Revised ASA 540: Just something for the auditor to worry about?

After the considerable change to accounting standards over the last 24-36 months, many accountants will be looking forward to a simpler reporting season in 2021.

Enter the revised version of ASA 540: Accounting Estimates, (unsurprisingly) the auditing standard that deals with the audit of accounting estimates. The revised standard has been brought about in reaction to increased complexity of reporting in recent years, coupled with continued drive by regulators globally to increase audit quality. The relevance of this is brought into focus when reading newspaper headlines on corporate reporting failures such as the restatement of write-downs of Freedom Foods which has led to significant erosion of shareholder value. The revised ASA 540 is now effective and applies to all audits for the upcoming reporting season.

Almost all businesses will have some accounting estimates, and these encompass everything from calculations of depreciation through to complex valuation models. The huge spectrum of risk is evident and is incredibly important as this drives the level of audit work performed.

At face value, this seems like being the auditors’ problem; after all, is it not them for which the new standard is written? However, it is likely for this change to lead to an increased need for audit evidence, which in turn is anticipated to increase to the amount of information requested from management. We see the key impact on management as follows:

Change to audit approach

Impact on management

Increased professional scepticism required from auditors.

Finance teams can expect auditors to provide more challenge to how management derive accounting estimates.

More detailed risk assessments at each stage of the audit.

Auditors are likely to place more emphasis on understanding the estimation process and key aspects and controls in place relating to accounting estimates.

Auditors may request copies of control and process documentation around estimates.

Improved linkage between the levels of estimation uncertainty, subjectivity, and complexity in accounting estimates and the magnitude of work performed.

There may be increased demand for information from the auditor in relation to estimates in areas of greater risk of material misstatement.

This may include requests for written assessments from management in relation to significant estimates.

Increased scrutiny of accounting estimate disclosure in financial statements. This includes focus on the sufficiency of disclosure and particular focus on the detail that highlights risk to readers of the financial statements.

The auditor may request increased, or more focused, disclosure in the financial statements.

More detailed management representations.

The auditor may request management to provide more detailed representations in relation to areas of significant estimation.

Ultimately, we see this as an important improvement to the quality and consistency of audits which in turn gives greater value to shareholders and other stakeholders. It also provides good opportunity for boards and management to consider their own approach to accounting estimates and judgements.

Please get in touch to your local PKF office if you require any support, guidance, or additional insights.

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