Lesson 8 of 8
The estimates inside
Five judgements from five real filings, each one moving reported profit without moving cash, and the exact note in the 10-K where each is disclosed.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- Every accrual contains a judgement, and each judgement is disclosed in a specific note rather than hidden.
- The largest ones are depreciation lives, credit loss allowances, warranty rates, pension discount rates and deferred tax valuation allowances.
- Each moves reported profit and none moves cash, which is why the cash flow statement is the fastest way to find them.
The previous lesson measured the gap between profit and cash. This one opens it.
Five estimates, from five real filings, each printed in a named note. None of them is wrong, none is evidence of anything, and each one could reasonably have been set differently by a different management team.
Five estimates and where each is disclosed
- 1Depreciationuseful lives and method, in the accounting policies note
- 2Credit lossesthe allowance, in the receivables note
- 3Warrantyclaim rates, in the guarantees note
- 4Pensionsthe discount rate, in the retirement benefits note
- 5Deferred taxthe valuation allowance, in the income taxes note
Depreciation: the life and the method
Caterpillar's fiscal 2025 10-K, filed on 13 February 2026, states in its accounting policies note that it computes depreciation of plant and equipment principally using accelerated methods, and reports consolidated depreciation expense of $2,093 million (Caterpillar Inc. FY2025 10-K, accession 0000018230-26-000008) for 2025, $1,983 million (Caterpillar Inc. FY2025 10-K, accession 0000018230-26-000008) for 2024 and $1,929 million for 2023.
Two choices sit in that sentence. The useful lives, and the decision to use accelerated methods rather than straight line. Most US industrial companies use straight line, which charges less in the early years of an asset's life. Comparing Caterpillar's margins with a straight-line competitor's is comparing two policies as well as two businesses.
Credit losses: how much of what is owed will arrive
Verizon's FY2021 10-K, filed on 11 February 2022, carries an allowance for credit losses of $896 million (Verizon Communications Inc. FY2021 10-K, accession 0000732712-22-000008) against gross accounts receivable of $24,742 million at 31 December 2021, which is 3.6 percent. The same balance sheet shows $1,252 million against $25,169 million a year earlier, which is 5.0 percent.
Between those two dates the company's view of how much of its receivables book would be collected improved by 1.4 percentage points. On a gross balance of roughly $25 billion, a change of that size is worth hundreds of millions of dollars of profit.
Warranty: what share of machines will fail
Caterpillar's product warranty liability was $1,626 million (Caterpillar Inc. FY2025 10-K, accession 0000018230-26-000008) at 31 December 2025, and the filing says the estimate comes from applying historical claim rates to the machines in the field and in dealer inventory, by model and by region, updated monthly.
Its auditor named this the one critical audit matter of the 2025 audit, citing the significant judgement in the estimate and the auditor judgement needed to test it. That is the auditor telling a reader, in the filing, which number was hardest to be sure about.
Pensions: the rate that values a promise
Lockheed Martin's FY2025 10-K, filed on 29 January 2026, discloses a weighted average discount rate for its qualified defined benefit pension plans of 5.375 percent (Lockheed Martin Corporation FY2025 10-K, accession 0001628280-26-004195) for 2025, against 5.625 percent for 2024 and 5.00 percent for 2023.
The obligation those rates discount was $26,735 million (Lockheed Martin Corporation FY2025 10-K, accession 0001628280-26-004195) at 31 December 2025. Service cost for the year, the value of benefits earned by employees working that year, was $50 million. Interest cost was $1,472 million. Almost the entire annual movement is the unwinding of a discount rate on promises made long ago.
Deferred tax: whether a future benefit will be used
Tesla's FY2023 10-K, filed on 29 January 2024, states that it released $6.54 billion (Tesla, Inc. FY2023 10-K, accession 0001628280-24-002390) of its valuation allowance on US federal and state deferred tax assets, after concluding that it was more likely than not that those assets would be realised.
The year's income tax line was a benefit of $5,001 million on pre-tax income of $9,973 million, so net income of $14,997 million exceeded pre-tax income. The trigger was a conclusion about the future, reached by management and reviewed by auditors, and no cash moved.
How to find them quickly
The operating section of the cash flow statement is the shortest route. Every line between net income and cash from operations is an accrual the company itemised itself, and the large ones point at the notes worth opening.
After that, the critical audit matters in the auditor's report name the estimates the auditor found hardest, and the significant accounting policies note names the choices. Three places, none of them buried, and between them they account for most of the difference between a profit figure and a bank balance.
Check yourself
Caterpillar depreciates plant and equipment principally using accelerated methods. Why does that matter to a comparison?
- It means the assets wear out faster
- Most peers use straight line, which charges less in an asset's early years, so a margin comparison compares policies as well as businesses
- It is not permitted under US rules
Show the answer
Answer: B.
Both methods are permitted and both charge the same total over an asset's life. They differ in timing, so two identical businesses on different methods report different margins.An allowance for credit losses falls from 5.0 percent of gross receivables to 3.6 percent. What happened?
- Customers paid faster
- The company's estimate of what it will collect changed, which moves profit with no cash effect
- Receivables were sold
Show the answer
Answer: B.
The allowance is a forecast carried as a contra asset. Changing it changes both the asset and the year's profit, and nothing moves through the bank.Where does a filing tell you which estimate the auditor found hardest to be sure about?
- The management discussion and analysis
- The critical audit matters in the auditor's report
- The summary of significant accounting policies
Show the answer
Answer: B.
Critical audit matters are the auditor's own list of the accounts involving especially challenging or subjective judgement. Caterpillar's 2025 audit named one: the product warranty liability.Sources
- Caterpillar Inc., FY2025 Form 10-K, filed 13 February 2026, accession 0000018230-26-000008, for the depreciation policy and consolidated depreciation expense, the product warranty liability, and the critical audit matter in the report of PricewaterhouseCoopers LLP.
- Verizon Communications Inc., FY2021 Form 10-K, filed 11 February 2022, accession 0000732712-22-000008, for the allowance for credit losses and gross accounts receivable at 31 December 2021 and 2020.
- Lockheed Martin Corporation, FY2025 Form 10-K, filed 29 January 2026, accession 0001628280-26-004195, for the weighted average discount rate, the benefit obligation, service cost and interest cost of the qualified defined benefit pension plans.
- Tesla, Inc., FY2023 Form 10-K, filed 29 January 2024, accession 0001628280-24-002390, for the valuation allowance release, the benefit from income taxes, pre-tax income and net income.
What this leaves out
- Every figure here is history, read from the filings named. None is a statement about any of these companies today and none is a view on any security.
- Naming an estimate is not an allegation. Each of these was disclosed by the company, reviewed by an auditor, and is one of several defensible choices.
- The five estimates chosen are the largest in common industrial and technology filings. Banks, insurers and investment companies carry different ones, several of which are larger.
- The percentage of gross receivables is computed here from the two filed figures. The company does not print that ratio itself.