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International Auditing and Assurance

Standards Board

Accounting Estimates, Including Fair

Value Accounting Estimates, andRelated Disclosures

ISA Implementation Support Module

Prepared by IAASB Staff

October 2009


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Introduction

Risk-Based Approach

Estimation Uncertainty

Responses to Assessed Risks

Indicators of Possible Management Bias

Disclosures Related to Accounting Estimates

Additional Aspects of ISA 540

SME Considerations

Overview

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Introduction

To increase the rigor and skepticism to be

applied in auditing accounting estimates

To provide enhanced guidance on estimationuncertainty and management bias

To conform with the risk-based approach

reflected in ISA 315 and ISA 330

IAASBs Objectives in Revising ISA 540

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Introduction

Principles in auditing fair values and more

traditional accounting estimates are the same

Application material in ISA 540 explains how

particular requirements are applied in the context of

both accounting estimates and fair values

More guidance has been added related to fair valueauditing considerations, including the use of models

Extant ISA 545 to be withdrawn

Application to Both Accounting Estimates

and Fair Value Accounting Estimates

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Risk-Based Approach

Understanding of how management makes theaccounting estimates, and of the underlying data

The method, including the applicable model, used and

changes in the method from the prior period

Relevant controls

Whether an expert has been used

The underlying assumptions

Whether and, if so, how management has assessed the

effects of estimation uncertainty

Risk Assessment Procedures

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Risk-Based Approach

ISA 540 expands on how ISAs 315, 330, andothers are to be applied to accounting estimates

Obtaining an understanding of the entity and its

environment, through risk assessment procedures

Based on that understanding, identifying and

assessing the risks of material misstatement

Obtaining sufficient appropriate audit evidenceregarding the assessed risks, through designing and

implementing appropriate responses to those risks

Risk-Based Approach

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Risk-Based Approach

Understanding of the requirements of theapplicable financial reporting framework

relevant to accounting estimates, including

related disclosures

Understanding of how management identifies

the need for accounting estimates to be

recognized or disclosed Includes making inquiries about changes in

circumstances that may give rise to new accounting

estimates or the need to revise existing ones


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Risk-Based Approach

Review the outcome of accounting estimatesincluded in the prior period financial statements

or, as applicable, their subsequent re-estimation

in the current periodNature and extent of review takes account of the

nature of the estimate and whether information to be

obtained is likely relevant to identifying and assessing

risks

Not intended to revisit prior judgments


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Risk-Based Approach

In identifying and assessing risks

Evaluate the degree of estimation uncertainty

associated with an accounting estimate

Determine whether, in the auditors judgment, any of

those accounting estimates that have been identified

as having high estimation uncertainty gives rise tosignificant risks

Identifying and Assessing Risks of Material

Misstatement

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The susceptibility of an accountingestimate to an inherent lack of precision in

its measurement

The degree of estimation uncertainty

affects the risk that the financial statements

are materially misstated and whether an

estimate is particularly susceptible tomanagement bias

Nature of Estimation Uncertainty

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Evaluating the degree of estimationuncertainty associated with an accounting

estimate includes consideration of, for

example,

Level of judgment involved

Sensitivity to changes in assumptions

Extent to which the estimate is based on

observable or unobservable inputs

Evaluation of Estimation Uncertainty

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Based on the assessed risks, determine

Whether management has appropriately applied

the requirements of the applicable financial

reporting framework

Whether the methods for making accounting

estimates are appropriate and applied consistently

If there have been changes in the method, are they

appropriate?

Responding to the Assessed Risks

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One or more of the following, taking account

of nature of the accounting estimate

Use of evidence from events occurring up to the

date of the auditors report

Testing of how management made the

accounting estimate and underlying data

Includes evaluation of measurement method and

reasonableness of assumptions


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Testing the operating effectiveness of controls,

together with appropriate substantive

procedures

Developing a point estimate or range to evaluate

managements point estimate

Remains necessary to understand managements

assumptions and methods

Range needs to be narrowed based on audit evidence

until all outcomes within the range are considered

reasonable


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Evaluate how management has considered

alternative assumptions or outcomes and why

they have been rejected, or how managementhas otherwise addressed estimation uncertainty

Evaluate whether the significant assumptions

used are reasonable

Where relevant, evaluate managements intent

and ability

Further Substantive Procedures to Respond

to Significant Risks

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Where necessary, develop a range to evaluate

reasonableness of the accounting estimate

Done when, in the auditors judgment,management has not adequately addressed the

effects of estimation uncertainty

Obtain sufficient appropriate audit evidenceregarding recognition and measurement

decisions

Further Substantive Procedures to Respond

to Significant Risks

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Review the judgments and decisions made bymanagement in making accounting estimates to

identify whether there are indicators of possible

management bias

Susceptibility of an estimate to management bias

increases with subjectivity involved

Indicators may affect auditors conclusion of

whether risk assessment or responses remainappropriate, but do not themselves constitute

misstatements for purposes of concluding on

reasonableness of individual estimates

Identifying Indicators

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Changes in an accounting estimate or method wheremanagement has made a subjective assessment that

there has been a change in circumstances

Use of an entitys own assumptions for fair value when

they are inconsistent with observable marketplace

assumptions

Selection or construction of significant assumptions

that yield a point estimate favorable to managementsobjectives

Selection of a point estimate that may indicate a pattern

of optimism or pessimism

Examples

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Disclosures Related to Accounting Estimates

Obtain sufficient appropriate audit evidenceabout whether disclosures related to accounting

estimates are in accordance with the applicable

financial reporting framework For estimates giving rise to significant risks,

also evaluate the adequacy of the disclosure of

estimation uncertainty in the context of theapplicable financial reporting framework

Disclosures

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Addi i l A f SA 40


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Obtain written representations regarding thereasonableness of significant assumptions used in

making accounting estimates

Representations alone do not constitute sufficientappropriate audit evidence

Guidance provided regarding additional

representations the auditor may consider dependingon nature, materiality, and extent of estimation

uncertainty

Written Representations

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Addi i l A f ISA 540


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Document

The basis for the auditors conclusions about

the reasonableness of accounting estimates and

their disclosure that give rise to significantrisks

Indicators of possible management bias, if any

Documentation

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SME C id i


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SME Considerations

Obtaining an understanding of how management (orowner-manager) identifies the need for accounting

estimates is often relatively straightforward

The ISA allows for different approaches forresponding to assessed risks depending on the nature

of the accounting estimate

In many cases (other than for fair value estimates),review of events occurring up to the date of the

auditors report may be an effective and efficient

approach

Applicability of the ISA to SME Audits

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Note

This set of support slides does not amend or override

the ISAs, the texts of which alone are authoritative.

Reading the slides is not a substitute for reading the

ISAs. The slides are not meant to be exhaustive and

reference to the ISAs themselves should always be

made. In conducting an audit in accordance with

ISAs, the auditor is required to comply with all the

ISAs that are relevant to the engagement.

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