General documentation requirements
ISA 230 Audit documentation, 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.
Specific documentation requirements for estimates
ISA 540 (Revised) specifically requires audit documentation to include:
- the key elements of the auditor’s understanding of the entity and its environment, including internal control relating to accounting estimates;
- the linkage of further audit procedures to the assessed risk of material misstatement at the assertion level;
- the response to situations where management has not taken appropriate steps to understand and address estimation uncertainty;
- indicators of possible management bias, if any and the auditor’s evaluation of the implications for the audit; and
- significant judgements made in the determination of whether the accounting estimates and related disclosures are reasonable, or are misstated, in the context of the applicable financial reporting framework.
It is particularly important that the documentation demonstrates how the auditor has exercised professional scepticism throughout the audit.
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
The auditor needs to follow the requirements of ISA 315 (Revised) Identifying and assessing the risks of material misstatement through understanding the entity and its environment and ISA 330 The auditor’s responses to assessed risk in documenting the understanding of the entity, risk assessments and responses to assessed risks. In the context of accounting estimates this documentation is likely to include key elements in relation to:
- The auditor’s understanding of the entity and its environment relating to accounting estimates, including:
- an understanding of the entity’s transactions and other events and conditions that may give rise to the need for, or changes in, accounting estimates to be recognised or disclosures;
- the requirements within the relevant financial reporting framework in respect of accounting estimates;
- regulatory factors or frameworks, if any, that are relevant to the entity’s accounting estimates; and
- the nature of accounting estimates and related disclosures that the auditor would expect to see in the entity’s financial statements based on its understanding of the entity.
- The entity’s internal control over those estimates, including:
- the nature and extent of oversight over the financial reporting process;
- how risks are identified and addressed;
- how management identifies the need for or applies specialised skills;
- the entity’s information system as it relates to estimates. For classes of transactions, events and conditions that are significant and give rise to the need for estimates:
- how management identifies, selects and applies the relevant methods, assumptions or sources of data that are appropriate; and
- how management understands the degree of, and addresses, estimation uncertainty;
- relevant control activities over management’s process for making accounting estimates; and
- how management reviews the outcome of previous accounting estimates and responds.
- The auditor’s judgements about the assessed risks of material misstatement relating to accounting estimates, including the reasons given to the risks (whether they relate to one or more inherent risk factor or control risk) and consideration of whether any of these risks represent a significant risk. Where an estimate has been identified as a significant risk, the audit documentation should include the auditor’s understanding of the entity’s controls, including control activities, relevant to that risk. The auditor is not, however, required to document how every inherent risk factor was taken into account in identifying and assessing the risks of material misstatement in relation to each estimate.
- The auditor is also required to document their review of the outcome of previous accounting estimates or their subsequent re-estimation to assist in identifying and assessing the risks of material misstatement in the current period.
During the audit fieldwork
During the audit fieldwork, the documentation should show the audit evidence obtained during the course of the audit and the conclusions drawn from the results of the further audit procedures performed. In particular, the documentation needs to:
- demonstrate how the further audit procedures selected responded to the assessed risks of material misstatement and the reasons given for the assessment of those risks;
- explain the auditor’s response when management has not taken appropriate steps to understand and address estimation uncertainty; and
- include the indicators of possible management bias related to accounting estimates, and implications for the audit.
The application material in ISA 540 (Revised) also notes that the auditor may consider documenting:
- where management’s application of the method involves complex modelling: whether management’s judgements have been applied consistently and, where relevant, whether the model design meets the financial reporting framework measurement objective; and
- where the selection and application of methods, significant assumptions or the data is affected by complexity to a higher degree: the auditor’s judgements as to whether there is a need for specialised skills/knowledge.
At the completion stage
The documentation should demonstrate the auditor’s significant judgements in determining whether the accounting estimates and related disclosures in the financial statements are reasonable in the context of the applicable financial reporting framework, or are misstated.
The documentation should also evidence that the balances and disclosures in the final approved financial statements agree with the audit working papers.
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.
Written representations should be obtained from management, and, where appropriate, those charged with governance about whether the methods, significant assumptions and the data used in making the accounting estimates and the related disclosures are appropriate to achieve recognition, measurement or disclosure that is in accordance with the applicable financial reporting framework. The auditor also needs to consider whether to obtain representation about specific estimates which may include matters such as:
- that significant judgements made in making estimates have taken account of all relevant information of which management is aware;
- the appropriateness and consistency in the selection or application of the methods, assumptions and data used;
- that the assumptions reflect management’s intent and ability to carry out specific actions;
- the completeness and reasonableness of the disclosures in the financial statements, including those describing estimation uncertainty;
- that appropriate skills or expertise has been applied in making the estimates;
- confirmation that there are no subsequent events that may lead to an adjustment of the accounting estimate and disclosures; and
- the appropriateness of management’s decision that the recognition or disclosure criteria of the financial reporting framework have not been met, where estimates are not recognised or disclosed.
Communication with those charged with governance
In accordance with ISA 260 (Revised) Communication with those charged with governance, the auditor is required to communicate with those charged with governance about significant qualitative aspects of the entity’s accounting practices relating to accounting estimates and related disclosures. Appendix 2 to ISA 540 (Revised sets out matters relating to accounting estimates that the auditor may wish to include.
Professional Scepticism
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 selection and application of methods, assumptions and data in making the accounting estimates. It further includes the subsequent follow up and corroboration of explanations provided by management.
Examples of documentation that may provide evidence of professional scepticism in the area of accounting estimates might include:
- how the auditor evaluated audit evidence and the judgements that were made in forming a conclusion as to the sufficiency and appropriateness of the audit evidence obtained, taking into account all evidence obtained, whether corroborative or contradictory;
- how the auditor has applied an understanding in developing the auditor’s own expectation of an accounting estimate and disclosures to be included in the financial statements and how that expectation compares with the financial statements prepared by management; and
- how the auditor has designed procedures that address indicators of possible management bias.
