ISA 540 - Accounting Estimates Flashcards
ISA 540
AUDITING ACCOUNTING ESTIMATES AND RELATED DISCLOSURES
Accounting estimates represent a significant risk of material misstatements in the financial statements because:
* They are ESTIMATES & cannot be reliably measured.
- They involve uncertainty (some estimates involve a higher degree of uncertainty than others) & involve the use of management judgement.
- Management can use these estimates TO MANIPULATE profit, asset & liability figures in the FS.
ISA 540
AUDITING ACCOUNTING ESTIMATES AND RELATED DISCLOSURES
- FAIR VALUE accounting estimates
- EXPECTED VALUE accounting estimates
- NPV accounting estimates
- Other accounting estimates
ISA 540
AUDITING ACCOUNTING ESTIMATES AND RELATED DISCLOSURES
(1) FAIR VALUE accounting estimates
- FV of complex financial instruments, not traded in
active market. - FV of share options at the grant date
- FV of assets & liabilities acquired in a business
combination, including the determination of goodwill & intangible assets - Requirement for Assets Held For Sale to be valued at the lower of carrying amount and FV less costs to sell
(1) FAIR VALUE accounting estimates
ISA 540
AUDITING ACCOUNTING ESTIMATES AND RELATED DISCLOSURES
(2) EXPECTED VALUE accounting estimates
- Provision for assurance
warranty
(2) EXPECTED VALUE accounting estimates
ISA 540
AUDITING ACCOUNTING ESTIMATES AND RELATED DISCLOSURES
(3) NPV accounting estimates
- Provision for decommissioning
- Impairment of goodwill, intangible assets
(Value In Use calculations)
(3) NPV accounting estimates
ISA 540
AUDITING ACCOUNTING ESTIMATES AND RELATED DISCLOSURES
(4) Other accounting estimates
- Inventory obsolescence
- Depreciation
- Allowance for Expected Credit Losses
- Outcome of pending litigation.
- Outcome of long term contracts.
- Revenue recognised on long term contracts
- Provision against the carrying amount of an investment where there is uncertainty regarding recoverability.
(4) Other accounting estimates
ISA 540
FACTORS giving rise to inherent risks on accounting estimates
- Complexity
- Subjectivity (MANAGEMENT Judgement)
- Estimation uncertainty
SUCCS-R+R (these are the same components)
ISA 540
FACTORS giving rise to inherent risks on accounting estimates
(1) Complexity
Complexity may be inherent in theprocess of making an accounting estimates involving a high degree of
uncertainty.
There may be complexity in the models, methods or data
(for example when data is difficult to obtain).
Greater complexity in the models & methods may require the audit team to have specialized skills or knowledge.
ISA 540
FACTORS giving rise to inherent risks on accounting estimates
(2) Subjectivity (MANAGEMENT Judgement)
With accounting estimates involving a high degree of uncertainty, there are inherent limitations in the
knowledge or data reasonably available. Because of the
subjectivity, management will have to make judgements about:
- which methods / models they use to develop the estimate & also
- Whether the assumptions are appropriate.
The judgements involve subjectivity.
Such judgments by management increase the risk of intentional and/or unintentional management bias.
(2) Subjectivity (MANAGEMENT Judgement)
ISA 540
FACTORS giving rise to inherent risks on accounting estimates
(3) Estimation uncertainty
With accounting estimates involving a high degree of uncertainty is susceptible to an inherent lack of precision.
(3) Estimation uncertainty
ISA 540
AUDIT APPROACHES to auditing accounting estimates
Many accounting estimates are complex and require judgment or have estimation uncertainty.
It is especially important that auditors design and perform procedures to ensure estimates’ reliability.
Accounting estimates involving a high degree of uncertainty are SIGNIFICANT RISKS. These will require SPECIAL AUDIT CONSIDERATION (including significant audit effort)
ISA 540 (Revised) using any of the three testing approaches (individually or in combination)
AUDIT APPROACHES to auditing accounting estimates
APPROACH 1
APPROACH 1 - TEST the processes used by management in making the accounting estimate
- Test METHOD / MODEL
- Does method / model comply with IAS/IFRS?
- Is method / model complex?
- Will team need assistance from auditor expert? - Test MANAGEMENT JUDGMENT (ASSUMPTIONS)
- Are assumptions consistent with those used
in other areas of the entity’s business activities
including any other accounting estimates?
- Are judgements about changes from prior year appropriate? - Test DATA
- Is data in calculations reliable?
- Are C - Calculations accurate? - GREAT ESTIMATION UNCERTAINTY
- Has management taken the necessary steps
to understand the source of the estimation uncertainty?
- Disclosures of estimation uncertainty adequate?
MADCS
ISA 540
AUDIT APPROACHES to auditing accounting estimates
APPROACH 1
APPROACH 2 – Developing the auditor’s a point estimate or a range to evaluate management’s point estimate
ISA 540
AUDIT APPROACHES to auditing accounting estimates
APPROACH 3
APPROACH 3- Obtain audit evidence from events occurring up to the date of the auditor’s report to confirm value of the estimate. (S - Subsequent events)
MADCS
