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Auditing Accounting Estimates

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AU Section 342

Auditing Accounting Estimates
Source: SAS No. 57; SAS No. 113. See section 9342 for interpretations of this section. Effective for audits of financial statements for periods beginning on or after January 1, 1989, unless otherwise indicated.
.01 This section provides guidance to auditors on obtaining and evaluating sufficient appropriateaudit evidence to support significant accounting estimates in an audit of financial statements in accordance with generally accepted auditing standards. For purposes of this section, an accounting estimate is an approximation of a financial statement element, item, or account. Accounting estimates are often included in historical financial statements because— a. b. The measurement of some amounts or thevaluation of some accounts is uncertain, pending the outcome of future events. Relevant data concerning events that have already occurred cannot be accumulated on a timely, cost-effective basis.

[Revised, March 2006, to reflect conforming changes necessary due to the issuance of Statement on Auditing Standards No. 105.] .02 Accounting estimates in historical financial statements measure theeffects of past business transactions or events, or the present status of an asset or liability. Examples of accounting estimates include net realizable values of inventory and accounts receivable, property and casualty insurance loss reserves, revenues from contracts accounted for by the percentage-of-completion method, and pension and warranty expenses.1 .03 Management is responsible for making theaccounting estimates included in the financial statements. Estimates are based on subjective as well as objective factors and, as a result, judgment is required to estimate an amount at the date of the financial statements. Management's judgment is normally based on its knowledge and experience about past and current events and its assumptions about conditions it expects to exist and courses ofaction it expects to take. .04 The auditor is responsible for evaluating the reasonableness of accounting estimates made by management in the context of the financial statements taken as a whole. As estimates are based on subjective as well as objective factors, it may be difficult for management to establish controls over them. Even when management's estimation process involves competent personnelusing relevant and reliable data, there is potential for bias in the subjective factors. Accordingly, when planning and performing procedures to evaluate accounting estimates, the auditor should consider, with an attitude of professional skepticism, both the subjective and objective factors.
1 Additional examples of accounting estimates included in historical financial statements are presented inparagraph .16.

AU §342.04

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The Standards of Field Work

Developing Accounting Estimates
.05 Management is responsible for establishing a process for preparing accounting estimates. Although the process may not be documented or formally applied, it normally consists of— a. b. c. d. Identifying situations for which accounting estimates are required. Identifying the relevant factors thatmay affect the accounting estimate. Accumulating relevant, sufficient, and reliable data on which to base the estimate. Developing assumptions that represent management's judgment of the most likely circumstances and events with respect to the relevant factors. Determining the estimated amount based on the assumptions and other relevant factors. Determining that the accounting estimate is presentedin conformity with applicable accounting principles and that disclosure is adequate.

e. f.

The risk of material misstatement of accounting estimates normally varies with the complexity and subjectivity associated with the process, the availability and reliability of relevant data, the number and significance of assumptions that are made, and the degree of uncertainty associated with the...