Professional judgment

Professional judgment connects an accounting requirement to the company's facts. Correct arithmetic is necessary, but it cannot decide which records belong in a calculation or whether an assumption is supported by evidence.

For example, Alder Instruments manufactures sensors and promises to repair qualifying defects under a warranty. Assume it must record an estimated warranty liability. Its accountant can calculate an estimate using last year's repair rate, but first needs to consider whether product defects, repair costs, or warranty terms have changed. Ignoring a known defect would not become acceptable merely because the calculation uses a familiar formula.

The mistaken idea is that judgment permits management to choose whichever estimate produces the desired income. The correction is that the estimate must follow the applicable requirements and use appropriate evidence. A range of possible outcomes does not make every chosen amount equally supportable.

What should the accountant document?

A review of Alder's estimate should establish:

• Which obligation and reporting date the estimate concerns.
• Which accounting requirements apply.
• Which records support the assumptions and which evidence contradicts them.
• Which reasonable alternatives were considered and why one was selected.
• Whether pressure to report higher income affected the decision.
• Which uncertainties remain and what new evidence could change the estimate.

Documentation lets another person follow the reasoning; it does not correct missing facts or an inappropriate method. Later repair costs can differ from a properly developed estimate. That difference alone does not prove that the original judgment was wrong.