It’s not uncommon for management to use accounting estimates for certain items on the balance sheet. However, current means of accounting for uncertainty may not cut it during an audit in today’s environment of unprecedented risk, including geopolitical influences, tax and regulatory reform, and cyber threats.
Accounting for uncertainty
Some financial statement items are relatively cut-and-dried. But others can’t be measured precisely and, instead, are based on what management expects to happen in the future.
Examples of accounting estimates include:
- Allowance for doubtful accounts
- Work-in-progress inventory
- Warranty obligations
- Depreciation method or asset useful life
- Recoverability provision against the carrying amount of investments
- Fair value of goodwill and other intangibles
- Long-term contracts
- Uncertain tax positions
- Costs arising out of litigation settlements and judgments
Accounting estimates may be based on subjective or objective information (or both) and involve a level of measurement uncertainty. Each accounting estimate is subject to its own level of uncertainty — and highly uncertain outcomes can lead to unintentional errors or, worse, intentional misstatement.
Use of specialists
Some estimates are easily determinable and may be made by in-house personnel with a fair degree of accuracy. This is especially true for estimates that can be made based on objective inputs (like published interest rates or percentages observed in previous reporting periods).
Other estimates are inherently subjective or complex — and may be derived from speculative inputs. Examples include share-based payments, goodwill and impairment write-offs. Managers are champions of the company’s products and strategies and, therefore, may have unrealistic expectations. To avoid painting a rosier picture than reality, companies often use outside specialists, such as business appraisers or actuaries, to independently estimate complex items.
Ready for audit season?
Audit season is right around the corner for calendar-year-end businesses. In light of today’s volatile marketplace, expect auditors to give renewed attention to your accounting estimates. For example, they may ask more in-depth questions or perform additional testing procedures. You can facilitate audit fieldwork and minimize audit adjustments by identifying accounts that are based on management’s estimates and reviewing the procedures used to make the estimates.
Based on the current level of volatility, some adjustments may need to be made to measurement techniques you’ve used in the past. If you have questions about how marketplace uncertainty could affect your estimates, JLK Rosenberger can help you get a timely, accurate assessment of financial performance before the start of audit season. For more information, call us at 949-860-9902 or click here to contact us.