Estimates on the Books

Generally speaking, bookkeeping involves mostly precise amounts from sale and purchase invoices, cash receipts and disbursements, among others.  There are however, various situations in which estimates need to be used, and other situations in which they cannot be avoided.  Consider for example depreciation on capital assets.  Does anyone really know exactly how much the value of a particular asset has declined in a given year, and if you could figure it out, would the exact number be different enough from your estimate as to make the time and trouble to figure it out worth it?  Most likely, no.
Other common and important estimates include the allowance for uncollectable receivables, percentage of completion of long-term contracts, liabilities for vacation time, income tax accruals and deferred taxes.  All of these items must be estimated since very few times, if ever, do the actual amounts present themselves until long after your financial statements have been needed by a banker for a loan or perhaps a bonding agent.
Since estimates play such a large role in a company’s financial statements, it is important that an estimate is used when necessary, rather than opting for including nothing at all.  There are various standard calculations for developing estimates, depending on the subject matter.  Going back to the depreciation example, most often depreciation is calculated by assigning a life to each asset, such as 10 years, and then depreciating the assets evenly over a ten year period until it is fully depreciated.
Just remember, when you book an estimate, it is just that, an estimate.  There is no requirement that it turn out to be exactly correct, only that it is reasonable.
/posted by Kenny Keener, CPA