Final answer:
Changes in estimates in financial reporting are treated prospectively, impacting only current and future financial statements without revising past data. This ensures financial data is up-to-date but can alter financial trends and ratios, necessitating explanations in financial notes.
Step-by-step explanation:
Changes in estimates in financial reporting are accounted for prospectively, meaning they are recognized in the current and future periods affected by the change, but without adjusting past periods. This is in accordance with the accrual basis of accounting, which requires that revenues and expenses be recognized in the period they are earned or incurred, rather than when cash is exchanged
An implication of this approach is that financial statements reflect the most current information, but retrospective changes to previously issued financial statements are not made. This can affect trends and ratios derived from the financial statements and may require explanation within the notes to the accounts to ensure users understand the basis on which the changes have been made. It emphasizes the dynamic nature of financial information and the need to use caution when comparing over time.
For example, if a company revises the estimated useful life of an asset, the depreciation expense will change for the current and future periods, impacting the income statement through reduced or increased depreciation charges and the balance sheet through adjusted accumulated depreciation and net book values of assets.