Assumptions are not just a throw-away

The term ‘assumption’ figures prominently in some accounting standards, but can give the wrong impression.

Where accounting standards refer to ‘assumptions’

The term appears in contexts where a preparer needs to make an accounting estimate. IAS defines accounting estimates as ‘monetary amounts in financial statements that are subject to measurement uncertainty’.

Some IFRS standards use the term ‘assumption’ for some inputs into an accounting estimate: typically, those inputs that are based at least partly on subjective judgments, rather than purely on observable and indisputable facts.  

Even when they are partly subjective, those inputs need to result from a best effort to make an accounting estimate that is consistent with the measurement basis being used. The person preparing the input (and senior management endorsing it) needs to take full responsibility for (and ownership of) both:

  • that input; and
  • the overall accounting estimate that results from it.

The word ‘assumptions’

To my mind, the word ‘assumptions’ sounds too weak to convey that idea clearly. Some people could easily misinterpret that word as implying that they don’t need to make a genuine attempt to make a real estimate. They might feel, incorrectly, that:

  • the input is just a working hypothesis that they don’t need to take seriously.
  • they just can walk away from responsibility for the input if it turns out to be inconvenient or unsuitable.
  • disclosing the input in the financial statements reduces or eliminates their responsibility for arriving at the input that is most appropriate in the circumstances.

At least IAS 19 does define actuarial assumptions as an entity’s ‘best estimates of the variables that will determine the ultimate cost of providing post employment benefits’ (paragraph 76). It also states explicitly that an entity ‘shall determine its mortality assumptions by reference to its best estimate of the mortality of plan members both during and after employment’ (paragraph 81). [emphasis added]

But ‘assumption’ may not be the best word—in IAS 19 or in other standards—to convey concisely that need for the estimate to be the best estimate. And people may not always remember that need when they see the word ‘assumption’ outside the full context of all IFRS Standards.

Could the IASB have used a different term?

In projects I worked on, I tried— without success—to replace ‘assumption’ with ‘estimate’:

  • for the 1998 version of IAS 19 Employee Benefits, the phrase ‘actuarial assumption’ was too entrenched.
  • for IFRS 13 Fair Value Measurement , the term ‘assumption’ was too entrenched.
  • the scope of the 2021 amendment to IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors even introduced a new reference to assumptions. That new reference confirms that ‘assumptions’ made in applying IFRS 13 are some of the inputs used in developing an accounting estimate of fair value.

I understand why IASC kept ‘actuarial assumptions’ in IAS 19 and why the IASB used ‘assumptions’ in IFRS 13. Those decisions were reasonable at the time.

But the word ‘assumption’ runs the risk that preparers may read it in isolation, outside of its full context. If they read it that way, they may come up with estimates that are just convenient (or easy to make) but not defensible as a genuine attempt to come up with their best estimate.

Conclusion

There is probably no reason now for the IASB to replace the term ‘assumption’ in IFRS Standards with ‘estimate’ or some other more suitable term.

Nevertheless, preparers and auditors need to remember that in IFRS Standards ‘assumptions’ mean estimates that preparers can stand behind because they have made a genuine attempt to make a measurement on the basis required in that instance.

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