Accounting Estimate

Intermediate

An accounting estimate is an approximation of an amount in the financial statements that cannot be measured precisely and depends on judgment about future events, such as bad debts, warranty costs or an asset's useful life.

Many figures in financial statements involve uncertainty. Managers must estimate how many customers will fail to pay, how long equipment will last, how much a legal claim will cost, what an asset could be sold for or how much inventory is worth.

For example, a company estimates that 3% of its 2 million of receivables will not be collected and records an allowance for doubtful accounts of 60,000. That figure is an accounting estimate.

Estimates are based on past experience, current information and reasonable expectations about the future. They are reviewed at each reporting date. When new information shows an estimate needs changing, the change is applied from that point forwards, affecting the current and future periods, rather than restating earlier years.

This differs from a change in accounting policy, which is a change in the method used and is usually applied to earlier periods too.

Because estimates involve judgment, they create room for error and, potentially, manipulation. Auditors pay close attention to significant estimates, and companies disclose the key assumptions behind them in their notes.

For worked examples and full lessons, visit notesbysara.org.