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You be the judge

Estimates, judgements and uncertainty are the most challenging aspects of any audit, but they offer an opportunity for many firms to improve the quality of their audit judgements, as Simon Kettlewell explains.

One of the most difficult, and therefore risky, aspects of an audit is dealing with estimates, judgements and uncertainty. It has been said many times that the only thing you know for certain about an estimate is that it is almost certain to be wrong; however it is important for the auditor to establish that an estimate is not materially wrong.

The quality of audit judgements is one of the principal areas where firms can improve their audit quality, according to Audit Essentials 2016, which summarises the findings from 700 audit-monitoring visits carried out in 2015 by ICAEW’s Quality Assurance Department (QAD). I have often noted in my file reviews that areas such as estimates, judgements and uncertainty are ignored, perhaps because they are deemed “too hard to audit”.

The theory

The International Standards on Auditing (ISAs) are a useful source of help in this area. ISA 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures includes some assistance for auditors when faced with estimation uncertainty.

Paragraph 13 of ISA 540 provides a list of suggested procedures to be carried out in response to the assessed risks of material misstatement (as required by ISA 330 The Auditor’s Responses to Assessed Risks).

Where the estimate or uncertainty represents a significant risk, paragraph 15 of ISA 540 mandates further procedures to be undertaken. One of the key requirements of ISA 540 is for the auditor to understand precisely how management has made the accounting estimate, including the assumptions used, and then to determine whether these are reasonable.

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