Accounting estimates can best be described as the approximation of the amount to be debited or credited in the respective account, where no precise means of measurement are readily available.
Accounting estimates are generally derived from specialized knowledge and judgment, which is derived from experience and training.
Mostly they are used in determining the carrying value of assets and liabilities in the Balance Sheet at the end of the specific date, and their respective heads in the Income Statement during the specific period.
Accounting estimates require judgment about future benefits that can be derived from the assets, and obligations that are likely to incur as a factor of those liabilities.
Furthermore, they are mainly based on the information which reflects the situations and circumstances that exist at the date of the estimation. The subjectivity issue in this regard requires proper calculations, which might need revisions and re-estimation.
IAS 8 is the relevant standard that can be used to benchmark regarding handling and calculating these accounting estimates.
IAS 8 lays out a direction regarding the treatment of these accounting estimates, by mentioning that if the accounting estimate is duly changed, the impact of such should be reflected in the profit and loss account, for all the periods of change, both current and future, depending on the longevity of the impact itself.
Accounting estimates are extremely important for an organization because for certain accounts, or types of accounts, there are no quantifiable methods for the respective treatment.
From an auditor’s perspective, it can be seen that they have to look for aspects like management biases, subjective assumptions, and judgment errors when calculating these accounting estimates.
Examples of Accounting Estimates
There are numerous accounting estimates, which are given below.
- Accounts Receivables
- Depreciation Method and Useful Life
- Contingent liabilities
- Warranty Estimates
- Pension and Post-Retirement Obligations
- Credit Losses Allowance
For all the examples that have been listed above, it needs to be ensured that the basis of calculation for all these features is properly aligned with the ideology to get the most precise, and consistent values for all the respective heads.
The items listed above are highly subjective and vary from situation to situation. Therefore, there is a need to have a generalized approach, which can act as a rule of thumb to ensure that there is an existing basis to make these calculations across all years of operation and all different industrial trends.
For example, as far as inventory is concerned, it can be regarded as an asset meant to generate positive financial returns for the business. However, the rule states that inventory should be recorded at a lower cost or net realizable value.
Furthermore, all the inventory losses also have to be considered, including damaged and obsolete goods. From an accountant’s perspective, it’s important to analyze that these entries have been made correctly.
From an auditor’s perspective, it is important to see that these accounting estimates have been done correctly.