Accounting Estimate is the approximate amount that the accountant records into the financial statement when the exact amount is not available. It can be recorded into the debit or credit side of any particular account. An accounting estimate is made based on the management judgment with the supporting technical team, history data, and experience.
We will be able to see the accounting estimate in the balance sheet when it is used to evaluate the amount carry forward of asset and liability. It also part of the income statement when the revenue or expense cannot be measure with precision and certainty.
Accounting Estimate Example
- Fixed Asset Useful life: In order to calculate the fixed asset depreciation per month, we need to set its useful life. The useful life should be closely related to the actual usage and consistent from one accounting period to another.
- Fixed Asset Impairment: The impairment happens fixed asset fair value drop below the book value in balance sheet. Fair value is the accounting estimate where management compares similar asset in the market to receive the quoted price.
- Fixed Asset Revaluation: similar to impairment, it requires the company to estimate the market price of the asset and compare it to the record on balance sheet.
- Bad Debt Expense: Management estimates the amount of bad debt before it actually happens.
- Provision for Inventory: Inventory in warehouse may be broken and expired due to the slow-moving, it will become the company’s expense. Management will provide provision base on their estimate to accrue expenses on a monthly basis.
- Warranty Claim: We do not know how many products will be broken and claim warranty, so to record the expenses we need to estimate using past data and other indicators.
Change in Accounting Estimate
Accounting Estimate is the result of management judgment base on available information at that time. Subsequently, they may receive more information which leads to revision. To correct the previous error, we need to make changes in our accounting estimate.
Accounting estimate needs to change when:
- It impacts the carrying amount of existing assets or liabilities on the balance sheet.
- It impacts future assets or liabilities.
Accounting estimate is easy to make but it is challenging when the variance is too big compare to the actual. It requires experience, knowledge technical support to make proper judgment otherwise it will impact the whole financial statement.
Accounting estimate is also subject to be manipulated by the management to window-dressing the financial statement. Auditors will pay attention to the accounts where management has made accounting estimates. It will require more experience auditors to review and conclude on those accounts.