Many high profile accounting scams and financial restatements have been attributed to complex accounting estimates such as impairments of long-lived assets, valuations of financial and nonfinancial assets, and allowances for doubtful accounts. This is partially because estimates almost always involve some level of measurement uncertainty; this uncertainty can even call for the use of outside specialists such as engineers or appraisers.
Understanding the audit process and the role of estimates is crucial. Companies that take the time to understand the audit process fully are better equipped to facilitate audit fieldwork and have better relationships with their auditors.
Here are some crucial points of understanding about auditing the use of estimates as we enter the next audit season.
Some audits will be inherently complex. Auditing standards generally provide the following three approaches for substantive testing accounting estimates and fair value measurements:
- Testing management’s process. The reasonableness and consistency of management’s assumptions will be evaluated by auditors. They will also test if the underlying data is complete, accurate, and relevant.
- Developing an independent estimate. Auditors come up with an estimate to compare to what’s reported on the internally prepared financial statements using management’s assumptions (or alternate assumptions).
- Reviewing subsequent events or transactions. Looking at events or transactions that happen after the balance sheet dates but before the auditor’s report can help identify the reasonableness of estimates.
The auditor will usually select one of a combination of these three approaches to use, as all three are not necessarily appropriate for each estimate.
The agenda of the Public Company Accounting Oversight Board (PCAOB) has included accounting estimates since its creation by Congress in 2002, under the Sarbanes-Oxley Act. In early 2018, the leadership of PCAOB changed, but their focus on improving the auditing standards for accounting estimates has remained a priority. Current leadership has indicated that these projects should be completed in coming months. Updating auditing standards will help to reduce diversity in practice, provide more-specific direction, and be better aligned with the risk assessment standards.
Prepare for your next audit
Policy for the audit standards for the use of estimates and the work of specialists will be changing and enhanced soon. Awareness of these changes is important in planning for next year’s audit. Companies should contact their audit partners for the latest developments on the standards for auditing and the use of estimates and specialists to determine what changes have occurred.
If you have questions about how estimates and specialists are used in the preparation of your company’s financial statements, we can help. Contact us at 818-334-8623 or click here, and we will contact you.