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SESSION 17 – ACCOUNTING ESTIMATES OVERVIEW Objective To describe the audit approach to accounting estimates DEFINITION Examples Responsibilities DETERMINATION AUDIT PROCEDURES Audit evidence Approaches Data and assumptions EVALUATION Subsequent events Uncertainties 1701 SESSION 17 – ACCOUNTING ESTIMATES DEFINITION [ISA 540] An approximation of the amount of an item in the absence of a precise means of measurement 1.1 Examples Allowances: to reduce inventory to estimated net realisable value (NRV); to reduce accounts receivable to estimated recoverable amount; to allocate costs of non-current assets over estimated useful lives (i.e depreciation) Provisions: warranty claims; losses on contract work in progress; loss from a lawsuit 1.2 Responsibility Management is responsible for making accounting estimates included in financial statements DETERMINATION May be simple (e.g to accrue a charge for rent) complex (e.g requiring analysis of current data and sales forecasts to estimate slowmoving or surplus inventory) Any formulae used (e.g standard depreciation rates) need to be reviewed regularly (e.g every year) by management to assess their appropriateness and continued use May be routine (i.e operating on a continuing basis) non-routine (i.e operating only at the period end) AUDIT PROCEDURES 3.1 Audit evidence Evidence on accounting estimates is often more difficult to obtain and less conclusive than evidence available to support other items in the financial statements 1702 SESSION 17 – ACCOUNTING ESTIMATES 3.2 Approaches The auditor should use one, or a combination, of the following: Review and test management’s process used to develop estimate Evaluate data and assumptions Test calculations Use an independent estimate to compare with management’s See “Using the work of an expert” (Session 18) Compare prior period estimates with actual Consider management’s review and approval procedures Review subsequent events to confirm estimate made May reduce or remove need for alternative approaches Subsequent events may be more cost effective Make a final assessment of the reasonableness of the management’s approach to estimates based on understanding of the entity and its environment Determine if estimates are consistent with other audit evidence 3.3 Data and assumptions 3.3.1 Considerations Consistency of accounting data with that processed in financial accounting system Sources outside entity (e.g customer orders, industry data, lawyers) Appropriateness of projections Sensitivity of assumptions to variations Cumulative impact of prior year estimates 1703 SESSION 17 – ACCOUNTING ESTIMATES EVALUATION 4.1 Subsequent events Consider whether there are any which affect the data and assumptions used 4.2 Uncertainties Evaluate differences between amount supported by best available alternative evidence and amount included in financial statements: within a range of acceptable results? biased in one direction? FOCUS You should now be able to: discuss the problems associated with the audit and review of accounting estimates 1704 ... responsible for making accounting estimates included in financial statements DETERMINATION May be simple (e.g to accrue a charge for rent) complex (e.g requiring analysis of current data and sales forecasts... expert” (Session 18) Compare prior period estimates with actual Consider management’s review and approval procedures Review subsequent events to confirm estimate made May reduce or remove need for. .. requiring analysis of current data and sales forecasts to estimate slowmoving or surplus inventory) Any formulae used (e.g standard depreciation rates) need to be reviewed regularly (e.g every year) by
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