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Company A performs a quarterly analysis to estimate it's excess and obsolete inventory reserve (E&O reserve)....

Company A performs a quarterly analysis to estimate it's excess and obsolete inventory reserve (E&O reserve). The Company’s policy is to identify and specifically reserve for obsolete inventory and review forecasted sales to calculate excess inventory on hand. Based on the most recent forecast which shows a decrease in sales, the Company determines that its current E&O reserve is understated. Accordingly, the Company records an adjustment to increase the E&O reserve balance. The change is not material to the financial statements. 1. Is this change allowed? If so, is it a –Change in accounting principle –Change in accounting estimate –Correction of an error in previously issued financial statements, or –Change in reporting entity 2. In what Period should this be recognized (retrospective, current and/or prospective) 3. Is financial statement disclosure required?

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Answer:-

1.This is change in accounting estimate. Because company didn’t know the sales would decrease, so it is not an error in previously issued financial statements. Since new information is received, the estimate number needs to be adjusted.

2.It should be recognized now and in future period.

3.Since the change is not material, company doesn’t need financial statement disclosure.

Explanation:-

Examples of Changes in Accounting Estimate

All of the following are situations where there is likely to be a change in accounting estimate:

  • Allowance for doubtful accounts
  • Reserve for obsolete inventory
  • Changes in the useful life of depreciable assets
  • Changes in the salvage values of depreciable assets
  • Changes in the amount of expected warranty obligations

When there is a change in estimate, account for it in the period of change. If the change affects future periods, then the change will likely have an accounting impact in those periods, as well.

A change in accounting estimate does not require the restatement of earlier financial statements, nor the retrospective adjustment of account balances.

If the effect of a change in estimate is immaterial (as is usually the case for changes in reserves and allowances), do not disclose the alteration. However, disclose the change in estimate if the amount is material. Also, if the change affects several future periods, note the effect on income from continuing operations, net income, and per share amounts.

ekkarill92 answered 1 year ago
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