Auditing the Use of Estimates and Specialists
Jennifer A. Kartychak, CPA, CGMA
Monday, August 13, 2018
Complex accounting estimates — such as allowances for doubtful accounts, impairments of long-lived assets, and valuations of financial and nonfinancial assets — have been the source of many high-profile accounting scams and restatements. Estimates generally involve some level of measurement uncertainty, and some may even require the use of outside specialists, such as appraisers or engineers.
As a result, examining estimates is a critical part of an audit. Here’s what companies need to know about auditing the use of estimates.
Some estimates may be easily determinable, but many are inherently complex. Auditing standards generally provide the following three approaches for substantively testing accounting estimates and fair value measurements:
- Test management’s process. Auditors evaluate the reasonableness and consistency of management’s assumptions, as well as test whether the underlying data is complete, accurate and relevant.
- Develop an independent estimate. Using management’s assumptions (or alternate assumptions), auditors calculate an estimate to compare to amounts reported on the financial statements.
- Review subsequent events. The reasonableness of estimates can be gauged by looking at events or transactions that happen after the balance sheet date but before the date of the auditors’ report.
All three approaches might not necessarily be appropriate for every estimate. For each estimate, the auditor typically selects one or a combination of these approaches.
Proposals to enhance the auditing standards for the use of accounting estimates and the work of specialists remain top priorities of the Public Company Accounting Oversight Board (PCAOB). Earlier this summer, Chairman William Duhnke told the PCAOB’s Standard Advisory Group (SAG) that he hopes to complete these projects in the coming months. The updated auditing standards would help reduce diversity in practice, provide more specific direction and be better aligned with the risk assessment standards.
Improvements on the audit standards for the use of estimates and the work of specialists could be coming soon. Companies should inquire as to developments to determine whether additional information will be required during the audit engagement.
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Jennifer's expertise spans a variety of service offerings and industries. She rejoined Lumsden McCormick in 2016 after spending ten years in management positions with both a Big 4 accounting firm and, most recently, a multinational publicly traded manufacturer. Her extensive service offerings include the areas of technical accounting matters, SEC reporting, employee benefit plans, financial statement audits, policies and procedures, internal controls, Sarbanes-Oxley compliance, risk assessment, operations management, compliance audits, internal audits and information technology audits.