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SriLankaAuditingStandard540
AuditofAccountingEstimates
Sanath Fernando PartnerErnst&Young
3October2012
Introduction
Whatareaccountingestimates
EstimationUncertainty
Auditresponses
Overview
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NewAuditingStandards
Previously:
theauditorwas
permittedtorely
upontheassumption
ofmanagements
goodfaithand
integrity
Now
Toincreasetherigorandskepticismtobeappliedin
auditingaccountingestimates
Toprovideenhancedguidanceonestimationuncertainty
andmanagementbias
SLAuS 315andSLAuS 330discussedriskbasedaudit
approach
ObjectivesinRevisingSLAuS 540
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Auditorshouldobtainsufficientappropriateauditevidence
regardingaccountingestimates
accountingestimates,arereasonable;and
relateddisclosuresareadequate
AuditorsObjective
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Accountingestimatereferstoapproximationofamount
ofiteminabsenceofprecisemeansofmeasurement
Allowanceforbaddebts,inventory
Deferredtax
Provisionforlossfromalawsuit
Lossesinconstructioncontractsinprogress
Provisionsforwarrantyclaims
Actuarialvaluations
Impairmenttestingetcetc
FVarealsoestimatesthatarespecificallyaddressedin
SLAuS 545
WhatareAccountingestimates?
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Managementisresponsibleformakingsuchestimates
Estimatesareoftenmadeinconditionsofuncertainly
andusesjudgment
Riskofmisstatementgreaterbecauseofelementof
uncertainty
Whoisresponsible?
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Thesusceptibilityofanaccountingestimatetoan
inherentlackofprecisioninitsmeasurement
Thedegreeofestimationuncertaintyaffectstherisk
thatthefinancialstatementsaremateriallymisstated
andwhetheranestimateisparticularlysusceptibleto
managementbias
NatureofEstimationUncertainty
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Natureofaccountingestimates
Determinationofestimatemaybe:
Simple(e.g.rentaccrual)orComplex(e.g.slowmoving
inventory)
Estimatesmaybe:
Doneaspartofroutineaccountingsystem,operating
continuouslyorNonroutine,beingdoneonlyatperiod
end
Oftendonebyapplyingformulabasedonexperience
Formulashouldthenbereviewedregularlyby
management
Itemmaybeincapableofreasonableestimation
Auditormustthenconsidereffectonhisreport
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AuditProceduresandevaluation
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Auditorshouldobtainsufficientappropriateauditevidence
astowhetherestimateisreasonableandappropriately
disclosed
Understandingoftheentityandenvironment
Internalcontrols
Understandingoftheproceduresandmethodsincluding
relevantcontrolactivities,usedbythemanagementhelps
theauditortodesigntheN,T&E
Auditprocedures
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Threeauditapproaches (canbecombined):
1. Reviewandtestprocessusedbymanagementto
developestimate
2. Compareindependentestimatewithmanagements
3. Reviewsubsequenteventsconfirmingestimate
Auditapproaches
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1. Reviewingandtestingprocessusedbymanagement
Evaluationofdataandconsiderationofassumptionson
whichestimateisbased
Testingofcalculationsinvolved
Comparisonofestimatesforpriorperiodswithactual
results
Why?
Considerationofmanagementsapprovalprocedures
Auditapproaches
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2. Useofindependentestimate
Auditorwouldordinarily:
Evaluatedata
Considerassumptions
Testcalculationprocedures
3. Reviewofsubsequentevents
Eventsafteryearendbutbeforecompletionofaudit
mayprovideauditevidenceregardingestimate
E.g.provisionforbaddebtsorobsoletestock
Auditapproaches(continued)
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Auditorshouldmakefinalassessmentofreasonablenessof
estimate,basedon:
Hisknowledgeofbusiness
Whetherestimateisconsistentwithotheraudit
evidenceobtainedduringaudit
Evaluationofdifferencescanbedifficultduetoelementof
uncertainty
Ifthereisdifference,auditorshouldconsiderif
adjustmentisrequired
Ifyes,andmanagementrefusestorevisetheir
estimate:differenceshouldberegardedas
misstatement
Evaluationofresultsofprocedures
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Auditingactuarialvaluationofgratuity
Discussion:Practicalscenario
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Estimatesareinherentlyimpreciseandmostofthe
numbersinFSarenotfacts,butestimates
EvaluateAssumptions
DetermineAppropriatenessofModel
Testthedataandcalculations
Useindependentestimates,
Reviewsubsequentevents
Conclusion
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Thepresentationiswrittenintheauthor'spersonalcapacity
anddoesnotreflecttheviewofErnst&Young.