Question

The Balance Sheet has accounts where the accountant must make estimates. Some situations in which estimates affect amounts reported in the balance sheet include:

Allowance for doubtful accounts.

Depreciable lives and estimated salvage values for plant and equipment.

Warranty returns.

Determining the amount of revenues that should be recorded as unearned.

select one of the four areas above and give a summary of how the estimate can impact the usefulness of the balance sheet.

Answer 1

Depreciable lives and estimated salvage values for plant and equipment.

Salvage value or Scrap Value is the value of an asset after its useful life is over. When a company purchases an asset, first, it calculates the salvage value of the asset. Thereafter this value is deducted from the total cost of the assets and then the depreciation is charged on the remaining amount. If it’s very difficult to calculate this value, the normal practice is to depreciate the asset on the total cost, considering its value as nil. There is one issue with this concept. Since this value is deducted before depreciation is charged, people can use it in a fraudulent way. They can deduct more salvage value and as a result, the amount of depreciation would be reduced. And that means the profit of the company will increase too.

Useful life is “an estimate of the average number of years an asset is considered useable before its value is fully depreciated. According to GASB 34, to estimate useful life, “governments can use (a) general guidelines obtained from professional or industry organizations, (b) information for comparable assets of other governments, or (c) internal information.” If not strictly following guidelines obtained from an organization, you may find it helpful to consider an assets current condition, the quality of the asset, or how the asset will be used when estimating its useful life. Regardless, we recommend that all organizations have guidelines in place for how they plan to estimate the useful life

summary of how the estimate can impact the usefulness of the balance sheet.

Making accounting estimates is a very complex process that connotes obtaining of all required information about the topic, understanding different accounting estimates’ alternatives resulting from accounting standards and national laws, recognizing the consequences of such alternatives and identifying the need of judgment’s reassessment in the future. Accounting estimates can be observed from different party’s point of view. First of all, standard-setters think on accounting estimates when developing accounting standards. an estimate can provide relevant information, even if the estimate is subject to a high level of measurement uncertainty. Nevertheless, if measurement uncertainty is high, an estimated is less relevant than it would be if it were subject to low measurement uncertainty. Measurement uncertainty arises when a measure for an asset or a liability cannot be observed directly and must instead be estimated.

The Interpretations Committee has acknowledged that even distinguishing a change in accounting policy from a change in accounting estimate can require judgment and may be challenging (IFRS, 2014). IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors describes a change in an accounting estimate as ‘’an adjustment of the carrying amount of an asset or a liability, or the amount of the periodic consumption of an asset, that results from the assessment of the present status of, and expected future benefits and obligations associated with, assets and liabilities’’. Management should take into consideration new information when making changes in accounting estimates. On the other hand, ‘’accounting policies are the specific principles, bases, conventions, rules, and practices applied by an entity in preparing and presenting financial statements’’. Therefore, during the determination and implementation of accounting policies the judgment is required for making the choice of a certain policy. Supplementary, International Accounting Standard 1 Presentation of Financial Statements requires entities to disclose the summary of the judgments apart from accounting policies and other significant notes. This summary should be presented ‘’apart from those involving estimations, that management has made in the process of applying the entity’s accounting policies and that have the most significant effect on the amounts recognized in the financial statements’’

Empirical analysis of accounting estimates' influence on financial statements

IAS 38 Intangible Assets determines the accounting treatment of intangible assets and IAS 16 Property, Plant and Equipment the principles of accounting evidence of property, plant, and equipment. Both standards are related to IAS 36 Impairment of Assets which offers an additional setting for these assets. The most significant areas of accounting estimates within the scope of IAS 38 and IAS 16 can be divided into two broad categories: classification estimates and estimates related to the measurement of the cost of assets. The most common recognition and classification estimates of intangible and tangible assets are (International Financial Reporting Standards Foundation, 2015): x assessment of whether an entity controls intangible or tangible resources, x differentiation research from development phase and their related costs, x grouping of assets of a similar nature and x distinguishing investment property from property which will be used for ordinary business operation and from property held for sale in the ordinary course of business. Further, an entity can have significant estimates related to the measurement of the cost of an asset, such as x estimating the useful life, x estimating the residual value, x measuring the fair value or x differentiation upgrade from cost. Estimates of the value of intangibles have increasing certain industries, such as human capital intensive, high technology and innovative companies (OECD, 2015). Although in practice, many entities apply the conservative approach to research and development expenditures, Nixon (1997), stresses that the substantive evidence of R&D productivity at the firm level and the views of its empirical survey on the ex-post benefits of R&D strongly suggest that many development projects still meet the criteria for capitalization.