An accounting estimate is a monetary amount for which the measurement of value is subject to estimation uncertainty, all in line with the requirements of an applicable financial reporting framework. It is also defined as a technique to measure such items on financial statements that have no accurate quantification and are therefore figured out based on judgment and knowledge derived from experience and past performance. Estimation uncertainty, per se, is the susceptibility to an inherent lack of precision in measurement. Typically, it is used for an amount measured at fair value where there is an inherent lack of precision in measurement, and also for other amounts for which an estimate is required due to lack of accurate or observable inputs.

The value of such items cannot be always determined or reached at based on any particular data or observations. The process of estimation usually involves a lot of uncertainties and hence a certain degree of expertise, skill and experience is required to determine the value of such elements, which, after all, will always be an approximation.

Estimates, routine or non-routine, about transactions and events are also necessary for maintaining proper details in the books of accounts for future reference and use. Therefore, even though uncertainties and values must be estimated using historical data and approximations, all such estimates should also be a part of financial reporting. A well-established estimation provides for transparent and reliable financial statements, and vice versa.

Accounting estimates vary greatly in nature and are required to be made by an entity’s management when the monetary amounts cannot be directly observed from available data or conditions. The process of making accounting estimates involves selecting and applying a specific method that would be based on a set of assumptions and data, requiring the application of management’s judgment.

Estimation uncertainty

The estimation used for measurement of such monetary amounts is subject to the so-called estimation uncertainty, corresponding to inherent limitations in management’s judgment or data. These limitations lead to inherent subjectivity and variation in the measurement outcomes. Applying management’s judgment adds to complexity and subjectivity of the process of estimation, and the effects of such factors and other inherent risk factors on the measurement of monetary amounts would increase their susceptibility to misstatement.

Inherent uncertainty arise from differences in valuation, measurement or the method applied in the recognition process of financial statement items such as assets, liabilities, revenue and expenses.

Examples of accounting estimates

Examples of accounting estimates may include items such as:

• valuation of financial instruments.
• valuation of property or infrastructure assets.
• stock and trade debtor provisions.
• depreciation, amortization or impairment of assets.
• provision for expected credit losses (ECLs).
• fair values of assets and liabilities acquired in a business combination, including the determination of goodwill and intangible assets.
• exchange of assets or liabilities without monetary consideration.
• revenue recognition, e.g. in long-term contracts.
• employee retirement benefits liabilities.
• share-based payments.
• deferred tax.
• outcome of pending litigation, claims or warranty provisions.
• other types of contingent liabilities.