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International Auditing and Assurance
Standards Board
Accounting Estimates, Including Fair
Value Accounting Estimates, andRelated Disclosures
ISA Implementation Support Module
Prepared by IAASB Staff
October 2009
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Introduction
Risk-Based Approach
Estimation Uncertainty
Responses to Assessed Risks
Indicators of Possible Management Bias
Disclosures Related to Accounting Estimates
Additional Aspects of ISA 540
SME Considerations
Overview
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Introduction
To increase the rigor and skepticism to be
applied in auditing accounting estimates
To provide enhanced guidance on estimationuncertainty and management bias
To conform with the risk-based approach
reflected in ISA 315 and ISA 330
IAASBs Objectives in Revising ISA 540
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Introduction
Principles in auditing fair values and more
traditional accounting estimates are the same
Application material in ISA 540 explains how
particular requirements are applied in the context of
both accounting estimates and fair values
More guidance has been added related to fair valueauditing considerations, including the use of models
Extant ISA 545 to be withdrawn
Application to Both Accounting Estimates
and Fair Value Accounting Estimates
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Risk-Based Approach
Understanding of how management makes theaccounting estimates, and of the underlying data
The method, including the applicable model, used and
changes in the method from the prior period
Relevant controls
Whether an expert has been used
The underlying assumptions
Whether and, if so, how management has assessed the
effects of estimation uncertainty
Risk Assessment Procedures
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Risk-Based Approach
ISA 540 expands on how ISAs 315, 330, andothers are to be applied to accounting estimates
Obtaining an understanding of the entity and its
environment, through risk assessment procedures
Based on that understanding, identifying and
assessing the risks of material misstatement
Obtaining sufficient appropriate audit evidenceregarding the assessed risks, through designing and
implementing appropriate responses to those risks
Risk-Based Approach
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Risk-Based Approach
Understanding of the requirements of theapplicable financial reporting framework
relevant to accounting estimates, including
related disclosures
Understanding of how management identifies
the need for accounting estimates to be
recognized or disclosed Includes making inquiries about changes in
circumstances that may give rise to new accounting
estimates or the need to revise existing ones
Risk Assessment Procedures
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Risk-Based Approach
Review the outcome of accounting estimatesincluded in the prior period financial statements
or, as applicable, their subsequent re-estimation
in the current periodNature and extent of review takes account of the
nature of the estimate and whether information to be
obtained is likely relevant to identifying and assessing
risks
Not intended to revisit prior judgments
Risk Assessment Procedures
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Risk-Based Approach
In identifying and assessing risks
Evaluate the degree of estimation uncertainty
associated with an accounting estimate
Determine whether, in the auditors judgment, any of
those accounting estimates that have been identified
as having high estimation uncertainty gives rise tosignificant risks
Identifying and Assessing Risks of Material
Misstatement
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Estimation Uncertainty
The susceptibility of an accountingestimate to an inherent lack of precision in
its measurement
The degree of estimation uncertainty
affects the risk that the financial statements
are materially misstated and whether an
estimate is particularly susceptible tomanagement bias
Nature of Estimation Uncertainty
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Estimation Uncertainty
Evaluating the degree of estimationuncertainty associated with an accounting
estimate includes consideration of, for
example,
Level of judgment involved
Sensitivity to changes in assumptions
Extent to which the estimate is based on
observable or unobservable inputs
Evaluation of Estimation Uncertainty
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Responses to Assessed Risks
Based on the assessed risks, determine
Whether management has appropriately applied
the requirements of the applicable financial
reporting framework
Whether the methods for making accounting
estimates are appropriate and applied consistently
If there have been changes in the method, are they
appropriate?
Responding to the Assessed Risks
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Responses to Assessed Risks
One or more of the following, taking account
of nature of the accounting estimate
Use of evidence from events occurring up to the
date of the auditors report
Testing of how management made the
accounting estimate and underlying data
Includes evaluation of measurement method and
reasonableness of assumptions
Responding to the Assessed Risks
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Responses to Assessed Risks
Testing the operating effectiveness of controls,
together with appropriate substantive
procedures
Developing a point estimate or range to evaluate
managements point estimate
Remains necessary to understand managements
assumptions and methods
Range needs to be narrowed based on audit evidence
until all outcomes within the range are considered
reasonable
Responding to the Assessed Risks
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Responses to Assessed Risks
Evaluate how management has considered
alternative assumptions or outcomes and why
they have been rejected, or how managementhas otherwise addressed estimation uncertainty
Evaluate whether the significant assumptions
used are reasonable
Where relevant, evaluate managements intent
and ability
Further Substantive Procedures to Respond
to Significant Risks
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Responses to Assessed Risks
Where necessary, develop a range to evaluate
reasonableness of the accounting estimate
Done when, in the auditors judgment,management has not adequately addressed the
effects of estimation uncertainty
Obtain sufficient appropriate audit evidenceregarding recognition and measurement
decisions
Further Substantive Procedures to Respond
to Significant Risks
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Indicators of Possible Management Bias
Review the judgments and decisions made bymanagement in making accounting estimates to
identify whether there are indicators of possible
management bias
Susceptibility of an estimate to management bias
increases with subjectivity involved
Indicators may affect auditors conclusion of
whether risk assessment or responses remainappropriate, but do not themselves constitute
misstatements for purposes of concluding on
reasonableness of individual estimates
Identifying Indicators
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Indicators of Possible Management Bias
Changes in an accounting estimate or method wheremanagement has made a subjective assessment that
there has been a change in circumstances
Use of an entitys own assumptions for fair value when
they are inconsistent with observable marketplace
assumptions
Selection or construction of significant assumptions
that yield a point estimate favorable to managementsobjectives
Selection of a point estimate that may indicate a pattern
of optimism or pessimism
Examples
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Disclosures Related to Accounting Estimates
Obtain sufficient appropriate audit evidenceabout whether disclosures related to accounting
estimates are in accordance with the applicable
financial reporting framework For estimates giving rise to significant risks,
also evaluate the adequacy of the disclosure of
estimation uncertainty in the context of theapplicable financial reporting framework
Disclosures
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Addi i l A f SA 40
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Additional Aspects of ISA 540
Obtain written representations regarding thereasonableness of significant assumptions used in
making accounting estimates
Representations alone do not constitute sufficientappropriate audit evidence
Guidance provided regarding additional
representations the auditor may consider dependingon nature, materiality, and extent of estimation
uncertainty
Written Representations
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Addi i l A f ISA 540
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Additional Aspects of ISA 540
Document
The basis for the auditors conclusions about
the reasonableness of accounting estimates and
their disclosure that give rise to significantrisks
Indicators of possible management bias, if any
Documentation
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SME C id i
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SME Considerations
Obtaining an understanding of how management (orowner-manager) identifies the need for accounting
estimates is often relatively straightforward
The ISA allows for different approaches forresponding to assessed risks depending on the nature
of the accounting estimate
In many cases (other than for fair value estimates),review of events occurring up to the date of the
auditors report may be an effective and efficient
approach
Applicability of the ISA to SME Audits
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Note
This set of support slides does not amend or override
the ISAs, the texts of which alone are authoritative.
Reading the slides is not a substitute for reading the
ISAs. The slides are not meant to be exhaustive and
reference to the ISAs themselves should always be
made. In conducting an audit in accordance with
ISAs, the auditor is required to comply with all the
ISAs that are relevant to the engagement.
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