ASA 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, And Related Disclosures – Effective date 01 Jan 2010

ASA 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, And Related Disclosures Requirements

Risk Assessment Procedures and Related Activities

ASA 540 require auditor to obtain following understanding as part of its understanding of entity under ISA 315;

The requirements of the applicable financial reporting framework relevant to accounting estimates, including related disclosures.
How management identifies those transactions, events and conditions that may give rise to the need for accounting estimates to be recognized or disclosed in the financial statements. In obtaining this understanding, the auditor shall make inquiries of management about changes in circumstances that may give rise to new, or the need to revise existing, accounting estimates.
How management makes the accounting estimates, and an understanding of the data on which they are based, including;
- The method, including where applicable the model, used in making the accounting estimate;
- Relevant controls;
- Whether management has used an expert;
- The assumptions underlying the accounting estimates;
- Whether there has been or ought to have been a change from the prior period in the methods for making the accounting estimates, and if so, why; and
- Whether and, if so, how management has assessed the effect of estimation uncertainty.

ASA 540 require auditor to review the outcome of accounting estimates included in the prior period financial statements, or, where applicable, their subsequent re- estimation for the purpose of the current period. The nature and extent of the auditor’s review takes account of the nature of the accounting estimates, and whether the information obtained from the review would be relevant to identifying and assessing risks of material misstatement of accounting estimates made in the current period financial statements.

However, the review is not intended to call into question the judgments made in the prior periods that were based on information available at the time.

Identifying and Assessing the Risks of Material Misstatement

ASA 540 require auditor to identifying and assessing the risks of material misstatement, as required by ISA 315 (Revised) the auditor shall evaluate the degree of estimation uncertainty associated with an accounting estimate.
ASA 540 require that the auditor shall determine whether, in the auditor’s judgment, any of those accounting estimates that have been identified as having high estimation uncertainty give rise to significant risks.

Responses to the Assessed Risks of Material Misstatement

ASA 540 require auditor that based on the assessed risks of material misstatement, the auditor shall determine;

Whether management has appropriately applied the requirements of the applicable financial reporting framework relevant to the accounting estimate; and
Whether the methods for making the accounting estimates are appropriate and have been applied consistently, and whether changes, if any, in accounting estimates or in the method for making them from the prior period are appropriate in the circumstances.

ASA 540 require auditor that In responding to the assessed risks of material misstatement, as required by ISA 330, the auditor shall undertake one or more of the following, taking account of the nature of the accounting estimate:

Determine whether events occurring up to the date of the auditor’s report provide audit evidence regarding the accounting estimate.
Test how management made the accounting estimate and the data on which it is based. In doing so, the auditor shall evaluate whether:
- The method of measurement used is appropriate in the circumstances; and
- The assumptions used by management are reasonable in light of the measurement objectives of the applicable financial reporting framework.
The assumptions used by management are reasonable in light of the measurement objectives of the applicable financial reporting framework.
Develop a point estimate or a range to evaluate management’s point estimate. For this purpose:
- If the auditor uses assumptions or methods that differ from management’s, the auditor shall obtain an understanding of management’s assumptions or methods sufficient to establish that the auditor’s point estimate or range takes into account relevant variables and to evaluate any significant differences from management’s point estimate.
- If the auditor concludes that it is appropriate to use a range, the auditor shall narrow the range, based on audit evidence available, until all outcomes within the range are considered reasonable.

ASA 540 require auditor that in determining the matters identified or in responding to the assessed risks of material misstatement, the auditor shall consider whether specialized skills or knowledge in relation to one or more aspects of the accounting estimates are required in order to obtain sufficient appropriate audit evidence.

Further Substantive Procedures to Respond to Significant Risks

Estimation Uncertainty

ASA 540 require auditor that for accounting estimates that give rise to significant risks, in addition to other substantive procedures performed to meet the requirements of ISA 330,7 the auditor shall evaluate the following:

How management has considered alternative assumptions or outcomes, and why it has rejected them, or how management has otherwise addressed estimation uncertainty in making the accounting estimate.
Whether the significant assumptions used by management are reasonable.
Where relevant to the reasonableness of the significant assumptions used by management or the appropriate application of the applicable financial reporting framework, management’s intent to carry out specific courses of action and its ability to do so.

ASA 540 require auditor that If, in the auditor’s judgment, management has not adequately addressed the effects of estimation uncertainty on the accounting estimates that give rise to significant risks, the auditor shall, if considered necessary, develop a range with which to evaluate the reasonableness of the accounting estimate.

Recognition and Measurement Criteria

ASA 540 require auditor that For accounting estimates that give rise to significant risks, the auditor shall obtain sufficient appropriate audit evidence about whether:

Management’s decision to recognize, or to not recognize, the accounting estimates in the financial statements; and
The selected measurement basis for the accounting estimates,

are in accordance with the requirements of the applicable financial reporting framework.

Evaluating the Reasonableness of the Accounting Estimates, and Determining Misstatements

ASA 540 requires that the auditor shall evaluate, based on the audit evidence, whether the accounting estimates in the financial statements are either reasonable in the context of the applicable financial reporting framework, or are misstated.

Disclosures Related to Accounting Estimates

ASA 540 require that the auditor shall obtain sufficient appropriate audit evidence about whether the disclosures in the financial statements related to accounting estimates are in accordance with the requirements of the applicable financial reporting framework.

ASA 540 require that the for accounting estimates that give rise to significant risks, the auditor shall also evaluate the adequacy of the disclosure of their estimation uncertainty in the financial statements in the context of the applicable financial reporting framework.

Indicators of Possible Management Bias

ASA 540 require that the auditor shall review the judgments and decisions made by management in the making of accounting estimates to identify whether there are indicators of possible management bias. Indicators of possible management bias do not themselves constitute misstatements for the purposes of drawing conclusions on the reasonableness of individual accounting estimates.

Written Representations

ASA 540 require that auditor shall obtain written representations from management and, where appropriate, those charged with governance whether they believe significant assumptions used in making accounting estimates are reasonable.

Documentation

ASA 540 require that auditor shall include in the audit documentation;

The basis for the auditor’s conclusions about the reasonableness of accounting estimates and their disclosure that give rise to significant risks; and
Indicators of possible management bias, if any.

ASA 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, And Related Disclosures Scope

ASA 540 deals with the auditor’s responsibilities relating to accounting estimates, including fair value accounting estimates, and related disclosures in an audit of financial statements. Specifically, it expands on how ISA 315 (Revised) and ISA 330 and other relevant ISAs are to be applied in relation to accounting estimates. It also includes requirements and guidance on misstatements of individual accounting estimates, and indicators of possible management bias.

ASA 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, And Related Disclosures Objective

The objective of the auditor is to obtain sufficient appropriate audit evidence about whether:

accounting estimates, including fair value accounting estimates, in the financial statements, whether recognized or disclosed, are reasonable; and
related disclosures in the financial statements are adequate, in the context of the applicable financial reporting framework.

ASA 540 – Definitions

Accounting estimate – Definition

An approximation of a monetary amount in the absence of a precise means of measurement. This term is used for an amount measured at fair value where there is estimation uncertainty, as well as for other amounts that require estimation. Where this ISA addresses only accounting estimates involving measurement at fair value, the term “fair value accounting estimates” is used.

Auditor’s point estimate or auditor’s range –Definition

The amount, or range of amounts, respectively, derived from audit evidence for use in evaluating management’s point estimate.

Estimation uncertainty –Definition

The susceptibility of an accounting estimate and related disclosures to an inherent lack of precision in its measurement.

Management bias –Definition

A lack of neutrality by management in the preparation of information.

Management’s point estimate –Definition

The amount selected by management for recognition or disclosure in the financial statements as an accounting estimate.

Outcome of an accounting estimate –Definition

The actual monetary amount which results from the resolution of the underlying transaction(s), event(s) or condition(s) addressed by the accounting estimate.