Linkedin
Facebook
Email
more
Users of financial statements are often surprised at the extent of estimation involved in the preparation of financial statements. One would think that accounting is more of an art than a science and that the world of reporting consisted of measurables – prices, percentages, debits, credits, etc. Sadly, that is not the case anymore. As business has become more sophisticated, estimation has increased. Businesses are now selling products that cannot necessarily be measured as accurately as in the past (some products can’t even be seen or touched). Debtors are more uncertain and significant financial instruments are becoming more complex and assets are often more intangible than otherwise.
All of the above requires some form of informed estimation, not only by the preparer of the financial statements but also by the auditor. The auditor’s responsibilities are set out in International Standard on Auditing 540. The International Auditing and Assurance Standards Board (IAASB) recently proposed significant changes to be made to ISA 540 which could result, in some cases, in more audit work being required.
Previously fair value estimates were dealt with separately. The new standard not only includes fair value estimates but also all accounting estimates and related disclosures.
The proposed new ISA 540, like its predecessor, aims to focus the auditor’s attention on identifying and responding to the risks of material misstatement. The standard allows the auditor to take into account the extent to which estimates are affected by particular factors, including complexity in making the accounting estimate; the need for management to use judgment and the potential for management bias; and estimation uncertainty.
A reason for the increased emphasis in ISA 540 on the appropriate application of professional scepticism is due to accounting estimates that may be subject to management bias. This includes enhanced requirements for the auditor to perform a “stand back evaluation” of audit evidence obtained – i.e. to “stand back” and consider if all the evidence supports the conclusion reached.
The existing standard already requires the auditor to perform specific audit procedures when an estimate represents a significant risk, but the proposed standard also emphasises that the audit evidence the auditor obtains from addressing the assessed risk will be more persuasive the higher the risk.
ISA 540 consists of detailed guidance to assist the auditor to determine whether an accounting estimate or related disclosure is misstated. The proposed standard significantly expands and elevates this guidance, creating more procedures that need to be performed by auditors and more onerous requirements that need to be met.
The new standard will not only require auditors to be more focused with regard to the risk that material misstatement could occur as a result of the use of accounting estimates, but also to address such risks with a more detailed and technical audit approach. These proposed changes to will have a significant impact on many audits but a far greater impact on audits of financial institutions, like insurance companies and banks, mainly due to the new requirement put in place in IFRS 9 for accounting of expected credit losses.
Auditors will need to fulfil more stringent requirements when signing off ‘accounting estimates’ in financial statements. It will also require the auditor to apply greater scepticism, and to carry out a further final review of the audit work in connection with the estimate before the audit is completed.
There have been some objections from initial commentators on the standard. The standard does not contain much guidance, and it imposes high expectations on both the preparers and auditors, in terms of the ‘accuracy’ of the forecasts and projections underpinning many estimates. Banks and other financial institutions are having difficulties with the implementation of certain fair value estimates and too onerous verification requirements may just worsen the situation. For example, the concept of a “reasonable estimate” is used throughout the proposed standard. Guidance should be added to clarify that the auditor may need to adapt the standard in circumstances where the applicable financial reporting framework uses a concept other than “reasonable estimate” such as “best estimate.” While many estimates may be reasonable, only one may be the best, and the auditor may need additional evidence that the estimate is actually the best estimate.
This new development seems to represent a more prescriptive, procedural approach by the standard setter and commentators do not all seem to agree with the new direction. The Exposure Draft was issued in mid-April, for comment by August 1st 2017, whereafter the final direction will become clearer.
Riekie Burger | Junior Trainee Accountant, Johannesburg
Henk Heymans | Head of Audit, Johannesburg.
References:
1. Eric Turner, CPA, CA. `May 19, 2017
2. Sara White, Editor, Accountancy and CCH Daily. April 26, 2017
3. Thinus Peyper, CA(SA), Project Director: Assurance at SAICA. June 1, 2017
