Change in the percentage used to determine bad debts.
options:
1) CPR Change in Principle reported Retrospectively
2) CPP Change in Principle reported Prospectively
3) CES Change in Estimate
4) CRE Change in Reporting Entity
5) PPA Prior Period Adjustment required
The correct answer and explanation is:
The correct answer is: 3) CES Change in Estimate
Explanation:
A change in the percentage used to determine bad debts is classified as a “Change in Estimate” under accounting standards. This is because when estimating bad debts, companies typically use historical data or trends to project future write-offs of uncollectible accounts. However, if the company notices a shift in these trends—such as changes in the economy, customer behavior, or collection practices—it may need to update its estimation method.
Key Concepts:
- Change in Estimate (CES): This occurs when there is a revision to the expected amount of a specific financial estimate. For example, if a company initially estimated bad debts at 5% of accounts receivable but later determines that 6% is more accurate, this would be considered a change in estimate. The revised estimate reflects updated assumptions about future events.
- Impact on Financial Statements: A change in estimate is applied prospectively, meaning it is not applied to prior periods. The new estimate is used in the current and future periods, and it adjusts the bad debt expense accordingly. It does not result in retroactive adjustments to previous financial statements.
- No Prior Period Adjustment (PPA): Unlike changes in accounting principles or errors, a change in estimate does not require a prior period adjustment. The effect of the change is recognized in the period in which the change is made, ensuring the current financial statements are accurate.
- Why Not Other Options?
- CPR Change in Principle reported Retrospectively involves a change in the method of applying accounting principles. Bad debt estimation is a form of estimation, not a change in principle.
- CPP Change in Principle reported Prospectively refers to a change in accounting principles applied in the future, but bad debt estimation typically falls under estimates, not principles.
- CRE Change in Reporting Entity refers to a change in the entity being reported on (e.g., consolidation of subsidiaries), which is unrelated to changes in estimates for bad debts.
- PPA Prior Period Adjustment required applies when there’s an error in prior financial statements, not for a change in estimate.
By understanding that bad debt estimates are revised based on new information and trends, the correct classification is a Change in Estimate.