Changes in accounting estimate in Buisness

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A change in accounting estimate is 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.

Changes in accounting estimates result from new information or new developments and, accordingly, are not corrections of errors.

A change in accounting estimate may be needed if changes occur in the circumstances on which the estimate was based, or if new information becomes available.

A change in estimate is not the result of discovering an error in the way an item has been accounted for in the past and it is not a correction of an error.

IAS 8 requires a change in an accounting policy to be accounted for retrospectively whereas a change in an accounting estimate is normally recognised from the current period.

The effect of a change in accounting estimate should be recognised prospectively, by including it:  in profit or loss for the period in which the change is made, if the change affects that period only; or  in profit or loss for the period of change and future periods,

if the change affects both. To the extent that a change in estimate results in a change in assets and liabilities, it should be recognised by adjusting the carrying amount of the affected assets or liabilities in the period of change

 

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Earnings management techniques include deferring or accelerating expense or revenue transactions, or using other methods designed to influence short-term earnings.

Aggressive earnings management results in stakeholders being misled to some extent about an entity's performance and profitability. At the extreme, aggressive earnings management can involve acts that may constitute a criminal offence.

Commercial pressures The strength of a regulatory framework may be undermined by commercial pressures on those responsible for preparing financial statements.

Examples of these commercial pressures are:  Adverse market reactions to the share price of a listed entity when results fail to meet the market's expectations (which directors and management may have encouraged), whether or not the expectations were reasonable;

 Directors and management's incomes being highly geared to results and/or heavily supplemented by stock options;

 

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The importance of meeting targets to ensure protection of the jobs of directors, management and other employees;  The desire to understate profits to reduce taxation liabilities;  Legal and regulatory requirements to meet specific financial thresholds or ratios; and  The need to ensure compliance with loan covenants or to pacify bankers.

Creative accountants do not always work to increase profit.

Sometimes they want to decrease the current year profit. The reason for this is that it might allow them to increase profits in the future. For example, if an asset is written off this year but used in the future there will be no future expense to set against the future revenue. Similarly, if a liability were to be set up this year it would reduce profit.

If the liability was found to be unnecessary in the future it could be reversed back to the statement of profit or loss.