Estimating

An estimate, as it relates to the creation of financial statements, is a calculation of a financial transaction for which no exact value is determinable, and is based upon judgment, historical understanding, and experience.

Accountants use estimates when it’s not possible to calculate an exact figure supporting a financial transaction, but it is known that a future transaction will occur and it’s reasonably estimated. Typically, accountants will apply a consistent methodology between the different account periods. This methodology may rely on estimates for the basis of the financial statement transaction.

The use of estimates may be required for a vast number of reasons. Typically, they are ultimately required when information to support an exact figure is not available, or the issue generating the transaction is not complete, and therefore may be pending at the time of a financial statement close.

Accountants will use all information available, including historical trends, past experience, and judgment to estimate the true value of a financial transaction. Depending on the value of the transaction and its impact on the financial statements taken as a whole, additional disclosures may be required.

Disclosures outline how the estimate was derived and the risks associated with the true transaction value differing from the estimate. In some instances, subsequent differences between the actual amount of the financial transaction, and the estimate, may require subsequent adjustments to the financial statements.

As discussed previously, once you have forecasted the main element of sales, everything else from your projections follows from this. The following items form an important part of your projections:

• Capital spending
• Employee costs
• Non-employee costs
• Other income and costs

Projecting Capital Spending

Projecting capital spending involves determining what property, vehicles or equipment will be needed to support the sales forecasts.

The following steps should be followed when projecting capital spend:

1. Ask yourself what assets you are going to need.
2. Estimate their expected cost as well as any payment terms.
3. Estimate their useful life spans, residual values and any other costs or benefits.
4. Determine the method of depreciation that you should use.
5. Draw up a depreciation schedule.
6. Set the cost of the acquisitions against your bank balance (offset by an increase in fixed assets).
7. Record depreciation as an expense.
8. Record any other possible expenses, such as maintenance costs or insurance.
9. Take note of any benefits that the assets would have that might impact other aspects of your projections (for example, better machinery might equate to higher levels of production).

Before we go any further, let us look at the two calculations you need when you project capital spending, i.e. interest calculation and depreciation: Interest calculation is explained in detail in Learning Unit 6.

Click here to view a video that explains the four items required for projections.