Financial statements are the backbone of a company's financial health, providing crucial information to investors, creditors, and other stakeholders. One of the key aspects of preparing financial statements is the use of estimates, which can significantly impact various areas such as deferred tax, revenue, and more. In this blog, we will explore the importance of estimates in financial statements and discuss some of the areas that could be affected by them.

Going Concern

The going concern assumption is a fundamental principle in financial reporting, which assumes that a company will continue its operations in the foreseeable future. Although going concern may not seem like an estimate, it is based on estimated future cash flows and financial performance. Accountants must carefully consider these estimates when determining whether the going concern assumption is appropriate for a particular client.

Deferred Tax Assets

Deferred tax assets are another thing that you need to consider future cash flows. One of the recognition requirements in FRS 102 for deferred tax is that the entity must be reasonably certain that there will be future taxable profits against which the assessed losses can be offset. As these profits will only be incurred in the future the estimated future cash flows are relied upon.

Provision of Inventory Obsolescence

We also need to think about provisions for inventory obsolescence. Do we need to provide for a level of obsolescence of our inventory? This depends on the type of inventory. Something like a grocery store would always have a provision for inventory obsolescence because they're never going to sell all of their goods within the sell-by dates. Another company, for example, a construction company, may not need a provision for inventory objections because they're only building houses or office blocks that they've been contractually obliged to build.

Recognition of Intangible Assets

Recognition of intangible assets, particularly internally generated ones, also require estimates. Accountants need to determine whether there will be future economic benefits from these assets, which involves estimating future cash flows. This can be challenging, as the value of intangible assets is often uncertain and subject to change.

Accounting Policies

It is imperative to make sure you've got accounting policies in place and that they are applied where there are estimates that you are disclosing things like depreciation rates and provision for bad debts in your debtor's policy. You should have accounting policies for every line item that's relevant to a particular client.

Significant Judgements and Estimates Disclosure

This note disclosure is not required for section 1A companies, but it is required under FRS102. There are a lot of small companies out there that are doing weird and wonderful things and they have significant estimates in those. So, if you are involved with any of those type of companies where they are doing something unusual and they are doing something where there is a significant estimate, even though that note is not strictly acquired, it probably is relevant for giving a true and fair view and in that case, it is required.

Disclosure in the Notes Relating to Uncertainty

Ensure that, where relevant, you are meeting all of the disclosure requirements around things like uncertainty so you know where you are recognising a provision. For example, have a look at the requirements in FRS 102 for recognising that provision and make sure you are meeting those disclosure requirements.

Conclusion

Estimates play a vital role in the preparation of financial statements, impacting various areas such as deferred tax, revenue recognition, going concern, and intangible assets. Accountants must exercise professional judgment and carefully consider the company's specific circumstances when making these estimates. By doing so, they can help ensure that financial statements provide a true and fair view of the company's financial position and performance, ultimately benefiting all stakeholders involved.

If you require assistance or advice in relation to any of the above matters, please contact our team on 053 91 000 00 or email [email protected].

The contents of this article are meant as a guide only and are not a substitute for professional advice. The authors accept no responsibility for any action taken, or refrained from, as a result of the material contained in this document. Specific advice should be obtained before acting or refraining from acting, in connection with the matters dealt with in this article.