INVESTORS may treat a company's financial statements as the truth, but a new study shows that most asset values listed in them rely on estimation, which may have a significant impact on the bottom line if the estimates are off the mark.
About 82 per cent of the asset values in the balance sheets of Singapore-listed firms are based on estimates and these must be re-calculated in the next financial year, according to KPMG's study of 200 firms listed on the Singapore Exchange released yesterday.
And a 1 per cent change in the total asset value of the firm can result in a change in net profit by as much as 38 per cent, according to the accounting and professional services giant.
Much of the estimation involves trying to update a firm's asset values from year to year. By contrast, only 10 per cent of its liabilities are based on estimates - most of the liabilities are carried "at cost" in the books, without yearly adjustments.
A company's assets include its property, plant and equipment. Estimates by its management may be needed to assess the assets' useful lives and residual values. As for the investment properties in its books, the firm could be engaging external experts to estimate the value of these properties from year to year.
Auditors have for some time known that many of the asset value figures have to be derived via estimates - and the KPMG study quantifies the extent of this.
"Estimates are by their very nature subjective," said Mr Ong Pang Thye, head of audit at KPMG in Singapore. "They are underpinned by the nature and reliability of the information used to form these accounting estimates, which can vary widely."
The study showed that a significant proportion of total asset values in financial statements is based on judgment calls. As such, they are susceptible to bias, errors and mis-statement.
To complicate matters, methods and assumptions used to derive the estimates may also change each year. This could mean that asset values across a number of financial years may not be comparable, Mr Ong said.
KPMG suggested that firms' managers and audit committees should have strict internal frameworks to detect potential errors in estimation, and should continually assess and challenge estimates.
"It is also important to ensure that auditors spend sufficient time and effort, and have the necessary specialist knowledge, to challenge any estimates made by management," said the report.