Overview of key changes and challenges
The revised standard is intended to be scalable for all types of estimates. Those auditing less complex and/or less risky estimates will need to consider the application material in the revised ISA and think about how the standard can be scaled for this work.
ISA 540 (Revised) also places additional emphasis on scepticism. 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. It is also important when there is greater susceptibility to misstatement due to management bias or fraud. But what practically does this mean for your audit, and in particular, the auditors’ approach to management bias?
Alongside this there is more to do in the following areas:
More focus on risk assessment
The risk assessment requirements have been strengthened and auditors will need to get to grips with:
- 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 need for separate inherent and control risk assessments 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.
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.
A new overall evaluation requirement on disclosures
Auditors will be required to assess whether the estimates and related disclosures are reasonable or misstated.
More documentation
More prescriptive 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.
Reporting to those charged with governance
There are also specific requirements in relation to communicating with those charged with governance.
What next?
We will be exploring what additional implementation support may be needed to address these challenges, including practical guidance, examples and webinars.
