Accounting estimate

What it means

An accounting estimate is a judgement a company makes where the exact amount cannot be established when the accounts are prepared. Estimates determine, for example, the amount of provisions, allowances for receivables and inventory, accruals and the useful lives of assets for depreciation.

Estimates are a natural part of accounting and the law permits them if they rest on available information, experience and reasonable judgement. They must follow the prudence principle, meaning uncertain income is not recognised and known risks are taken into account.

A change in an estimate is not an error. If an estimate proves inaccurate, the difference is recorded in the period when this becomes known, and past accounts are not changed. Correcting an error is a different situation, dealt with under the rules for prior-period corrections.

How it works in practice

When preparing the financial statements we go through the areas involving estimates with the client: unbilled supplies, untaken leave and bonuses, lawsuits, obsolete stock and doubtful receivables. For each estimate we record the data it is based on.

How estimates are made is set out in the accounting policy, for example allowance percentages by days overdue or depreciation periods for asset groups in the depreciation plan. This ensures that estimates are made the same way every year.

Information that arrives after the reporting date but before the accounts are finalised is used to refine estimates. For example, if a debtor goes bankrupt after the year end, we reflect this in the allowance under the rules on events after the reporting period.

What to watch out for

Estimates are the most common tool for deliberately smoothing results: higher provisions in a good year, released in a weak one. Auditors and banks therefore examine estimates most closely and ask for them to be justified.

The tax treatment of estimates has its own rules. Many provisions and allowances are correct in the accounts but are not tax-deductible, or only partly. These differences must be added back in the tax return and tracked in later years.