SA - 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, And Related Disclosures. -By Silky Parmanandka 1 BAS & CO. LLP
Introductjon Scope of This Section Scope of This Section This Standard on Auditing (SA) deals with the auditor’s responsibilities regarding This Standard on Auditing (SA) deals with the auditor’s responsibilities regarding accounting estimates, including fair value accounting estimates, and related accounting estimates, including fair value accounting estimates, and related disclosures in an audit of financial statements. Specifically, it expands on how SA disclosures in an audit of financial statements. Specifically, it expands on how SA 315 and SA 330 and other relevant SAs are to be applied in relation to accounting 315 and SA 330 and other relevant SAs are to be applied in relation to accounting estimates. It also includes requirements and guidance on misstatements of estimates. It also includes requirements and guidance on misstatements of individual accounting estimates, and indicators of possible management bias. individual accounting estimates, and indicators of possible management bias. Effective Date Effective Date This SA is effective for audits of financial statements for periods beginning on or This SA is effective for audits of financial statements for periods beginning on or after April 1, 2009. after April 1, 2009. 2 BAS & CO. LLP
What is Accountjng Estjmate? “Accountjng estjmate" means an approximatjon of the amount of an item in the absence of a “Accountjng estjmate" means an approximatjon of the amount of an item in the absence of a precise means of measurement. Management is responsible for making accountjng estjmates precise means of measurement. Management is responsible for making accountjng estjmates included in fjnancial statements. These estjmates are ofuen made in conditjons of uncertainty included in fjnancial statements. These estjmates are ofuen made in conditjons of uncertainty regarding the outcome of events that have occurred or are likely to occur and involve the use regarding the outcome of events that have occurred or are likely to occur and involve the use of judgement. As a result, the risk of material misstatement is greater when accountjng of judgement. As a result, the risk of material misstatement is greater when accountjng estjmates are involved. Examples are: estjmates are involved. Examples are: ♦ ♦ Allowances to reduce inventory and accounts receivable to their estjmated realisable Allowances to reduce inventory and accounts receivable to their estjmated realisable value. value. ♦ ♦ Provisions to allocate the cost of fjxed assets over their estjmated useful lives. Provisions to allocate the cost of fjxed assets over their estjmated useful lives. ♦ ♦ Accrued revenue. Accrued revenue. ♦ ♦ Provision for taxatjon. Provision for taxatjon. ♦ ♦ Provision for a loss from a lawsuit. Provision for a loss from a lawsuit. ♦ ♦ Insurer's liability for outstanding claims. Insurer's liability for outstanding claims. ♦ ♦ Losses on constructjon contracts in progress. Losses on constructjon contracts in progress. ♦ ♦ Amortjsatjon of certain items like goodwill and deferred revenue expenditure. Amortjsatjon of certain items like goodwill and deferred revenue expenditure. ♦ ♦ Provision to meet warranty claims. Provision to meet warranty claims. ♦ ♦ Provision for retjrement benefjts in the fjnancial statements of employers. Provision for retjrement benefjts in the fjnancial statements of employers. 3 BAS & CO. LLP
Nature of Accountjng Estjmate 4 BAS & CO. LLP
Types of Accountjng Estjmates Fair Value Accounting Estimates Other Accounting Estimates The Measurement objective of Fair Value All accountjng estjmates other than Fair Accounting Estimate is to estimate the value value accountjng estjmate is the Other of Financial Statement items based on Accountjng Estjmates. The measurement conditions prevalent on the measurement objectjve of these accountjng estjmates date (say, 31 st March or any interim period). can vary depending on the applicable Example: Net Realisable Value of any asset fjnancial reportjng framework and the or liability. fjnancial item being reported. Example: Example: 1. Depreciatjon Method or Useful life of Estimate of NRV of Inventory 1. Asset. Estimate of Revaluation / Impairment of 2. Provision of Bad and Doubtgul Debts 2. Asset. Contjngencies arising out of Litjgatjons 3. Estimate of futures and derivatives 3. Outcome of a Long Term Contract. 4. 4. Estimate of Equity Share Based Payments. 5 BAS & CO. LLP
Estjmatjon Uncertainty The Susceptibility of an accounting estimate to an inherent lack of precision in its measurement. The Susceptibility of an accounting estimate to an inherent lack of precision in its measurement. The degree of estimation uncertainty affects the risk that financial statements are materially The degree of estimation uncertainty affects the risk that financial statements are materially misstated and whether an estimate is particularly susceptible to management bias. misstated and whether an estimate is particularly susceptible to management bias. Evaluating the degree of estimation uncertainty Evaluating the degree of estimation uncertainty associated with an accounting estimate includes associated with an accounting estimate includes consideration of, for example: consideration of, for example: Level of Sensitivity to Extent to which the Level of Sensitivity to Extent to which the estimate is based on estimate is based on Judgement changes in Judgement changes in observable or observable or involved assumptions involved assumptions unobservable inputs unobservable inputs 6 BAS & CO. LLP
Auditor’s Objective Auditor’s Objective The objective of an auditor is to obtain sufficient The objective of an auditor is to obtain sufficient appropriate audit evidence regarding accounting appropriate audit evidence regarding accounting estimates in the context of the applicable Financial estimates in the context of the applicable Financial Reporting Framework: Reporting Framework: (a) accounting estimates, including fair (a) accounting estimates, including fair value accounting estimates, in the financial value accounting estimates, in the financial statements, whether recognised or statements, whether recognised or disclosed, are reasonable; and disclosed, are reasonable; and (b) related disclosures in the financial (b) related disclosures in the financial statements are adequate. statements are adequate. 7 BAS & CO. LLP
Risk Assessment Procedures and Related Actjvitjes When performing risk assessment procedures and related activities to obtain an understanding of When performing risk assessment procedures and related activities to obtain an understanding of the entity and its environment, including the entity’s internal control, as required by SA 315 the the entity and its environment, including the entity’s internal control, as required by SA 315 the auditor shall obtain an understanding of the following in order to provide a basis for the auditor shall obtain an understanding of the following in order to provide a basis for the identification and assessment of the risks of material misstatement for accounting estimates: identification and assessment of the risks of material misstatement for accounting estimates: • (a)The requirements of the applicable financial reporting framework relevant to accounting estimates, including related disclosures • (b) How management identifies those transactions, events and conditions that may give rise to the need for accounting estimates to be recognised 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. • (c) How management makes the accounting estimates, and an understanding of the data on which they are based, including: • (i) The method, including where applicable the model, used in making the accounting estimate; • (ii) Relevant controls; • (iii) Whether management has used an expert; • (iv) The assumptions underlying the accounting estimates; • (v) 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 • (vi) Whether and, if so, how management has assessed the effect of estimation uncertainty. 8 BAS & CO. LLP
Identjfying and Assessing the Risks of Material Misstatement In identifying and assessing the risks of material misstatement, as required by SA In identifying and assessing the risks of material misstatement, as required by SA 315, the auditor shall evaluate the degree of estimation uncertainty associated with an 315, the auditor shall evaluate the degree of estimation uncertainty associated with an accounting estimate. accounting estimate. The auditor shall determine whether, in the auditor’s judgement, any of those The auditor shall determine whether, in the auditor’s judgement, any of those accounting estimates that have been identified as having high estimation uncertainty accounting estimates that have been identified as having high estimation uncertainty give rise to significant risks. give rise to significant risks. 9 BAS & CO. LLP
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