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Definition
“Accounting estimate" means an approximation of the amount of an item in the absence of a precise means of measurement. Significant estimates include, but are not limited to, amounts for pensions, accrued charges, provisions, contingent liabilities, and forecasts of revenues (recoveries).
Management is responsible for making accounting estimates included in financial statements. These estimates may be simple (e.g. accruing a charge for rent) or complex (estimating a provision for slow-moving or surplus inventory). They are often made in conditions of uncertainty regarding the outcome of events and involve the use of managerial judgement. As a result, there may be a risk of [link title="material" link="%2Faware%2FGAP%2FPages%2FCA-FA%2FPlanning%2FMateriality.aspx" /]
misstatement, which the auditor may determine to be a significant risk that requires special audit consideration.
Instructions
Audit approach
The auditor should design and perform audit procedures to obtain sufficient appropriate [link title="audit%20evidence" link="%2Faware%2FGAP%2FPages%2FAudit-evidence.aspx" /]
as to whether the entity’s accounting estimates are reasonable in the circumstances and, when required, appropriately disclosed. Such audit evidence will often be difficult to obtain and less persuasive than in other areas; the auditor therefore needs to exercise judgement in assessing the sufficiency and appropriateness of the available audit evidence.
Considerations during the planning phase
When performing risk assessment procedures, the auditor should obtain an understanding of the requirements regarding accounting estimates, how management identifies events giving rise to such estimates, and management's process for making the estimates, as well as reviewing the outcome of the prior year's estimates.
When identifying and assessing the risks of [link title="material" link="%2Faware%2FGAP%2FPages%2FCA-FA%2FPlanning%2FMateriality.aspx" /]
misstatement, the auditor should evaluate the degree of uncertainty and potential bias regarding estimates, and thus determine whether there are significant associated risks.
Audit procedures
The auditor should:
- determine if the methods for determining accounting estimates have been applied consistently;
- consider whether an auditor's expert is required;
- test the operating effectiveness of the relevant controls; and
- develop a range to test management's estimate.
Furthermore, for estimates giving rise to significant risks, the auditor should evaluate alternative assumptions considered by management, consider whether the assumptions used are reasonable and, where relevant, assess management's intent to implement specific courses of action.
Where the auditor judges that management has not adequately addressed uncertainty for estimates giving rise to significant risks, (s)he should develop a range so as to evaluate the estimate's reasonableness.
The auditor should obtain [link title="written%20representations" link="%2Faware%2FFA%2FPages%2FExamination%2FWritten-representations.aspx" /]
from management regarding the reasonableness of significant assumptions it has used to develop accounting estimates.
Evaluation and disclosure
The auditor should evaluate whether the estimates and related disclosures are reasonable or misstated.
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[link new-window title="ISA%20540" link="https%3a%2f%2fwww.ifac.org%2fsystem%2ffiles%2fpublications%2ffiles%2fIAASB-2020-Handbook-Volume-1.pdf%23INTERNATIONAL%2520STANDARD%2520ON%2520AUDITING%2520540%2520(REVISED)" /]
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