Accounting Estimation and Auditing
The nature of estimation in financial accounting is often underestimated. Accounting estimates are often more freeform than static entries and can pose a problem of accuracy, creating a realm of uncertainty. An estimation is an approximation of the expense or revenue consequence of transactions expected in the near future. Estimations are different then the more concrete entries of the past which accountants traditionally would use to provide certainty. Estimation puts the weight of a company’s decision-making on the accountant’s shoulder and can put them into a position of accounting for the future.
When applied to financial statements, such estimates are in the form of accruals. Accruals are accounts in a businesss financial statements that operate as a place holder for future transactions that have not yet been recorded or paid. An accrual includes a series of invoices, payments or debts that have been made, but which have not been finalized. It is accounted for as expenses or revenues which have not yet been realized or paid for.
Thus, estimations are used to account for future expected expenses or revenues in anticipation of their occurrence. They represent an understanding of the circumstances surrounding a future event, and the potential outcome of that event. Estimations may include values such as forecasted sales, product delivery costs, labors, shipments and any other type of expected expenditure or income associated with a particular transaction or series of transactions.
The use of estimations in accounting can have consequences if not handled properly. A wrong or incomplete estimation can skew the financial statements and give an inaccurate picture of the company’s financial health. To properly account for estimations, a company needs to have in place a system of checks and balances to ensure that accurate information is being used and that estimate calculations are correct. The need for such a system is amplified when a company chooses to bring in an auditor.
Auditing is the evaluation of the accounts and information in a company to ensure the accuracy of its financial statements. An auditor can assist an organization in imposing an orderly system of accounting procedures and ensuring that the information being reported is true, accurate, and timely.
An auditor will review the company’s accounting and financial information, considering the company’s financial recording and reporting practices, observing and inspecting documents and other evidence, questioning management representatives and other parties, and performing tests of the accuracy of data and processes. The auditor will then provide an opinion about the fairness of the company’s financial reporting and the accuracy of the financial statements.
Estimation and auditing work together to create a comprehensive view of a company’s finances. Estimation provides the ability to plan for the future, while auditing provides the assurance that the numbers reported are based on fact. Estimation and auditing are necessary components of a good accounting system, as it helps to ensure the accuracy and integrity of financial records.
