INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS OF UGANDA
BRIEF ON ISA 540 (REVISED), AUDITING ACCOUNTING ESTIMATES AND RELATED DISCLOSURES
In October 2018, the International Auditing and Assurance Standards Board (IAASB) issued ISA 540 (Revised), Auditing Accounting Estimates and Related Disclosures. The IAASB revised this standard on accounting estimates to respond to the rapidly evolving business environment. The revision ensures that the standard continues to keep pace with the changing market (particularly changes to financial reporting standards that have increased the importance and visibility of accounting estimates to users of financial statements).
The Objective of the auditor under this standard is to obtain sufficient appropriate evidence about whether accounting estimates and related disclosures in the financial statements are reasonable in the context of the applicable financial reporting framework.
Overview of key changes and challenges:
The Revised standard places additional emphasis on applying appropriate professional scepticism when auditing accounting estimates to foster a more independent and challenging sceptical mind-set in auditors. The exercise of professional scepticism in relation to accounting estimates is affected by consideration of inherent risk factors, with its importance increasing when accounting estimates are subject to a greater degree of estimation uncertainty or are affected to a greater degree by complexity, subjectivity or other inherent risk factors. Some of the significant revisions include:
1. More focus on risk assessment
The risk assessment requirements have been strengthened and auditors will need to think more deeply about the risks inherent to accounting estimates, thus:
- Identifying and assessing risk in view of the specific risk factors in ISA 540 (Revised): estimation uncertainty, subjectivity and complexity and considering how they interact.
- The introduction of the concept of ‘a spectrum of risk’ and considering how practically this affects the audit.
- The introduction of a separate assessment of inherent risk and control risk for accounting estimates when assessing the risk of material misstatements at the assertion level; and
- Understanding what needs to be done to assess the effectiveness of the design of control activities around estimates and what to document.
2. Responses to risk: additional requirements
There are requirements for (more) work: on post balance sheet events, testing management’s process for making the estimate (including methods, assumptions, data and ranges) including where the estimate has been developed by a management’s expert, testing controls (where appropriate), management’s disclosures in relation to estimation uncertainty, and developing the auditors own range or point estimate.
3. A new overall evaluation requirement on disclosures
Auditors will be required to assess whether the related disclosures are reasonable or misstated – enhanced disclosure requirements to obtain audit evidence about whether the related disclosures are reasonable.
4. More documentation
The standard introduces more prescriptive/ strict documentation requirements covering:
- The auditor’s understanding of the entity and its environment, including the entity’s internal control related to the entity’s accounting estimates;
- The linkage of the auditor’s further audit procedures with the assessed risks of material misstatement at the assertion level;
- The auditor’s response(s) when management has not taken appropriate steps to understand and address estimation uncertainty;
- Indicators of possible management bias related to accounting estimates and the auditor’s evaluation of the implications for the audit; and;
- Significant judgements relating to the auditor's determination of whether the accounting estimates and related disclosures are reasonable – or are misstated – in the context of the applicable financial reporting framework.
There are also requirements in relation to accounting estimates present in the prior period financial statements. The documentation should include a review of the outcome of these accounting estimates or, where applicable, their subsequent re-estimation for the current period.
The documentation at the planning stage should also include the auditor’s consideration of whether any of the accounting estimates identified represent a significant risk of material misstatement and the reasons for the judgements made.
5. Reporting to those charged with governance, management or other relevant parties
The standard has included a new requirement to consider matters regarding accounting estimates when communicating with those charged with governance.
The standard now requires that the auditor in applying ISA 260 (Revised) and ISA 265, to consider the matters, if any, to communicate regarding accounting estimates and take into account whether the reasons given to the risks of material misstatement relate to estimation uncertainty or the effects of complexity, subjectivity or other inherent risk factors in making account estimates and related disclosures.
Additionally, in certain circumstances, the auditor is required by law or regulation to communicate about certain matters with other relevant parties such as regulators or prudential supervisors.
6. Effective Date
ISA 540 (Revised) becomes effective for financial statement audits for periods beginning on or after December 15, 2019. Early adoption is permitted and encouraged.
Please visit the IAASB website for more information and Watch presentation on: http://www.ifac.org/news-events/2019-01/isa-540-revised-presentation