Concept of estimation uncertainty

In the context of accounting estimates, estimation uncertainty refers to the susceptibility of the estimate and related exposures 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.

An accounting estimate refers to an approximation of a monetary amount in the absence of a precise tools of measurement. This principally applies to an amount measured at fair value involving a degree of estimation uncertainty, as well as for other amounts that require estimation. The nature and reliability of information available to an entity’s management to support its accounting estimates vary extensively, which thereby affects the degree of estimation uncertainty associated with accounting estimates. In turn, the degree of estimation uncertainty affects the risks of material misstatement of accounting estimates, including their susceptibility to unintentional or intentional management bias. Management bias represents the lack of neutrality by management in the preparation of financial information.

Examples

Some accounting estimates involve relatively low estimation uncertainty and may give rise to lower or limited risks of material misstatements in the financial statements of an entity. Examples of such accounting estimates include the following:

• accounting estimates coming up in entities that carry out simple business activities (activities that are not complex by nature such as grocery supplying).
• accounting estimates that are frequently made and updated due to their connection to routine transactions.
• accounting estimates that are extracted from readily available (observable) data such as published interest rate data or exchange-traded prices of securities.
• fair value accounting estimates arising from a simple method of measurement prescribed by the applicable financial reporting framework. Such a method can be easily applied to the asset or liability measurable at fair value.
• fair value accounting estimates arising from an established and generally accepted business model for measuring the estimated values. The model’s assumptions or inputs shall be observable.