Navigating accounting estimates

September 15, 2025

Estimates are used to account for uncertainties in financial statements to ensure that they fairly reflect a company’s financial position and performance. Accounting estimates require management to make educated judgments about the amount, timing, and likelihood of future events or conditions that can affect financial outcomes. Complex items may require external specialists to help management develop reliable, objective estimates. This article explains the role that accounting estimates play in financial reporting, the estimation process and ways auditors evaluate estimates.

Common types of estimates

Estimates are woven into various aspects of financial reporting and can be based on both subjective and objective data. Examples of accounting estimates include:

Fair value measurements are another common type of accounting estimate. Items that may be reported at fair value include share-based payments, acquired goodwill, intangible assets and asset impairments.

In-house estimation process

When making accounting estimates, management should consider the following factors:

Historical data. Analyzing the company’s past performance helps predict future trends and potential issues. And evaluating past estimates against actual outcomes can pinpoint problems in the estimation process that, if remedied, can lead to better estimates going forward.

Current conditions. External influences — such as market trends, regulatory changes and technological advancements — can affect accounting estimates.

Expert opinions. Estimating might involve consultations with various types of specialists, such as actuaries for pension liabilities, engineers for asset valuations and business valuation professionals for goodwill impairment.

In addition, management may need to review and adjust estimates as more information becomes available. Ongoing evaluation helps in maintaining the accuracy of financial statements and reflects changes in circumstances.

Transparency and consistency are essential to this process. The methods and assumptions used in making estimates should be clearly disclosed. And they should be consistent over time. Any changes in estimation techniques should be well-justified and disclosed in the financial statement footnotes.

Auditing process

External auditors pay close attention to accounting estimates during audit fieldwork. They review the methods and models used to create estimates, along with supporting documentation, to ensure they’re appropriate for the specific accounting requirements. In addition, auditors examine the company’s internal controls over the estimation process to ensure they’re robust and designed to prevent errors or manipulation.

When testing inputs, auditors assess the accuracy, reliability and relevance of the data used and perform independent recalculations. They often apply different assumptions or methods or conduct a “sensitivity analysis” to see if management’s estimate is reasonable. A sensitivity analysis shows how changes in key assumptions affect an estimate, helping to evaluate the risk of material misstatement.

In addition, auditors watch for signs of management bias, such as overly optimistic or conservative assumptions that could distort the financial statements. They also consider the objectivity of those involved in the estimation process, ensuring there’s no undue influence or pressure that could affect the estimate’s outcome.

As fieldwork wraps up, auditors evaluate events that happen after the balance sheet date but before the audit report is issued. Subsequent events may provide additional evidence about the reasonableness of accounting estimates. Over time, uncertainties that existed at the end of the reporting period may become clearer with hindsight.

Importance of external audits

Accounting estimates are often based on complex, subjective analyses. In today’s uncertain markets, accounting estimates may not always be accurate, potentially leading to financial statement revisions. Additionally, there’s a risk of bias or manipulation, where estimates might be adjusted to meet financial targets or expectations. External audits play a crucial role in assessing the reasonableness of management’s estimates based on the data that’s currently available.