Requirements
ISA 230, Audit documentation (ISA 230), sets out the auditor’s objective to prepare documentation that provides a sufficient and appropriate record of the basis for the auditor’s report and evidence that the audit was planned and performed in accordance with ISAs and applicable legal and regulatory requirements. ISA 230 includes requirements on the form, content and extent of audit documentation required.
ISA 540, Auditing accounting estimates including fair value accounting estimates (ISA 540), and related disclosures, specifically requires audit documentation to include:
- the basis for the auditor’s conclusions about the reasonableness of accounting estimates and their disclosures that give rise to significant risks; and
- indicators of possible management bias, if any.
The documentation throughout the audit needs to demonstrate how the auditor has applied professional scepticism to the audit of accounting estimates. This will include details of how the auditor has challenged management, particularly around the method for making the accounting estimate, the appropriateness of the data used, and any assumptions used in this area. It further includes the subsequent follow up of explanations provided by management.
There are a number of key stages during the audit where the working papers will need to demonstrate compliance with these documentation requirements. The stages identified below represent commonly used terminology in audits. While some audits may not have separately identifiable stages such as these, the documentation requirements still need to be met in the audit working papers.
At the planning stage
There are a number of key matters that will need to be documented including:
- an understanding of requirements within the relevant accounting framework in respect of accounting estimates and the related disclosures;
- how management identifies the need for accounting estimates to be recognised or disclosed in the financial statements;
- how management calculates the accounting estimate, including the method or model used, underlying assumptions and any relevant controls that the entity has in place;
- whether management has used an expert to assist with the accounting estimate, or if there is any indication that an auditor’s expert may need to be engaged; and
- where management has used an expert, an evaluation of the expert’s competency, capability and objectivity.
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.
During the audit fieldwork
During the audit fieldwork, the documentation will need to demonstrate the auditor’s consideration of whether the accounting estimates in the financial statements are reasonable in the context of the applicable financial reporting framework, or are materially misstated. It also needs to demonstrate reasons for the conclusions reached.
The documentation should clearly demonstrate the testing strategy, the audit evidence obtained during the course of the audit and the conclusions drawn from the results of the tests performed. In particular, the documentation should demonstrate the consideration of whether:
- management has applied the requirements of the applicable financial reporting framework relevant to the accounting estimate;
- the methods for making the accounting estimates are appropriate and have been applied consistently;
- the inputs used in the development of an accounting estimate are valid; and
- changes, if any, in accounting estimates or in the method for making them from the prior period are appropriate in the circumstances.
It is important to consider the consistency of assumptions used by management across accounting estimates. For example, management might make assumptions about cash flows and future growth to support an impairment assessment and to support its going concern assessment. The expectation is that the assumptions for both analyses would be consistent. The audit documentation should evidence the auditor’s consideration of the consistency of such assumptions.
Where an estimate has been identified as a significant risk, the audit documentation should include details of how management has considered alternative assumptions or outcomes, and why they have been rejected. It should also include how management has otherwise addressed the estimation uncertainty (eg, sensitivity analysis) in making the estimate and the auditor’s evaluation of this. The audit documentation also needs to include an evaluation of whether significant assumptions used by management are reasonable.
At the completion stage
The documentation should demonstrate how the auditor has assessed whether the disclosures in the financial statements relating to accounting estimates are in accordance with the requirements of the applicable financial reporting framework, including any requirement necessary to achieve fair presentation. The application material in ISA 540 provides further guidance here. The documentation should also evidence that the balances and disclosures in the final approved financial statements agree with the audit working papers.
For accounting estimates that give rise to significant risks of material misstatement, the documentation also needs to demonstrate how the adequacy of the disclosure of the estimation uncertainty in the financial statements has been evaluated.
Any uncorrected misstatements identified during the audit of accounting estimates should be recorded, evaluated and concluded upon in accordance with ISA 450, Evaluation of misstatements identified during the audit (ISA 450).
Written representations should be obtained from management, and, where appropriate, those charged with governance concerning accounting estimates. These representations will need to include whether management or, where appropriate, those charged with governance believe significant assumptions used in making accounting estimates are reasonable. They might include some or all of the following matters:
- the appropriateness of the recognition and measurement criteria for accounting estimates in the financial statements;
- the appropriateness and consistency of the assumptions and models used to make the estimates;
- the completeness and appropriateness of the disclosures in the financial statements; and
- confirmation that there are no subsequent events that may lead to an adjustment of the accounting estimate and disclosures.
Finally, consideration should be given to whether there are any matters arising from the audit of accounting estimates that need to be communicated to those charged with governance.
