Definition: An estimated liability is a debt or obligation of an unknown amount that can be reasonably estimated. In other words, it’s a known liability that management knows exists, but there is no way of knowing the exact amount of the liability. Management can however estimate with reasonably accuracy the total outstanding obligation.
What Does Estimated Liability Mean?
Does this sound confusing? How can a company owe a debt and not know how much they owe? Well, it is actually a pretty common practice. Most employee guaranteed benefit programs are impossible to measure. Take pension and retirement plan for example. These obligations are based many different things like the number of employees, employee retirement rates, employee compensation, vesting rules, etc. It would be impossible to calculate exactly how much the company will be on the hook for with all of these conditions.
Using actuaries, management can reasonably determine an estimate of the outstanding liability and fund the pension plan accordingly.
Retirement plans are not the only liability that must be estimated. Employee healthcare and product warranty programs work the same way as pension funds. When a manufacturer offers a warranty on any of its products, it has no way of knowing how many customers will need to return their purchases or how much it will cost to fix the defective products. Again, statistics is used to reasonably estimate a defect percentage and the estimated liability is then reported in the financial statements.
Another great example is property taxes. Although these taxes are a little easier to estimate than pension fund obligations, there is no guarantee that current rates will continue to stay the same in the future. The assessed property value could be changed or the local government could raise or lower the mill rate. Property taxes must be estimated in the same way that benefits plans are.