4/14/2020 Preparing for Changes to ISA 540 on Auditing Accounting Estimates | IFAC

SUPPORTING INTERNATIONAL STANDARDS

Preparing for Changes to ISA

540 on Auditing Accounting
Estimates
Louise Sharp | February 24, 2020 |

    
Auditing accounting estimates has never been easy. Estimates are dif cult to measure,
often involve management’s judgment and can be based on highly complex models. So, by
their very nature, they pose huge challenges for auditors. Not only are they dif cult to
audit, but their importance to investors and other stakeholders has increased in recent
years, as changes to nancial reporting standards have resulted in the inclusion of more
accounting estimates in the nancial statements.

Published in 2018 and applicable for accounting periods beginning on or after 15 December
2019, ISA 540 (Revised), Auditing Accounting Estimates and Related Disclosures, introduces

https://www.ifac.org/knowledge-gateway/supporting-international-standards/discussion/preparing-changes-isa-540-auditing-accounting-estimates 1/9
4/14/2020 Preparing for Changes to ISA 540 on Auditing Accounting Estimates | IFAC

a number of changes that auditors will need to understand and implement. The signi cance
of the changes shouldn’t be underestimated.

While the standard has been written to be scalable to estimates with low risk, auditors are
going to need to understand the requirements properly before they are able to make a
judgment about what work they need to do.

There is going to be a fair amount of work to do to tackle the requirements in the revised
standard; including appropriately capturing the changes into audit methodologies and
guiding the work of auditors in this area.

This article focuses on three key areas – risk assessment, professional skepticism and
documentation.

Risk assessment
While auditors will be very familiar with the idea of risk assessment and may incorporate
the concept of low, medium and high risk into their methodologies, regulators are not
convinced that risk assessment for estimates is being done well. Given that there are more
high risk estimates now and, therefore, more potential for misstatement, this is an area that
the IAASB believed needed stronger requirements and guidance.

The revised standard requires auditors to perform separate inherent risk and control risk
assessments at the assertion level to form the basis for designing and performing further
audit procedures to respond to the risks of material misstatement. If audit rms currently
perform combined risk assessments, this is going to be a signi cant change for those
practices and possibly more audit work.

https://www.ifac.org/knowledge-gateway/supporting-international-standards/discussion/preparing-changes-isa-540-auditing-accounting-estimates 2/9
4/14/2020 Preparing for Changes to ISA 540 on Auditing Accounting Estimates | IFAC

In recognition that all risks are not equal, the revised standard also introduces the concept
of the spectrum of inherent risk. This is one of the key drivers of scalability in the revised
standard because where the assessed risk falls on the spectrum will determine what further
audit procedures the auditor will need to perform. Ultimately, the higher on the spectrum
the risk falls, the more persuasive the audit evidence needs to be.

These risk assessments will be based on auditors’ understanding of the entity, its
environment and internal control, and here we also see enhanced risk assessment
procedures to ensure that auditors have gained a good knowledge of the business.

As part of risk assessment procedures, auditors are required to review and document the
outcome of previous accounting estimates. This is important as it helps auditors to make
judgments about management’s track record in making estimates and assists in identifying
and assessing the risks of material misstatement in the current period.

While auditors will be familiar with estimation uncertainty in the existing standard, the
revised standard introduces and formalises the idea of ‘inherent risk factors.’ The three key
ones that the standard addresses are:


estimation uncertainty: susceptibility to an inherent lack of precision in the
measurement of an accounting estimate;

subjectivity: inherent limitations in the data or knowledge that is reasonably available
about valuation attributes; and

complexity: the complexity inherent in the process of making an accounting estimate.

There may, however, be other inherent risk factors such as change, susceptibility to
misstatement due to management bias or fraud to also consider.

https://www.ifac.org/knowledge-gateway/supporting-international-standards/discussion/preparing-changes-isa-540-auditing-accounting-estimates 3/9
4/14/2020 Preparing for Changes to ISA 540 on Auditing Accounting Estimates | IFAC

So, the auditors’ assessment of inherent risk will depend on the degree to which these risk
factors affect the likelihood or magnitude of misstatement. The higher the risk falls on the
spectrum, the more work auditors will need to do to obtain suf cient appropriate audit
evidence. This is where exercising and demonstrating professional scepticism is particularly
relevant.

Professional Scepticism
Because of repeated calls from regulators in recent years for auditors to be more sceptical
on audits and given the extent of complexity, uncertainty and judgment involved in making
some accounting estimates, this is, of course, going to be an area for scrutiny.

Having a skeptical mind-set is the bedrock of auditing, but regulators are concerned about
the lack of professional scepticism demonstrated on the audit les.

The IAASB has sought to raise the bar by introducing a number of provisions designed to
enhance professional skepticism. One of these is that further audit procedures designed and
performed by the auditors should not be biased towards obtaining corroborative evidence or
towards excluding contradictory evidence. So, auditors don’t just look for supporting
evidence but equally don’t disregard contradictory evidence. Obtaining audit evidence in an
unbiased manner may involve obtaining evidence from multiple sources within and outside
the entity. However, auditors are not required to perform an exhaustive search to identify
all sources of audit evidence. Getting the balance right is going to be tricky and auditors will
need to refrain from making prejudgments or overly relying on checklists. Demonstrating
that auditors have applied professional skepticism will be dependent on good planning,
audit team training, coaching and supervision, and effective and timely le review.

Enhanced application of professional skepticism is also introduced through a stand-back

requirement. Auditors are required to ask themselves and evaluate, based on the audit
https://www.ifac.org/knowledge-gateway/supporting-international-standards/discussion/preparing-changes-isa-540-auditing-accounting-estimates 4/9
4/14/2020 Preparing for Changes to ISA 540 on Auditing Accounting Estimates | IFAC

procedures performed and audit evidence obtained, whether:


the assessments of the risks of material misstatement at the assertion level remain
appropriate, including when indicators of possible management bias have been
identi ed;

management’s decisions relating to recognition, measurement and presentation and
disclosures are in accordance with the applicable nancial reporting framework; and

suf cient appropriate audit evidence has been obtained. 

While the idea of standing back and reviewing the audit evidence obtained might not sound
new, it does help to emphasise that the audit of accounting estimates is an iterative process.
The risk assessment requirements recognise this, and the stand-back requirement allows
auditors to re ect on work performed, the appropriateness of the risk assessments and
whether they have obtained unbiased suf cient appropriate audit evidence. Being skeptical
(and hence unbiased) in seeking, evaluating and documenting audit evidence is therefore
expected to improve audit quality.

Documentation
The revised ISA also introduces enhanced documentation requirements. Some may look
familiar, but auditors shouldn’t be complacent here as these enhanced requirements are
likely to require more documentation on their audit les.

ISA 540 (Revised) speci cally requires audit documentation to include:


the key elements of the auditor’s understanding of the entity and its environment,
including internal control relating to accounting estimates;

https://www.ifac.org/knowledge-gateway/supporting-international-standards/discussion/preparing-changes-isa-540-auditing-accounting-estimates 5/9
4/14/2020 Preparing for Changes to ISA 540 on Auditing Accounting Estimates | IFAC


the linkage of further audit procedures with the assessed risk of material misstatement
at the assertion level;

the response to situations where management has not taken appropriate steps to
understand and address estimation uncertainty;

indicators of possible management bias, if any, and the auditor’s evaluation of the
implications for the audit; and

signi cant judgments made in the determination of whether the accounting estimates
and related disclosures are reasonable, or are misstated, in the context of the
applicable nancial reporting framework.

It is particularly important that the documentation demonstrates how auditors have

exercised professional scepticism throughout the audit. Auditors need to document the
journey to their conclusions, including the challenges and judgments they made along the
way.

For further ICAEW guidance on auditing estimates, including guides and webinars visit
www.icaew.com/technical/audit-and-assurance/audit/auditing-estimates.

Visit icaew.com/internationalstandards for more information.

*This is an excerpt from a previously published article in the ICAEW publication Audit & Beyond

https://www.ifac.org/knowledge-gateway/supporting-international-standards/discussion/preparing-changes-isa-540-auditing-accounting-estimates 6/9
4/14/2020 Preparing for Changes to ISA 540 on Auditing Accounting Estimates | IFAC

Issues and Insights

Supporting International Standards

Contributing to the Global Economy

Building Trust & Ethics

Developing the Accountancy Profession

Preparing Future-Ready Professionals

Recent Articles
COVID-19 Resources from IFAC's
Network
APRIL 14, 2020

The Financial Reporting Implications of

COVID-19
APRIL 13, 2020 | STATHIS GOULD,
CHRISTOPHER ARNOLD

Online CPD Services for Professional

Accountancy Organizations
APRIL 9, 2020

Seven Essential Crisis Management

Planning Steps for PAOs
APRIL 1, 2020 | LINDA LACH, DARLENE NZORUBARA

Ibero-American PAO Response to COVID-

https://www.ifac.org/knowledge-gateway/supporting-international-standards/discussion/preparing-changes-isa-540-auditing-accounting-estimates 7/9
4/14/2020 Preparing for Changes to ISA 540 on Auditing Accounting Estimates | IFAC

19
MARCH 31, 2020 | MANUEL ARIAS

Louise Sharp
Technical Manager, ICAEW

Louise is a Technical Manager at ICAEW. She develops technical and practical online content to meet the needs of subscribers to ICAEW’s International
Standards service and ICAEW Audit and Assurance Faculty members.ICAEW’s International Standards service offers organisations access to world-class
technical resources to support the implementation of global standards on financial reporting, auditing and ethics.Developed for an international
audience, the service is designed to support global professional member bodies, international businesses, global accounting firms and networks.Through
an annual corporate subscription, International Standards provides employees or members with online access to a range of tools, information and
practical guidance, including live webinars, on-demand video recordings, technical factsheets, guides, thought leadership articles and case studies.

Join the Conversation

To leave a comment below, login or register with IFAC.org

Related Articles

https://www.ifac.org/knowledge-gateway/supporting-international-standards/discussion/preparing-changes-isa-540-auditing-accounting-estimates 8/9
4/14/2020 Preparing for Changes to ISA 540 on Auditing Accounting Estimates | IFAC

Online CPD Services for Audit Committees in If Your PAO Isn’t Working The Value of Audit for
Professional Accountancy Europe: Facing Change Remotely Yet, Use This SMEs in Spain
Organizations MARCH 31, 2020 | Critical Time to Plan NOVEMBER 3, 2019 | FRANCISCO

APRIL 9, 2020
DR. SUSANNA DI FELICIANTONIO,
(translated versions SERRANO, ICJCE, HEAD OF THE
RESEARCH DEPARTMENT AND ADELA
CHRISTIANE CUNNINGHAM
available) VILA, ICJCE, DIRECTOR OF THE
INTERNATIONAL DEPARTMENT
MARCH 24, 2020 | JOSEPH BRYSON

https://www.ifac.org/knowledge-gateway/supporting-international-standards/discussion/preparing-changes-isa-540-auditing-accounting-estimates 9/9