The effect of estimates in financial statements
Raubenheimer, Elizabeth Johanna
MetadataShow full item record
The International Financial Reporting Standards (IFRSs) requires a number of accounting estimates for the preparation of financial statements. The purpose of this study is to establish the effect of estimates in financial statements. The possible increases in required accounting estimates in the IFRSs are examined by comparing the IFRSs of 2003 to 2006. With this comparison it is established that the requirements of the IFRSs for fair value accounting is mainly responsible for the increases in allowed accounting estimates. The IFRSs of 2006 is examined to establish the frequency of use of estimates in financial statements. In order to get a better picture of the frequency of use of accounting estimates in financial statements, a list of allowed accounting estimates for each of the components on the Balance Sheet (also referred to as the “statement of financial position”) has been compiled. It is concluded that the components on the balance sheet are to a significant extent influenced by accounting estimates. The literature on earnings management and creative accounting are examined to determine if there is any risk that accounting estimates could be used to manipulate financial statements. This gives an indication of the reliability of accounting estimates within financial statements. It is concluded that the difference between fair presentation and creative accounting seems to be the intention of management which is difficult to assess. The “corporate reporting supply chain” has some responsibilities to prevent and detect creative accounting practices and fraud. These responsibilities can limit the risk that accounting estimates may be used in creative accounting and financial statement fraud. In the wake of some financial disasters, these checks and balances should restore public trust in financial reporting. An empirical study is performed on five companies that form part of the Construction and Materials sector of the JSE to establish the effect of estimates on their financial statements. The study indicated that: • the average percentages of assets, including cash and cash equivalents, of the five companies affected by accounting estimates are 60% for 2004, 60% for 2005 and 59% for 2006. If cash and cash equivalents are excluded from the calculation of assets affected by accounting estimates, the average percentages are 72% for 2004, 77% for 2005 and 76% for 2006; • there is an increase in the number of “estimate” hits from 2004 to 2006 in the financial statements of the five companies in the empirical group; and • the disclosure provided on key sources of estimation uncertainty is however, limited. A number of recommendations are made to limit the risk that accounting estimates could be used for creative accounting purposes. The negative effect of the use of accounting estimates in financial statements is a loss of reliability. The positive effect of the use of accounting estimates in financial statements is that of relevance.