The Need for Intrafirm Standardization for Audit of Accounting Estimates

Abstract

Accounting estimates are widely used in practice, and they vary in nature. Their use is challenging due to a combination of sophisticated mathematical methods, models, uncertainties regarding future events, subjectivity of management, and strict demands to the quality of audit evidences. These circumstances make estimation one of the most sophisticated and responsible areas of audit, which requires standardized approaches, in-depth professional judgment, and steady reliance on the principle of professional skepticism. The authors demonstrate that the role of ISA 540 “Auditing Accounting Estimates and Related Disclosures” is increasing in view of the present-day requirements. Thus, the martial law changes approaches to estimating assets, devaluation, useful life, and cost documentation. The authors propose a structure of the intrafirm standard for accounting estimates, covering: legal requirements to audit of accounting estimates; risk estimates; determining further procedures and collection of evidences, their estimation, and estimation of misstatements; documenting of the accomplished audit procedures. Each section having its own function, altogether they form a complete methodical cycle. The section on legal requirements ensures coordinated auditors’ handling of ISA 54 and the other standards, lays down a framework and determines a single reference point on which all the subsequent procedures are built. The section on estimating risks of material misstatement of financial reporting through accounting estimates ensures consistency and predictability in planning of audit. The section on actions in response to estimated risks is designed to unify approaches to testing methods and models of accounting estimates, assumptions, and data; it helps enhance the professional skepticism. The section on general estimation of misstatements ensures similarity of the criteria for determining the materiality of misstatements, consistent formulation of conclusions, and reduction of the risk of wrong auditor’s judgment. The section on documenting aims to unify work documentation, thus helping codify the auditors’ knowledge and creating a framework for high-quality performance of audit. In view of the above, the authors systematized normative requirements to the audit of accounting estimates, provided examples of accounting estimates, built an algorithm for ISA 540 applications in audit practices, and summed up the measures of management control, to reduce the risk of improper applications of accounting policies. The authors’ propositions include estimation of a structure for control actions, procedures for estimating the degree of uncertainty in accounting estimation, actions in response to the estimated risks of material misstatement with regard to accounting estimates, estimation of misstatements detected by the auditor, and requirements to documentation. Checklists, documentation templates, and extended procedures developed by the authors allow the auditors to respond more effectively to the risks related with accounting estimates, thus enhancing the quality of audit.