apply those changes prospectively. This means that the effects of the change are reflected in the financial statements for the current and future periods only, rather than adjusting prior period financial statements.

Accounting estimates involve subjective judgments by management about future developments. Examples of estimates include useful lives of assets, allowance for doubtful accounts, and inventory obsolescence. Since these estimates are inherently uncertain, a change may arise as new information becomes available or as better methods of estimation are developed. The accounting standards dictate that any adjustments stemming from a change in estimate do not retroactively affect the financial statements of prior periods, recognizing that estimates are revised based on new information and should not distort the previously reported results.

This approach provides consistency and reliability in financial reporting, ensuring that users of the financial statements are not misled by restatements of previously reported figures that were based on estimates applicable at that time.