 In this presentation, we will discuss change in estimates related to the calculation of depreciation. Remember that depreciation is the allocation of the cost of property plant and equipment over the useful life. Therefore, when we purchase the equipment, even if we paid cash for it, we're putting it on the books as an asset rather than expensing it at the time of purchase and then we're going to allocate the cost over the life of that asset in accordance with the matching principle, trying to match up the expense with the related period in which it helps to generate revenue. So, as we consume the property plant and equipment, we want to write off the expense when it has been consumed to help generate revenue. That gives us the best matching principle, the best comparability. Now, to do that, of course, we have to use an estimate to do that. So, it's not perfect when we make this estimate and our estimating methods might be something like straight line or an accelerated method like double declining balance. No matter what method we use, however, it is just an estimate and if it becomes clear in the future that our estimate is off or we think that it's clear that we need to update the estimate, then what are we going to do? How are we going to do that? First, note that there's a couple areas where the estimate could clearly change. So, when we have depreciation, the cost is the cost. We bought it for what we bought it for. That's not generally an estimate. What's an estimate is, one, the salvage value could be an estimate, meaning how much do we think it's going to be worth at the end of its useful life? How much do we think that we can scrap it for at the end of using it during its useful life? And two is going to be the useful life itself. How long do we think this thing is going to last and how long are we going to be using this thing in operations? Those are the two things that could change. If there's a significant change in these, then we would want to go back and we want to take a look at it and say, okay, how are we going to deal with the fact that we have new information that now makes it so that one of these factors or both are now changed. When recording a change in estimate, we typically do it at the point in time that the change has taken place going forward. In other words, we typically won't go back in time and change the estimate back to the prior periods which have already passed. One reason for that is that it would change things within the past. It would be difficult for us to go through the books that had already been closed and then change the income statement which would change retained earnings. So oftentimes we'll just draw a line and say, okay, we think that this estimate has changed at this point in time and then make the calculation in order to change the estimate at this point in time moving forward. Let's take a look at this with an example. So here's going to be our data down here. We've got the cost of property, plant and equipment at 50,000 salvage value, 1,000 useful life starting at three years. Then at the end of year two, we decide that the useful life actually has three at the end of year, at the beginning of year three, the end of year two. We think the useful life at that point has four more years to go. So that's a change in estimate and we believe the salvage value is going to change from 1,000 to 500 as that change takes place. What we'll do is we'll use this original data here in order to record the depreciation and then we'll consider what that change will do when it happens at the end of two years. So the original data, we're just going to say we had $50,000 cost, we had a salvage value of 1,000. This is just a straight line calculation. We're going to be doing straight line calculation. Then that gives us the 49,000 to be depreciated 50,000 cost minus the salvage, what we think we'll be able to get for it for scrap at the end of its useful life gives us the amount we're going to depreciate over its useful life currently three years. So if we had 49,000 divided by three years that we're going to depreciate over that gives us our 16,333 this is an estimated number here it's really 16,333.333 we're estimated to the nearest dollar. So if we take a look at our book value calculation always important to do this by the way because a book problem even if we're doing this for a book problem will generally always ask or could ask something other than just the depreciation. So being able to calculate depreciation is not the full not everything you need to know we need to know how to calculate the accumulated depreciation and how to calculate the book value because those are going to be common forms of questions and just to understand of course the concepts. So the book value at the end of year one is going to be the cost 50,000 less the accumulated depreciation which is only one year at this point being just the 16,333 subtracting out the 50,000 minus the 16,333 we have a book value after year one of 33,667. If we had a straight line method which we calculated here and we did that for year two we would still have a cost of 50,000 and the accumulated depreciation now would be that 16,333 from the prior year plus the current years 16,333 or 32,667 then the 50,000 minus the 32,667 would give us that 17,333. Now we would do this for another year and if we did that under the normal method we would get down to a salvage value of 1,000 the useful life having been completed and we would have fully depreciated. However we have a situation here where we're saying at the end of year two at this point in time there is a change in estimate we think it's going to last four more years. Now if we were to just end it off in year three then we couldn't extend the useful life because there would be nothing left to depreciate. In other words at this point in time we're not going back to the original 50,000 we're not going to update years one and two what we're going to do is go from year at the end of year two beginning of year three forward in order to make our adjustment. Part of the reason for that is that this depreciation has already been included in the expenses for years one and two and then has been closed out to retained earnings. So it's basically the expense half of this calculation is gone it's already passed it's timing the time has gone so in order to change it we'd have to go back retroactively and recalculate the prior year's income statement and then roll forward and reclose out the income statement to adjust retained earnings going forward. It oftentimes might not be most useful to do that what we can do instead so we can say okay we figured out the adjustment at this point in time we're going to say this is where we stand at this point in time this isn't the cost it's the book value as of the end of year two and then take that and adjust it going forward to allocate it out to the four years and the new salvage value. To do that we're going to do basically just the same type of straight line calculation however instead of starting with the cost we will start with the book value of where we're at the 17,333 at the end of year two then we'll subtract out the salvage which has changed now to 500 from 1000 if we subtract that out to 17,333 minus 500 gives us 16,833 useful life we're going to say is four years now so it's four more years it's already been two years and now we decided at the end of year two it's going to last four more years four years 16,833 to be depreciated divided by four more years gives us depreciation per year for the next four years 4,208 so now if we calculate the depreciation or our book value we get the 50,000 cost still and then the accumulated depreciation now I won't go back to the prior slide to pick up the prior one but we'll see it going forward it would be the accumulated depreciation for the last time period plus the 4,208 which gives us the 36,875 subtracting out the 50,000 plus the new accumulated depreciation brings it down to 13,125 so in essence this is where we stood book value wise in the prior year now we're at 13,125 going forward we have the same 50,000 then we're going to take this prior periods accumulated depreciation 36,875 plus the current year's depreciation that we have calculated using a straight line method 4,208 to give us 41,083 the 50,000 minus the 41,083 gives us 8,917 if we do this again we've got the 50,000 then we're going to add in the accumulated depreciation 41,083 and the 4,208 to give us 45,292 the 50,000 minus the 45,292 gives us 4,708 we'll do this one more time we've got the 50,000 then we got the accumulated depreciation being the 45,292 from the prior time period plus the current period's depreciation 4,208 giving us 49,500 subtracting out the 50,000 minus the 49,500 gives us the 5,000 so you can see as we start from this point in time we can arrive at the 500 our stopping point that being the salvage value without having gone back and made the changes to the original estimate we didn't make this calculation based on the 50,000 cost we basically took the book value as of the point in time that we thought the estimate had changed that being 17,333 then moving forward with that based on the new information that we have