Monday, September 17, 2012

International Standard on Auditing 540: Auditing Accounting Estimates

International Stanard on Auditing ("ISA") 540 discuss about the auditing of accounting estimates, including fair value accounting estimates and related disclosures. This is a crucial auditing standard for all auditors as auditing accounting estimates is not straight forward, involve critical review of assumptions and management's assessment, and the results have a significant impact on the financials of our audit client.

ISA 540 defines the natuer of accounting estimates as follows: Some financial statement items cannot be measured precisely, but can only be estimated.The nature and reliability of information available to management to suport the making of an accounting estimate varies widely, which thereby affects the degree of estimation uncertainty associated with accounting estimates. The degree of estimation uncertainty affects, in turn, the risks of material misstatement of accounting estimates, including their susceptibility to unintentional or intentional management bias.

To illustrate, while reviewing through the debtors' aging summary of your audit client, you noted a number of debtors has long outstanding debts overdue more than 120 days. Based on your understanding of the industry, the norm of the debtors' turnover is about 90 days. Management need to make an estimation on the provision for doubtful debts. The estimations based on a number of factors: repayment history of the particular customer, financial position of the customer, availability of repayment plan, etc. Auditor, need to carry out the review objectively to review for the reasonableness of management's estimation assessment.

Management may have incentive of not providing provision in order to make sure that their profitability appears to be favorable. As a result, a thorough review need to be carried out.

ISA 540 also mentions that the measurement objective for certain accounting estimates if to forecast the out come of one or more transactions, events or conditions giving rise to the need for the accounting estimate. For other accounting estimates, including many fair value accounting estimates, the measurement objective is different, and is expressed in terms of the value of a current transaction or financial statement item based on conditions prevalent at the measurement date.

No comments: