Final answer:
A change in accounting estimate is an adjustment to a company's accounting policy that affects future statements, and it must be applied prospectively. It affects either the demand or supply side based on the nature of the estimate. In practical terms, this could mean adjusting financial records, like Acme Bank updating its reserve amounts after an open market sale by the Fed.
Step-by-step explanation:
A change in accounting estimate is an update to an accounting policy that has an impact on future financial statements. It is important for a company to recognize this change and adjust its accounting records accordingly. This may involve revising amortization or depreciation schedules, modifying bad debt reserves, or changing warranty reserves among others, depending on the nature of the change.
Assessing the Impact
When a company discovers that an accounting estimate requires revision, it should determine whether this impacts the demand or supply factors of its business. For example, if the change affects production costs, like labor compensation, it would likely impact the supply side. The company would have to reassess its supply chain, production capacity, and cost structure, which could in turn adjust pricing and ultimately affect the supply of goods or services offered.
Recording the Change
Accounting standards generally require that changes in accounting estimates be applied prospectively, meaning from the date of the change onwards, and not retroactively. Adjustments to financial statements should reflect the change in the specific period in which the decision for the estimate change is made, and the effects should be recognized in the income statement when incurred.
Real World Example
Let's say Acme Bank must adjust its financial statements for an open market sale conducted by the Fed. As a result of selling $10 million in Treasury bonds, the bank must restore its required reserves (10 percent of deposits) by reducing its loans. This would necessitate changes in its balance sheet – decreasing its bond assets by $10 million and loans by a corresponding amount to maintain the required reserve ratio and comply with regulatory requirements.