The goal of this paper is to describe an advanced method of a crack detection: a new way to localize position and to estimate depth of a crack on rotating shaft. As a first step, the shaft is physically modelled with a finite element method and the dynamic mathematical model is derived using the Hamilton principle; thus, the system is represented by various subsystems. The equations of motion of the shaft with a crack are established by adapting the local stiffness change through breathing and gaping from the crack to an undamaged shaft. This is the reference system for the given system. Based on a model for transient behavior induced from vibration measured at the bearings, a nonlinear state observer is designed to detect cracks on the shaft. This is the elementary NL-observer (Beo). Using the observer, an Estimator (Observer Bank) is established and arranged at the certain position on the shaft. When a crack position is localized, the procedure for estimating of the depth is engaged.