There are important changes to three audit standards affecting 31 December 2020 audits. One of the changes will result in a new template for company reports (more on this in coming weeks) and all three standards will trigger the need to change audit programmes in line with the new requirements.

This week we will deal with the first of these changes regarding the audit of estimates. In these Covid times there are plenty of estimates that may be based on less than ideal foundations e.g. inventory obsolescence, revenue recognition on long-term contracts and impairment of long-lived assets, to name but a few. IAASA have just issued a discussion paper on the Audit of Accounting Estimates (23 November 2020) in which they give examples of good and poor practice in collecting audit evidence about estimates.

Main changes to ISA 540 Auditing Estimates and Related Disclosures

There are significant changes to this standard for the audits of accounting periods commencing on/after 15 December 2019. It has 27 requirements versus 16 in the previous standard, along with 152 paragraphs of application material versus 128 in the old standard.

The key changes are that:

  • The standard enhances the “stand back” requirement for auditors to assess estimates including both corroborative and contradictory audit evidence.
  • There is greater emphasis placed on the need for the auditor to display, in writing, professional scepticism about the managements’ estimates and estimation techniques.
  • A more detailed assessment is required of accounting estimates that could be materially misstated. This will need corroborated with written documentation. The application material contains an extensive list of examples of estimates that are likely to arise in the preparation of financial statements.
  • A greater focus is placed on the level of response by the auditor to estimation uncertainty, complexity and subjectivity when preparing accounting estimates, including the assessment of management bias.
  • The auditor is expected to document the auditor’s own estimate, assess subsequent events and document a more detailed understanding of the significant matters involved which influenced management’s key judgments and decision making.
  • A greater degree of audit work is expected on the audit file to show that the work underpinning the disclosure of accounting estimates in the financial statements is sufficiently robust.
  • All of the above needs to be supported by detailed written representations from management.

An example of poor practice from the IAASA Discussion Paper includes over-reliance by an auditor on a spreadsheet provided by the company’s administrator to support fair value pricing calculations where financial assets were a key risk. There was insufficient evidence of the auditor performing procedures to check the accuracy and completeness of the information provided within this spreadsheet.

These changes come into effect for the audit of accounting periods commencing 15 December 2019 which in practical terms means audits for periods ending 31 December 2020. An associated Technical Alert called ‘Information and support in implementing the revised ISA 540’ has just been issued by Chartered Accountants Ireland.

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