Auditing Accounting Estimates FRC Audit Inspections 2022

Estimates

Auditing accounting estimates are a challenging area for any audit. The UK’s largest firms were critiqued on their audit of estimates in the 2022 quality inspections, with 4 of the 7 firms falling short in their audit work.

Estimates are not exclusive to complex entities. In fact, estimates can often pose a greater challenge in audits of SMEs, where management may be less experienced in forming robust estimations. Smaller audit firms must therefore learn the lessons of these inspection results and apply the best practices discussed to their own audits to improve quality.

Challenging management and being professionally sceptical are key themes when reviewing audit work over estimates. This must be complemented by collating evidence which supports both sides of the argument, to arrive at an appropriate, balanced, and well documented conclusion.

Impairment

Ensuring impairment assessments I include all the necessary inputs, and that these inputs are accurate, is an important start point. Impairment assessments are often complex Excel spreadsheets so ensure formulas are correct and driving accurate calculations.

Key assumptions which require challenge include the determination of cash generating units (CGUs), sales, and cashflow forecasts. Evidence on the file your scepticism reviewing these forecasts.

Ensure the fundamentals of management’s assessment model are appropriate so you can focus your work on challenging the key assumptions within the model.

 

Going Concern and Viability Assessments

Audit methodologies should promote standardized procedures over forecasts and assumptions feeding into the going concern and viability assessments. As part of challenging key assumptions, sensitivity analysis should be performed on the forecasts.

Sufficient audit procedures are also required to test the directors’ viability assessment and consider reporting implications. If your audit methodology is merely a suite of checklists, then consider improving your audit procedures and embedding templates to standardise the work needed and ensure all requirements are adequately addressed.

Invest in improving your methodology and the process your teams follow to work through going concern and viability assessments.

 

Expected Credit Loss provision

Challenge is needed to the completeness of the provision, the rates applied to each aged debtor, and where no expected credit loss provision is created for specific assets. Assessment is needed when a simplified expected credit loss provisioning approach is adopted, with detailed audit procedures required over the methodology, inputs, credit risk variations, information used, and scenarios modelled. Be sure to work through all the necessary steps to thoroughly consider expected credit loss provisions.

 

Other Estimates

For net retirement obligations, following up on the findings of actuarial experts must be performed to ensure potential issues are closed off. In scenarios of high sensitivity auditors should quantify the potential impact of actuarial findings on the balance sheet valuation.

Provisions relating to contractual claims or uncertain tax positions require specific attention and may require the input of specialists in these fields. External valuations such as investment properties are also likely to require input from auditor experts to collate sufficient appropriate audit evidence.

Ensure you are appropriately seeking the input of specialists and experts in detailed estimates, and addressing the findings they report within your audit file documentation.

 

Next steps

Auditing accounting estimates require specific attention and these audit inspection results identity findings and provide advice relevant to every audit. No matter how experienced, auditors are continually refining how they approach the audit of estimates and the judgements management perform when calculating estimates. All the takeaways relating to estimates which could support your firm’s methodology, or your next audit, are available in our free guide. It includes quick reference cheat-sheets, detailing 25 tips for auditing estimates. A sample of these tips is included below.

 

Cheat sheet preview

ESTIMATES

Impairment

  • Assess and challenge the sales assumptions used in assessing the impairment of specific cash generating unit.

Going Concern and Viability Assessments

  • Standardize procedures over forecasts and other assumptions supporting the going concern and viability assessment across engagements.

Expected Credit Loss provision

  • Challenge the rates applied to each aged debtor and verified unique terms and conditions which are used to justify the non-recognition of ECL provisions.

Other Estimates

  • Challenge and evaluate the assumption supporting the net retirement obligations.
    • Follow up on any actuarial expert’s findings.
    • Quantify and evaluate the potential overstatement of the pension obligation identified in the expert’s report when the assumptions are highly sensitive to change.

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