In July of this year, the AICPA Auditing Standards Board (ASB) issued two new Statements on Auditing Standards (SAS) that focus on audit evidence and accounting estimates: SAS No. 142, Audit Evidence, and SAS No. 143, Auditing Accounting Estimates and Related Disclosures. These new standards will impact both management and the auditor, as SAS No. 142 relates to the type, extent, and quality of support the auditor will be requesting as audit evidence, while SAS No. 143 relates to the approach the auditor will take in auditing accounting estimates in an increasingly uncertain economic period.
SAS No. 142, Audit Evidence – Why the Change?
SAS No. 142 addresses the evolving nature of business, audit services, and issues that have arisen. These issues include:
- The increased use of emerging technologies, automated tools, and techniques by both preparers and auditors, including audit data analytics, artificial intelligence, and remote observation tools for obtaining audit evidence;
- The application of professional skepticism when evaluating information provided as audit evidence;
- The expanding sources of information to be used as audit evidence, including external sources; and
- A change in focus of the audit evidence standard to emphasize the attributes of the information used as audit evidence, namely its accuracy, completeness, relevance and reliability, and whether the information is sufficiently precise and detailed. Previously, the focus had been on the design and performance of audit procedures to obtain sufficient appropriate audit evidence, but the new standard now serves to enhance the auditor’s assessment of whether sufficient and appropriate audit evidence has been obtained. The standard also introduces new attributes of audit evidence to consider, including whether the information is corroborative or contradictory to management assertions, the authenticity of the evidence, and its susceptibility to management bias.
How Might This Affect You if Your Organization Undergoes an Audit?
If you have previously been involved in the compiling of audit evidence to provide to your auditors, SAS No. 142 may result in the audit team asking for different or further support than they have in the past or your data may be requested in a new format. As you review your books periodically, evaluate that the documentation you have to support the amounts in your financial statements would be sufficient and relevant for your auditors to use as evidence that, where relevant, they could independently confirm. One key aspect of an audit that the users of the financial statements value is that the engagement is conducted by the auditors with an attitude of “professional skepticism” – approaching the audit with a questioning mind, being alert for potential misstatements, and critically assessing the audit evidence gathered. The changes included in SAS No. 142 should offer further assurance to stockholders, investors, and other users of the financial statements that the audit evidence obtained in the course of the audit has been critically considered.
SAS No. 143, Auditing Accounting Estimates and Related Disclosures – Why the Change?
If you’re familiar with financial statement disclosures, you may recognize the paragraph that starts with a version of the following: “The preparation of financial statements in conformity with U.S. GAAP requires management to make judgments, assumptions, and estimates…” and end with, “Actual results could differ from those estimates.” This standard statement checks the box as one of the required disclosures in the footnotes to the financial statements, but it also serves to remind readers of the financial statements that not all amounts are as definite as cash, but are, instead, subject to management’s judgment and estimation.
SAS No. 143 was issued as part of the AICPA’s Enhancing Audit Quality Initiative and is intended to enhance the auditing standards related to auditing accounting estimates and the focus on different factors affecting estimation uncertainty and potential management bias. As we have recently entered a time of economic volatility and unpredictability, these new standards will help to guide the auditor as more assets and liabilities become increasingly subject to estimation uncertainty. In addressing these concerns, SAS No. 143:
- Explains the nature of accounting estimates, the concept of estimation uncertainty, and how the effects of complexity, subjectivity, or other inherent risk factors contribute to the susceptibility of estimated amounts to misstatement;
- Provides guidance on applying the standard to a range of accounting estimates, from simplistic (low estimation uncertainty) to complex (with high subjectivity and estimation uncertainty);
- When assessing the risk of material misstatement, requires that the auditor separately assess inherent risk and control risk for accounting estimates at the relevant assertion level;
- Provides enhanced risk assessment guidelines intended to assist the auditor when auditing accounting estimates by providing more specific risk assessment requirements and addressing the increasing complexity in business environments and financial reporting frameworks;
- Stresses the importance of linking the audit testing procedures to the reasons identified within the developed risk assessment;
- References to other relevant guidance regarding the auditor’s decisions about controls over accounting estimates;
- Emphasizes that the importance of exercising professional skepticism when auditing accounting estimates increases when the estimates are subject to a greater degree of estimation uncertainty, complexity, subjectivity, or other inherent risk factors; and
- Upon testing the accounting estimates, requires the auditor to determine the reasonableness of the estimates and related disclosures within the applicable financial reporting framework, or whether they are misstated.
How Might This Affect You if Your Organization Undergoes an Audit?
You may be wondering, what accounts and disclosures in my financial statements might be considered accounting estimates? While fair value accounting estimates may be the type you are most familiar with, some other examples of accounting estimates include the following:
- Depreciation of property and equipment;
- Employee retirement benefits liabilities;
- Fair value of assets or liabilities acquired in a business combination, including the determination of goodwill and intangible assets;
- Impairment of long-lived assets or property or equipment held for disposal;
- Nonmonetary exchanges of assets or liabilities between independent parties;
- Outcome of pending litigation;
- Provision for expected credit losses;
- Revenue recognized for long-term contracts;
- Share-based payments; and
- Valuation of financial instruments.
In auditing accounting estimates, the objective of the auditor is to obtain sufficient appropriate audit evidence about whether accounting estimates and related disclosures in the financial statements are reasonable, in the context of the financial reporting framework the company is reporting under. How can you be sure the accounting estimates in your financial statements are considered “reasonable” by auditing standards? Reasonable means that the requirements of the applicable financial reporting framework (which in most instances will be U.S. GAAP) have been appropriately applied, including those requirements that address the following:
- How the accounting estimate was developed, including the selection of the method, assumptions, and data in light of the nature of the accounting estimate and the facts and circumstances of the entity;
- The selection of management’s point estimate (the amount selected by management for disclosure in the financial statements as an accounting estimate); and
- Disclosures regarding how the accounting estimate was developed, as well as the nature, extent, and sources of estimation uncertainty.
The new auditing standard also allows for three approaches when testing an accounting estimate:
- Obtain audit evidence from activity occurring up to the date of the auditor’s report;
- Test how management developed their accounting estimate; and
- Prepare, as the auditor, an amount or range of amounts in order to evaluate management’s point estimate.
The greater the accounting estimate is subject to estimation uncertainty, the higher the risk of material misstatement, and consequently, the more persuasive the audit evidence needs to be. If you are undergoing an audit, be prepared to provide your auditors with all relevant data and inputs that were used to develop your accounting estimates, and where possible, provide a way for them to be able to corroborate the evidence you provide. The auditor will also be looking for potential management bias; as such, be mindful when developing your estimates that an independent third party would arrive within a similar estimated range using the same data and inputs. You also want to be sure your disclosures address estimation uncertainty and include all relevant information to allow the users of the financial statements to understand the nature and valuation of all significant accounting estimates. Your disclosures should achieve fair presentation of the financial statements.
The ASB allows for time for both management and auditors to understand and implement the new standards. SAS No. 142, Audit Evidence, is effective for periods ending on or after December 15, 2022, and SAS No. 143, Auditing Accounting Estimates and Related Disclosures, is effective for audits of financial statements for periods ending on or after Dec. 15, 2023.
If you have questions related to SAS No. 142 Audit Evidence or SAS No. 143 Auditing Accounting Estimates and Related Disclosures, please reach out to your Untracht Early advisor for more information.