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When companies report financial results, they often rely on estimates made by management. Examples include the allowance for doubtful accounts, warranty obligations, costs of pending litigation, goodwill impairment and the fair values of acquired intangible assets. How do auditors evaluate whether amounts reported on the financial statements for these items seem reasonable?<\/p>\n
Inquiry and testing<\/strong><\/p>\n Accounting estimates may be based on subjective or objective information (or both) and involve a level of measurement uncertainty. External auditors evaluate accounting estimates as part of their standard audit procedures.<\/p>\n For instance, they may inquire about the underlying assumptions (or inputs) that were used to make estimates to determine whether the inputs seem complete, accurate and relevant. Estimates based on objective inputs, such as published interest rates or percentages observed in previous reporting periods, are generally less susceptible to bias than those based on speculative, unobservable inputs. This is especially true if management lacks experience making similar estimates in the past.<\/p>\n Whenever possible, auditors try to recreate management\u2019s estimate using the same assumptions (or their own). If an auditor\u2019s estimate differs substantially from what\u2019s reported on the financial statements, the auditor will ask management to explain the discrepancy. In some cases, an independent specialist, such an appraiser or engineer, may be called in to estimate complex items.<\/p>\n Auditors also may compare past estimates to what happened after the financial statement date. The outcome of an estimate is often different from management\u2019s preliminary estimate. Possible explanations include errors, unforeseeable subsequent events and management bias. If management\u2019s estimates are consistently similar to what happened later, it adds credibility to management\u2019s prior estimates. But if significant differences are found, the auditor may be more skeptical of management\u2019s current estimates, necessitating the use of additional audit procedures.<\/p>\n Recent updates<\/strong><\/p>\n The Public Company Accounting Oversight Board (PCAOB) published revised requirements for auditing accounting estimates and using specialists in audits in December 2018. These changes were published in Release No. 2018-005, Auditing Accounting Estimates, Including Fair Value Measurements<\/em>, and Release No. 2018-006, Amendments to Auditing Standards for Auditor\u2019s Use of the Work of Specialists<\/em>. (Note: The work of specialists is often used to support accounting estimates made by management.)<\/p>\n Release No. 2018-005 is a risk-based standard that emphasizes the importance of professional skepticism when auditors evaluate management\u2019s estimates and the need for more attention to potential management bias. Under the updated standard, auditors consider both corroborating and contradictory evidence that\u2019s obtained during the audit. Similarly, Release No. 2018-006 extends the auditor\u2019s responsibility for evaluating specialists beyond simply obtaining an understanding of their work. In short, it requires auditors to perform additional procedures to evaluate the appropriateness of the company\u2019s data, as well as significant assumptions and methods used.<\/p>\n In December 2022, the PCAOB published its post-implementation review on these new-and-improved rules. About one-third of the audit firms surveyed reported that the new requirements on estimates and specialists improved auditing practices, according to Interim Analysis Report: Evidence on the Initial Impact of New Requirements for Auditing Accounting Estimates and the Auditor\u2019s Use of the Work of Specialists<\/em>. Other firms said that effects were limited and didn\u2019t have major consequences on the audit process or audit fees\/hours.<\/p>\n Though the new, more consistent guidance applies specifically to public companies, the effects filter down to audits of private entities that use accounting estimates or rely on the work of specialists.<\/p>\n Gray area in accounting<\/strong><\/p>\n Accounting estimates and fair value measurements involve a high degree of subjectivity and judgment and may be susceptible to misstatement. In today\u2019s uncertain market conditions, predicting metrics that underlie accounting estimates can be particularly challenging. Therefore, they require more auditor focus today than in more-stable prior accounting periods. Be prepared to provide comprehensive documentation to support your estimates during the upcoming audit season.<\/p>\n \u00a9 2023<\/em><\/p>\n <\/body> When companies report financial results, they often rely on estimates made by management. Examples include the allowance for doubtful accounts, warranty obligations, costs of pending litigation, goodwill impairment and the fair values of acquired intangible assets. How do auditors evaluate whether amounts reported on the financial statements for these items seem reasonable? Inquiry and testing […]<\/p>\n","protected":false},"author":3,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[13,7,10],"tags":[8,11,12],"class_list":["post-16556","post","type-post","status-publish","format-standard","hentry","category-aa","category-articles","category-news","tag-articles","tag-news","tag-updates"],"_links":{"self":[{"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/posts\/16556","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/comments?post=16556"}],"version-history":[{"count":1,"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/posts\/16556\/revisions"}],"predecessor-version":[{"id":16557,"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/posts\/16556\/revisions\/16557"}],"wp:attachment":[{"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/media?parent=16556"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/categories?post=16556"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/tags?post=16556"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}
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