Question

From an Accounting perspective, would you think that it would be better to overestimate or underestimate product warranty claims? Please explain.

Answer 1

From an Accounting perspective, would you think that it would be better to overestimate or underestimate product warranty claims? Please explain.

Always accounting estimates are at a high risk area for accountants and auditors as well , since it involves certain degree of uncertainty. Accounting estimates like provisions are also an integral part of the financial statements. This will have an impact on the understanding of the readers of these documents as well.

Here in the question , in case of product warranty claims are provided in the financial statements. as in every estimation ,warranty claims estimation also may lead to underestimate/overestimate. Warranty claims are provisions and thereby liabilities , so future cash outflows are there.

If a provision is overestimated and accounted then  the profits will be higher than actual , so managers may tend to overestimate such provisions to window dressing / showing higher profits and take advantage of that. In some cases for funding from banks , prospective investors , higher profits will be helpful. It may increases the tax liability to governments.

On the other side overstatement of Provisions have a negative effect on profit , it will be helpful in situations where management wants to show that the profits are low , company is going through a bad situation , they may look for buy out by themselves and for claiming subsidies , grants from the governments etc.

The best thing is that accounting estimates should be reasonable and it should be as per Standards on Accounting and GAAP and not estimate numbers with any intentions.