Auditing accounting estimates is a critical aspect of financial statement audits, as these estimates can significantly impact an entity's reported financial position and performance.
In Execution and Evidence Gathering & Completion Phase, Lindsay Webber explains that the process involves a series of objectives and requirements designed to ensure that estimates are reasonable, comply with relevant standards, and are free from material misstatement, including bias.
Objectives of Auditing Accounting Estimates
The primary objective when auditing accounting estimates is to evaluate whether they are reasonable in the context of the financial reporting framework. Auditors aim to:
- Assess the risks of material misstatement due to error or fraud in accounting estimates.
- Determine if the estimates are supported by sufficient and appropriate audit evidence.
- Ensure that estimates are consistent with the entity's financial statements and disclosures.
- Evaluate the degree of estimation uncertainty and how it affects the financial statements.
Requirements for Auditing Accounting Estimates
Risk Assessment Procedures and Related Activities
Gain Understanding of:
- Entity and its Environment: Auditors must understand the entity's operations, industry, regulatory environment, and the transactions that give rise to accounting estimates.
- Types of Transactions/Nature of Estimates/Recognition Criteria: Identifying the types of transactions that involve estimates, understanding the nature of those estimates, and the criteria for their recognition in the financial statements is essential.
- Entities Internal Controls: Evaluating the effectiveness of internal controls related to accounting estimates is crucial. This includes management's process for identifying and assessing risks, as well as the assumptions and uncertainties involved.
Identifying and Assessing the Risks of Material Misstatement
- Assess Estimation Uncertainty/Method, Assumptions & Date: Auditors assess the methods and significant assumptions used by management, as well as the data upon which the estimates are based, and the degree of estimation uncertainty.
- Review Outcome of Previous Estimates: Historical accuracy of estimates provides insight into the reliability of current estimates.
- Does Audit Team Have Specialist Knowledge: In certain cases, auditors may need to rely on specialist knowledge to evaluate complex estimates.
Responses to the Assessed Risks of Material Misstatement
- Evidence Occurring up to Date of Auditors’ Report: Auditors should gather evidence up to the date of their report to ensure that the latest information is considered.
- Testing How Management Made the Accounting Estimate: Auditors test the processes and controls management used to make the estimate, including recalculating the estimate where possible.
Disclosures Relating to Accounting Estimates
- Auditors must ensure that all required disclosures relating to accounting estimates are present, complete, and understandable.
Indicators of Management Bias
- Professional Scepticism: Auditors must exercise professional scepticism to identify any potential management bias in the presentation of estimates.
Overall Evaluation Based on Procedures Performed
- Determine if Estimates are Reasonable or Misstated: After performing the necessary procedures, auditors conclude whether the accounting estimates are reasonable or if there are indications of material misstatement.
Written Representations
- Auditors should obtain written representations from management confirming their responsibility for the fair presentation of accounting estimates in the financial statements.
Communication with Management
- Effective communication with management throughout the audit process is vital, especially regarding the selection and application of accounting estimates.
Documentation (Linkage to Assertions)
- Auditors must document their findings, the rationale for their conclusions, and how they link to the financial statement assertions.
Auditing accounting estimates requires a structured approach that encompasses understanding the entity and its environment, evaluating internal controls, assessing risks, gathering evidence, and exercising professional scepticism. By adhering to these requirements, auditors can provide assurance that accounting estimates within financial statements are reasonable and free from material misstatement.
For the full session, please click here. In the session, Lindsay Webber covers:
Session 5: Execution and Evidence Gathering;
- ISA 230 – Audit Documentation;
- ISA 500 – Audit Evidence;
- ISA 402 – Audit Consideration Relating to an Entity Using a Service Organisation;
- ISA 501 – Audit Evidence – Specific Consideration for Selected Items;
- ISA 540 – Auditing Accounting Estimates;
Session 6: Completion phase;
- ISA 560 – Subsequent Events;
- ISA 600 – Audits of Group Financial Statements (incl. the WORK of Component Auditors)
- ISA 450 – Evaluation of misstatements identified during the audit
- ISA 550 – Related parties
- ISA 520 – Analytical procedures
The contents of this article are meant as a guide only and are not a substitute for professional advice. The author/s accept no responsibility for any action taken, or refrained from, as a result of the material contained in this document. Specific advice should be obtained before acting or refraining from acting, in connection with the matters dealt with in this article.
