11 Nov How Accounting Estimates are Audited
Measuring accounting estimates involves some level of uncertainty. As a result, accounting estimates, such as allowances for doubtful accounts, impairments of long-lived assets, and valuations of financial and non-financial assets, require extra attention from auditors. Here is a closer look at the current standards for auditing estimates and examples of specialists who may be hired to provide independent estimates.
Applying the auditing standards
Some estimates may be easily determinable but many are inherently subjective or complex. Auditing standards generally provide three approaches for substantively testing fair value measurements and other accounting estimates:
- Testing 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.
- Developing an independent estimate. Using management’s assumptions (or alternative assumptions), auditors come up with an estimate to compare to what is reported on the internally prepared financial statements.
- Reviewing subsequent events or transactions. 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 auditor’s report.
Independence guidelines generally prohibit auditors from providing certain services for their public audit clients. To obtain independent accounting estimates, companies often turn to outside specialists.
Relying on specialists
Examples of specialists used to prepare accounting estimates include:
- Actuaries to determine employee benefit obligations
- Engineers to determine obligations regarding environmental remediation
- Appraisers to determine the value of intangible assets or real estate
- Geologists to estimate mineral deposits or oil reserves for mining & energy companies
- Lawyers to forecast the potential losses from a legal proceeding
Auditors often help direct these specialists to minimize the risk of misstatement, especially when specialists are not subject to the audit firm’s training, resources, and quality control systems.
Business transactions have grown more complicated in recent years, leading companies to make a significant number of subjective estimates and rely more heavily on outside parties to bring in specialized knowledge. We understand how to apply auditing standards to accounting estimates made in-house and/or using outside specialists. Contact us for additional information.