Accounts Notes: AUDIT OF ACCOUNTING ESTIMATES

Friday 25 March 2011

AUDIT OF ACCOUNTING ESTIMATES

Accounting Estimate -An approximation of an item in the absence of a precise means of measurement. For example, provision for taxation, provision for warranty claims, provision for a loss from a law suit, accrued revenue etc.
Responsibility for Accounting Estimates - Management is responsible for making accounting estimates included in financial statement.
Nature of Accounting Estimates - The determination of accounting estimates may be simple or complex, depending upon the nature of the item. Accounting estimates may be determined as part of the routine accounting system operating on a continuous basis, or may be non-routine only at the end of the period. The uncertainly associated with an item, or lack of. objective data may make it incapable of reasonable estimation.
Audit Procedures - The auditor should ensure that an accounting estimate is reasonable in circumstance, and when required, is appropriately disclosed in the financial statements. Following approaches should be used in the audit of an accounting estimate ¬
a. Review and test the process used by management to develop the estimate.
b. Use an independent estimate for comparison with that prepared by management, or
c. Review subsequent events, which confirm the estimate made.
d. Obtain external evidence, where possible, to corroborate internal evidence.
e. Evaluate the data and assumptions on which the estimate is based and ensure reasonableness and consistency of assumptions.
f. Use of experts in case of complex estimating process
g. Review the counting appropriateness of formula used by management.
h. Test the calculation procedures used by management.
i. Where possible, compare accounting estimates made for prior periods with actual results of those periods.
Evaluation of Results of Audit Procedures - The final assessment of an accounting estimate would be based on the auditor's knowledge of the client's business and its consistency with other audit evidence obtained during the audit. If he of the opinion that the accounting estimates prepared by the management is significantly different from that assesses the auditor, he should request the management to revise the same, If the management refuses to revise the estimate, it would be considered a misstatement and the auditor would need to consider its effect on the financial statements.