Implementation Tool for Auditors

Transcription

1 CANADIAN AUDITING STANDARDS IMPLEMENTATION PRACTITIONER SUPPORT STANDARD DISCUSSED 540, Auditing accounting estimates, including fair value accounting estimates, and related disclosures Auditing Accounting Estimates Under s: What, Why and How? There are many steps involved in auditing accounting estimates; find in this a one-page diagram that shows the main steps required. It is easily detachable and useful as a reminder. This () will help you implement the Canadian Auditing Standards (s) requirements auditing accounting estimates. The provides, in a practical tabular mat, a list of the steps required in auditing accounting estimates. You will need to adapt the to the specific circumstances of your audit engagement. 540: focuses auditors attention on areas of higher risks in accounting estimates; adopts a risk-based approach to the audit of accounting estimates, including fair value accounting estimates (in other words, it expands on how 315, 330 and other relevant s are to be applied to accounting estimates); emphasizes the importance of professional skepticism and ensuring that appropriate attention is paid to indicators of possible management bias and their audit implications. If, during the planning phase or later during your audit, you determine that there is a risk of material misstatement a particular accounting estimate, you will need to assess the estimation uncertainty to determine the timing, nature and extent of work you need to complete. This implies understanding how management makes the estimates and the data on which they are based, as well as other specific elements listed in 540. Practitioner Support Canadian Auditing Standards 1

2 Diagram Main steps in auditing accounting estimates under 540 when a risk of material misstatement exists 1 Obtain an understanding of management process accounting estimates [ 540.8] Identification and assessment of risks of material misstatements accounting estimates 2 Perm a retrospective review [ 540.9] 3 Evaluate the degree of estimation uncertainty [ ] Not high High 4 Determine if there is a significant risk of material misstatement [ and.11] Not significant Significant Response to assessed risks Evaluation of reasonableness of estimates and management bias Audit documentation and written representations 5a Evaluate application of requirements of the AFRF,* consistency in methods and basis changes [ ] Perm one or more of the four responses [ ] 6 Evaluate reasonableness of accounting estimates and disclosures and identify whether there are indicators of possible management bias [ ] 7 Obtain written representations [ ] 8 Document audit file [ ] 5b Perm procedures in response to identified significant risks: o Obtain an understanding of the entity's controls, including control activities relevant to that risk [ ] o Perm 5a o Perm the further substantive procedures [ ] *AFRF: Applicable Financial Reporting Framework An accounting estimate that has a high degree of estimation uncertainty and a significant risk of material misstatement requires you to perm more audit procedures and to obtain a more robust understanding of the entity s controls, including control activities relevant to that risk. Practitioner Support Canadian Auditing Standards 2

3 How do you use the? The illustrates, with a focus on the what, why and how, the steps to be permed under 540 in auditing accounting estimates when a risk of material misstatement exists. The also lists the relevant s to s. The WHAT column requirements The lists the steps outlined in 540 that you, as the auditor, shall perm. You may also have steps to perm under other s related to accounting estimates, which are, however, not covered in this (e.g., you shall communicate with those charged with governance your views about significant qualitative aspects of the entity s accounting practices, including accounting estimates, as required by 260, paragraph 16a). The HOW column Suggested practical considerations perming the step In practice, the actions taken to perm a step will vary with the circumstances. For example, 1, how deep an understanding of management s process you need will be based on your professional judgment; your primary consideration is to obtain an understanding sufficient the identification of risks of material misstatement and their assessment, which will provide a basis designing and implementing responses to them. The depth of understanding required will be less than what management needs to manage the entity. The WHY column Suggested reasons perming the step The sets out some rationale taking the steps to be permed. For example, perming 1 assists you in developing an expectation of the nature and type of accounting estimates that an entity may have. The explanations provided in the are not necessarily complete, however. You may have other objectives or reasons perming a step in your particular audit engagement. Practitioner Support Canadian Auditing Standards 3

4 ( requirements) perming the step) perming the step) 1 Obtain an understanding of management process accounting estimates 540 paragraph 8 You shall obtain an understanding of the following elements: the requirements of the applicable financial reporting framework relevant to accounting estimates; how management identifies the accounting estimates to be recognized or disclosed in the financial statements; how management makes accounting estimates; data on which accounting estimates are based, including: the method or model used; To assess the complexity and amount of the judgment made by management. To assist in developing an expectation of the nature and type of accounting estimates that an entity may have. To assess risks of material misstatements. How deep an understanding of management s process is needed will be based on your professional judgment; your primary consideration is to obtain an understanding sufficient the identification of risks of material misstatement and their assessment, which will provide a basis designing and implementing responses to them. The depth of understanding required will be less than what management needs to manage the entity. You may review management s documentation of their process. You may inquire about all required elements this understanding. You will have to ensure that management s answers are consistent with what you are expecting based on your knowledge of the client and the industry. If there are contradictions, you will have to investigate further. relevant controls; management s use of an expert; You may review some controls that management described in the process making accounting estimates. the underlying assumptions; whether there has been, or ought to have been, a change in the methods from the prior period; and how management has assessed the effect of estimation uncertainty. Practitioner Support Canadian Auditing Standards 4

5 ( requirements) perming the step) perming the step) 2 Perm a retrospective review 540 paragraph 9 You shall perm a retrospective review of management judgments and assumptions related to significant accounting estimates reflected in the financial statements of the prior year. To assess whether management s estimation process is an effective process. To identify possible management bias. To identify audit evidence that is pertinent to the re-estimation, in the current period, of prior period accounting estimates. To identify audit evidence of matters, such as estimation uncertainty, that may be required to be disclosed in the financial statements. How you will perm your retrospective review will vary with the circumstances; example, if you are able to compare actual amounts to the accrual amounts or not, if the accounting estimate identified has high estimation uncertainty or if the accounting estimate has changed from the prior period. When there is no actual amount to compare with the accrual amount, you may consider the following elements your review: Were there any changes in the assumptions or models? If so, why? Are the underlying assumptions in the models still appropriate? Are there any activities missing from the model? You will have to ensure that the answers provided by management are consistent with what you are expecting based on your knowledge of the client and the industry. If there are contradictions, you will have to investigate further. To assess risks of material misstatements. Prior year estimates with high estimation uncertainty may require a more detailed review than accounting estimates arising from routine and recurring transactions. For accounting estimates that arise from routine and recurring transactions, you may judge that the application of analytical procedures as risk assessment procedures is sufficient purposes of your review. Retrospective review is not intended to call into question the judgments made in the prior periods that were based on inmation available at the time. Practitioner Support Canadian Auditing Standards 5

6 ( requirements) perming the step) perming the step) 3 Evaluate the degree of estimation uncertainty 540 paragraph 10 You shall evaluate the degree of estimation uncertainty associated with an accounting estimate. To provide a basis designing and perming audit procedures. You may consider: the extent to which the accounting estimate depends on judgment; The degree of estimation uncertainty affects the risk that the financial statements are materially misstated. the sensitivity of the accounting estimate to changes in assumptions; the existence of recognized measurement techniques that may mitigate the estimation uncertainty; To assess risks of material misstatements. the length of the ecast period, and the relevance of data drawn from past events to ecast future events; To evaluate the estimate s susceptibility to bias. the availability of reliable data from external sources; the extent to which the accounting estimate is based on observable or unobservable inputs; the actual or expected magnitude of an accounting estimate; the recorded amount of the accounting estimate (that is, management s point estimate) in relation to the amount you expected to be recorded; whether management has used an expert in making the accounting estimate; the outcome of the review of prior period accounting estimates. Practitioner Support Canadian Auditing Standards 6

7 ( requirements) perming the step) perming the step) 4 Determine if there is a significant risk of material misstatement 540 paragraph paragraphs If you conclude that an accounting estimate has a high degree of estimation uncertainty, you must perm 4. You shall determine whether, in your judgment, any of the accounting estimates you identified as having high estimation uncertainty give rise to significant risks. To provide a basis designing and perming further substantive procedures to respond to significant risks. In exercising judgment as to which risks are significant, you shall consider at least the following: whether the risk is a risk of fraud; whether the risk is related to recent significant economic, accounting or other developments and, theree, requires specific attention; the complexity of transactions; whether the risk involves significant transactions with related parties; the degree of subjectivity in the measurement of financial inmation related to the risk, especially measurements involving a wide range of measurement uncertainty; and whether the risk involves significant transactions that are outside the normal course of business the entity, or that otherwise appear to be unusual. In exercising this judgment, you shall exclude the effects of identified controls related to the risk. 5a Evaluate application of requirements of the AFRF (applicable financial reporting framework, consistency in methods and basis changes) 540 paragraphs a applies to all levels of assessed risks. You shall determine: whether management has appropriately applied the requirements of the applicable financial reporting framework (AFRF) relevant to the accounting estimate; and To assist in obtaining sufficient appropriate audit evidence about the assessed risks of material misstatement, through designing and implementing appropriate responses to those risks. You shall consider whether you need specialized skills or knowledge dealing with one or more aspects of the accounting estimates in order to obtain sufficient appropriate audit evidence. If management has used an expert, you may need your own expert. How many responses should be permed depends on the situation. Your decision as to which response or combination of responses to the assessed risks of material misstatement to undertake may be influenced by matters such as: Practitioner Support Canadian Auditing Standards 7

8 ( requirements) perming the step) perming the step) Perm one or more of the four responses whether the methods making the accounting estimates are appropriate and have been applied consistently, and whether changes, if any, in accounting estimates or in the method making them from the prior period are appropriate in the circumstances. You shall undertake one or more of the following four responses to respond to assessed risks of material misstatement: Response 1: Determine whether subsequent events (occurring up to the date of the auditor s report) provide evidence about the accounting estimate. the nature of the accounting estimate, including whether it arises from routine or non-routine transactions; whether the procedure(s) is expected to effectively provide you with sufficient appropriate audit evidence (e.g., has there been a subsequent event (occurring up to the date of the auditor s report) to support the estimate, or does management have effective controls in place?); the assessed risk of material misstatement, including whether the assessed risk is a significant risk. Response 1 may be appropriate when events up to the date of the auditor s report are expected to occur and provide audit evidence that confirms or contradicts the accounting estimate. Response 2 may be appropriate Response 2: Test how management made the accounting estimate and the data on which it is based, and evaluate whether the method of measurement used is appropriate and the assumptions used are reasonable. Response 3: Test the operating effectiveness of relevant controls over the accounting estimate, together with appropriate substantive procedures. when the accounting estimate is: a fair value accounting estimate developed on a model; derived from the routine processing of data by the entity s accounting system; based on a large population of items of a similar nature that individually are not significant. when your review of similar accounting estimates made in the prior period financial statements suggests that management s current period process is likely to be effective. Practitioner Support Canadian Auditing Standards 8

9 ( requirements) perming the step) perming the step) Response 4: Develop a point estimate or a range to evaluate management s point estimate. Response 3 may be appropriate when: controls exist the review and approval of the accounting estimates by appropriate levels of management and, where appropriate, by those charged with governance; the accounting estimate is derived from the routine processing of data by the entity s accounting system. Response 3 is required when: your assessment of risks of material misstatement at the assertion level includes an expectation that controls over the process are operating effectively (that is, you intend to rely on the operating effectiveness of controls in determining the nature, timing and extent of substantive procedures); or substantive procedures alone do not provide sufficient appropriate audit evidence at the assertion level. Response 4 may be appropriate when: an accounting estimate is not derived from the routine processing of data by the accounting system; your review of similar accounting estimates made in the prior period financial statements suggests that management s current period process is unlikely to be effective; Practitioner Support Canadian Auditing Standards 9

10 ( requirements) perming the step) perming the step) the entity s controls within and over management s processes determining accounting estimates are not well designed or properly implemented; events or transactions between the period end and the date of the auditor s report contradict management s point estimate; there are alternative sources of relevant data available to you that can be used to develop a point estimate or a range. 5b Perm procedures in response to identified significant risks 540 paragraphs paragraph 29 If you conclude that an accounting estimate gives rise to a significant risk: You shall obtain an understanding of the entity s controls, including control activities relevant to that risk. You must perm 5a. You shall obtain sufficient appropriate audit evidence about whether: management s decision to recognize (or not) the accounting estimates in the financial statements is in accordance with the requirements of the applicable financial reporting framework; and To evaluate how management has assessed the effect of estimation uncertainty on the accounting estimate, and the effect such uncertainty may have on the appropriateness of the recognition of the accounting estimate in the financial statements and the adequacy of related disclosures. Considerations substantive procedure 1: Depending on the circumstances, management may evaluate alternative assumptions or outcomes of the accounting estimates through a number of methods (e.g., sensitivity analysis). No one particular method of addressing estimation uncertainty is more suitable than another. Management s consideration of alternative assumptions or outcomes need not necessarily be conducted through a detailed process supported by extensive documentation. Where management has not considered alternative assumptions or outcomes, you may consider it necessary to discuss with management, and request support, how it has addressed the effects of estimation uncertainty on the accounting estimate. the selected measurement basis the accounting estimates is in such accordance. Practitioner Support Canadian Auditing Standards 10

11 ( requirements) perming the step) perming the step) In addition to designing and perming substantive procedures each material class of transactions, account balance, and disclosure, you 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 (substantive procedure 1). Whether the significant assumptions used by management are reasonable (substantive procedure 2). 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 (substantive procedure 3). If, in your judgment, management has not adequately addressed the effects of estimation uncertainty, you shall, if considered necessary, develop a range with which to evaluate the reasonableness of the accounting estimate. To evaluate: whether the measurement of the accounting estimate is sufficiently reliable to meet the recognition criteria of the applicable financial reporting framework ( recognized accounting estimate); whether the recognition criteria of the applicable financial reporting framework have in fact been met ( an accounting estimate not recognized). Considerations substantive procedure 2: When there are no mal established processes, you may be able to evaluate the significant assumptions through inquiries of and discussions with management, along with other audit procedures, to obtain sufficient appropriate audit evidence. When there are mal established processes, support significant assumptions derived from management s knowledge may be obtained from management s continuing processes of strategic analysis and risk management. When considering whether or not the assumptions used by management are reasonable in light of the measurement objectives of the applicable financial reporting framework, your evaluation of the significant assumptions used by management is based only on inmation available to you at the time of the audit. For this evaluation, you may consider whether: individual assumptions appear reasonable; the assumptions are interdependent and internally consistent; the assumptions appear reasonable when considered collectively or in conjunction with other assumptions, either that accounting estimate or other accounting estimates; the assumptions appropriately reflect observable marketplace assumptions, in the case of fair value accounting estimates. Practitioner Support Canadian Auditing Standards 11

12 ( requirements) perming the step) perming the step) Considerations substantive procedure 3: When management s intent to carry out specific courses of action and its ability to do so is relevant your evaluation of the reasonableness of the significant assumptions, you may: review management s history of carrying out its stated intentions; review written plans and other documentation, including, where applicable, mally approved budgets, authorizations or minutes; inquire about management s reasons a particular course of action; review events occurring subsequent to the date of the financial statements and up to the date of the auditor s report; evaluate the entity s ability to carry out a particular course of action given its economic circumstances, including the implications of its existing commitments. Practitioner Support Canadian Auditing Standards 12

13 ( requirements) perming the step) perming the step) 6 Evaluate reasonableness of accounting estimates and disclosures and identify whether there are indicators of possible management bias 540 paragraphs At the end of the estimation process, you shall evaluate, in the context of the applicable financial reporting framework, and based on the audit evidence: whether the accounting estimates in the financial statements are either reasonable or misstated; whether the disclosures in the financial statements related to accounting estimates are in accordance with the requirements of the applicable financial reporting framework; accounting estimates that give rise to significant risks, the adequacy of the disclosure of their estimation uncertainty in the financial statements. You shall review management s judgments and decisions in making accounting estimates to identify whether there are indicators of possible management bias. To assist in concluding on the reasonableness of accounting estimates and disclosures. To assist in determining misstatements. To assist in the evaluation of whether the financial statements as a whole are free from material misstatement. To identify whether there are indicators of possible management bias, you will need to look at the broad picture, taking into account all accounting estimates. Management bias can be difficult to detect at an account level. It may be identifiable only when considered in the aggregate of groups of accounting estimates or all accounting estimates. You may need to develop a tool or a template that will include all accounting estimates. You will look a pattern in the way estimates are made. Does this pattern meet management s objective, e.g., is there a bias to reduce revenue to reduce income tax? The susceptibility of an accounting estimate to management bias increases with the degree of estimation uncertainty involved in making it. To identify whether there are indicators of possible management bias, you may consider the following indicators: changes in an accounting estimate, or the method making it, when management has made a subjective assessment that there has been a change in circumstances; use of an entity s own assumptions fair value accounting estimates when they are inconsistent with observable marketplace assumptions; selection or construction of significant assumptions that yield a point estimate favourable management objectives; selection of a point estimate that may indicate a pattern of optimism or pessimism. Practitioner Support Canadian Auditing Standards 13

14 ( requirements) perming the step) perming the step) Your evaluation of the reasonableness of the estimates is based on the audit evidence obtained and using your expertise (e.g., your understanding of the entity and its industry) and professional skepticism. Evaluating the reasonableness of accounting estimates and related disclosures included in the notes to the financial statements, whether required by the applicable financial reporting framework or disclosed voluntarily, involves essentially the same types of considerations applied when auditing an accounting estimate recognized in the financial statements. 7 Obtain written representations 540 paragraph 22 You shall obtain written representations from management and, where appropriate, from those charged with governance, whether they believe significant assumptions used in making accounting estimates are reasonable, as near as practicable to, but not after, the date of the auditor s report on the financial statements. To provide necessary audit evidence. (The representations do not, however, provide sufficient appropriate audit evidence on their own about any of the matters they cover.) In addition to obtaining required written representations, you may need to obtain a written representation from management: about the appropriateness of the measurement processes, including related assumptions and models, management uses in determining accounting estimates in the context of the applicable financial reporting framework, and the consistency in application of the processes; that the assumptions appropriately reflect management s intent and ability to carry out specific courses of action on behalf of the entity, where relevant to the accounting estimates and disclosures; that disclosures related to accounting estimates are complete and appropriate under the applicable financial reporting framework; that no subsequent event requires adjustment to the accounting estimates and disclosures included in the financial statements. Practitioner Support Canadian Auditing Standards 14

15 ( requirements) perming the step) perming the step) 8 Document audit file 540 paragraph paragraphs 8 and 11 You shall document the basis your conclusions about the reasonableness of the accounting estimates and their disclosure that give rise to significant risks and indicators of possible management bias, if any. To assist in concluding whether the auditor s risk assessment and related responses remain appropriate, and in evaluating whether the financial statements as a whole are free from material misstatement. Your documentation will have to demonstrate that you have permed the requirements above. If it is not documented, it is not done! If you identified inmation that is inconsistent with your final conclusion on a significant matter related to an accounting estimate, you shall document how you addressed the inconsistency. You shall prepare audit documentation that is sufficient to enable an experienced auditor, having no previous connection with the audit, to understand: the nature, timing and extent of the audit procedures permed to comply with s and applicable legal and regulatory requirements; the results of the audit procedures permed and the audit evidence obtained; and significant matters arising during the audit, the conclusions reached on them and the significant professional judgments made in reaching those conclusions. Practitioner Support Canadian Auditing Standards 15

16 Resources Visit the Canadian Institute of Chartered Accountants website at where you will find useful resources related to your audit of accounting estimates: Client Briefing The Importance of Effective Two-Way Communication Between the Auditor and the Client (i.e., Those Charged with Governance) Communications Between the Auditor and Those Charged with Governance: What, When and How? FAQ Questions Frequently Ask When Implementing Requirements Related to Communications with Those Charged with Governance Auditing and Assurance Bulletin Enhancing Professional Skepticism Audits of Financial Statements that Contain Amounts that Have Been Determined Using Actuarial Calculations (guide) Practitioner Support Canadian Auditing Standards 16

17 About this publication The Canadian Institute of Chartered Accountants (CICA) through its Guidance and Support group undertakes initiatives to support practitioners and their clients in the implementation of standards. As part of these initiatives, the CICA created the Advisory Group on of Canadian Auditing Standards to provide advice on the identification of issues related to the implementation of Canadian Auditing Standards (s) and on the development of non-authoritative implementation guidance related to these issues. The CICA s Guidance and Support group staff prepared this publication based on the advice of the advisory group. It provides non-authoritative guidance and has not been adopted, endorsed, approved or otherwise acted upon by the Auditing and Assurance Standards Board, any CICA board or committee, the governing body or membership of the CICA or any provincial institute/ordre or the organizations represented by the advisory group members. are expected to use professional judgment in determining whether the material in this publication is both appropriate and relevant to the circumstances of their particular audit engagements. This publication is based on the s as updated in September The CICA expresses its appreciation to the members of the Advisory Group on of Canadian Auditing Standards and to CICA staff preparing this publication. Advisory Group on of Canadian Auditing Standards Johanna Field, CPA, CA Grant Thornton LLP Stacy Hammett, CA PwC LLP Nazia Lakhani, CPA, CA BDO Canada LLP Norah Langill, CA Deloitte LLP Anilisa Sainani, CPA, CA Ernst & Young LLP Robert G. Young, FCA KPMG LLP Gordon Beal, CPA, CA Director, Guidance and Support group The Canadian Institute of Chartered Accountants This publication was originally published by The Canadian Institute of Chartered Accountants (CICA) in It has been reissued by the Chartered Professional Accountants of Canada (CPA Canada) as originally published non-authoritative guidance. Andrée Lavigne, CPA, CA CICA Hélène Marcil, CPA, CA CICA Eric R. Turner, CPA, CA CICA CPA Canada and the authors do not accept any responsibility or liability that might occur directly or indirectly as a consequence of the use, application or reliance on this material. Practitioner Support Canadian Auditing Standards 17