Accounting estimate is an approximation of the amount to be debited or credited on items for which no precise means of measurement are available. They are based on specialized knowledge and judgment derived from experience and training. They are used in the financial statements to determine the carrying amounts of assets and liabilities and the associated income or expense for the period where such amounts cannot be measured with precision and certainty.
Examples of accounting estimates include:
- Useful life of non-current assets
- Impairment of non-current assets
- Bad debts
- Provision for obsolete and slow-moving stock
- Revalued amounts of non-current assets
- Provision for pension benefits
Accounting estimates involve judgment regarding expected future benefits and obligations pertaining to the assets and liabilities (and the income and expense pertaining to such assets and liabilities). They are based on the information that best reflects the circumstances prevailing at the date of estimation. Since they are very subjective in nature, they might need revisions and re-estimation. They should be revised when changes occurs in the conditions and circumstances that were prevalent when the estimates were formed.
International Accounting Standard 8 (IAS 8) Accounting Policies, Changes in Accounting Estimates and Errors provides guidelines about handling changes in the accounting estimates. According to IAS 8:
The effect of a change in an accounting estimate shall be recognized prospectively by including it in profit or loss in:
- the period of the change, if the change affects that period only, or
- the period of the change and future periods, if the change affects both.
However, to the extent that a change in an accounting estimate gives rise to changes in assets and liabilities, or relates to an item of equity, it is recognized by adjusting the carrying amount of the related asset, liability, or equity item in the period of the change.
The change in accounting estimated affects only the current period in which the change is made and the future periods. Previous periods will not be affected by the changes in accounting estimates. Previous periods are affected only if correction of errors is required which is a separate case. The effects of changes in accounting estimates will take affect the financial statements prospectively, not retrospectively.