Date posted: 11/12/2020

Auditing accounting estimates

What are the changes to auditing accounting estimates in light of the revised new auditing standard?

In brief

  • ISA 540 (Revised) is applicable for December audits and contains a number of new requirements
  • The volatility and uncertainty caused by COVID-19 means auditors need a heightened level of professional skepticism when auditing accounting estimates
  • Accounting estimates are a continually evolving area of accounting and therefore a key focus area for the regulators

The ISA 540 (Revised) Auditing Accounting Estimates and Related Disclosures (and its AU and NZ equivalents) standard has implications for senior management and those responsible for financial statement preparation and the determination of accounting estimates.

It is effective for periods beginning on or after 15 December 2019, therefore impacts the 31 December 2020 financial reporting periods for the first time.

What are the key changes?

The revised standard addresses a number of matters including, but not limited to, the following:

Keeping public interest issues first

  • Auditing estimates require increased focus because of evolving audit risks due to a more complex business environment and, in particular, for the December 2020 reporting period, the increased levels of uncertainty many entities are experiencing because of COVID-19.
  • The regulators around the globe have consistent expectations for auditors to address audit quality and improve professional scepticism.
  • Enhanced two-way communication and transparency between auditors, management, directors and regulators to realise public interest benefits.

Key enhancements and improvements

  • Requirement for auditors to 'stand back' and evaluate the audit evidence regarding the accounting estimates.
  • Requiring separate assessment of inherent risk and control risk relating to accounting estimates and recognising the importance of auditor's decisions about whether to test controls or performing substantive audit work.
  • Introduction of 'inherent risk factors' to assist auditors assessing the risks arising from estimates
  • Disclosures around accounting estimates in financial statements can be lengthy and complex. Further requirements addressing disclosure of accounting estimates.

Enhance the use of Professional scepticism by auditors

  • Enhanced the requirements of the standards by including words such as 'challenge', 'question', 'reconsider' to allow auditors to further focus on professional scepticism and judgement.
  • Management bias can influence the outcome of estimates. Increased focus on management bias in addressing the risks of material misstatement.
  • Requirement for auditors to 'stand back' and evaluate the audit evidence regarding the accounting estimates.

The standard is Scalable

  • The revised standard includes specific paragraphs in the application material to address the  scalability concerns when auditors assess risks  of material misstatements and then responding to those assessed risks.
  • The  nature, timing and extend of audit of further work is tailored based on the results of risk assessment.
  • The standard emphasises that the higher the risks of material misstatements the more persuasive the audit evidence needs to be.

The ISA 540 (Revised) standard has implications for senior management and those responsible for financial statement preparation

The revised standard does have implications for senior management and those responsible for financial statement preparation and the determination of accounting estimates. This also includes the management’s inhouse and externally appointed experts who contribute to the calculation of estimates, for example, fair valuation specialists, actuaries or real estate specialists as well as for the directors and audit committees recommending the approval of financial statements.  

The key implications for preparers, management and directors are:

  • They will require more time to prepare sufficient appropriate documentation of management's estimates and recognise that increased efforts may be required by auditors to audit the estimates.
  • The need for management to better document processes and controls around accounting maintaining audit trails.
  • Enhanced and improved two-way dialogue between auditors, management, and audit committees/directors about the critical aspects of accounting estimates.

Video recording

The Australian Auditing and Assurance Standards Board (AUASB) recently discussed the "Practical implementation of ASA 540 Auditing Accounting Estimates and Related Disclosures" during the 2020 CA ANZ Audit Conference in Australia.

During the session, the AUASB discussed:

  • main changes and enhancements
  • scalability of the new standard
  • ASA 540 requirements and considerations
  • practical examples.

The session also included interactive question and answers.

Other AUASB accounting estimates resources 

The AUASB’s bulletin dealing with the auditor’s responsibilities relating to accounting estimates, including fair value estimates and related disclosures in an audit of a financial report, and the AUASB’s webinar on the standard.

Read more

IAASB Working Group Examples "other estimates"

The illustrated examples for auditing simple and complex accounting estimates. 

Read more

IAASB Working Group Examples "ECLs"

The illustrated examples for auditing expected credit loss (ECL) accounting estimates.

Read more

IAASB Staff Audit Practice Alert 

Auditing accounting estimates in the current evolving environment due to COVID-19.

Read more

A CAQ COVID-19 resource

Auditing Accounting Estimates in the COVID-19 Environment.

Read more

Search related topics