.

Republic of the Philippines

CEBU ROOSEVELT MEMORIAL COLLEGES
San Vicente St. Bogo City, Cebu

ARTICLE EVALUATION

In Partial Fulfillment of the Requirements of the Subject

ACCOUNTING RESEARCH METHOD

Presented by:

Jhell De la Cruz
Johnro Terana
Dave Gelig

Presented to:

Raymund Cometa, CPA

Instructor

Date of Submission:

March 2021
 SUMMARY
A Refined Approach to Auditing Accounting Estimates

Estimates in accounting aren't new, but they're having a bigger impact on earnings
than ever before. A PCAOB briefing identified estimates as a continuing area of audit
issues which is 29% of all audit findings were related to estimates, according to an IFIAR
report. There are three biggest challenges with auditing accounting estimates and it was
discussed by member of Auditing Standards Board (ASB).
The first issue is determining whether the assumptions underlying those estimates
are reasonable, the second issue relates to internal controls and the third issue is
understanding the data used to develop the estimate, particularly when a third-party
specialist is involved.
The PCAOB and the International Auditing and Assurance Standards Council
have revised their accounting estimate auditing standards. The ASB is working on
revising AU-C Section 540, Auditing Accounting Estimates. PCAOB and IAASB are not
substantially changing the approach to auditing accounting estimates. It's important for
auditors to think about management bias and auditors should take a more professionally
skeptical look at what could go wrong.
According to the member of Auditing Standards Board (ASB), auditors tend to be
honest people, so they may have a harder time envisioning fraud or even management
bias. Auditing Standards Board (ASB) hopes that the new standards will better articulate
the importance of risk assessment in estimates.
I. TITLE
"An Article Review on Auditing Accounting Estimates"

II. ARTICLE UNDER REVIEW

Farr, L. (2019, June 12). "A Refined Approach to Auditing Accounting".
https://www.journalofaccountancy.com/news/2019/jun/auditing-accounting-
estimates-201921413.html

III. MAJOR POINTS/ISSUES

1. Failure to assess the reasonableness of assumptions, including consideration of
contrary or inconsistent evidence.

2. Understanding the data used to develop the estimate, particularly when a third-
party specialist is involved.

3. The auditor also often needs to audit the company’s internal controls over
financial reporting, which includes the review of estimates by management.

4. Emphasize the need for professional skepticism.

6. Better articulate the importance of risk assessment in estimates.

IV. DEFINITION OF TERMS

 Accounting Estimate – An approximation of a monetary amount in the absence of
a precise means of measurement. This term is used for an amount measured at fair
value where there is estimation uncertainty, as well as for other amounts that
require estimation.

 Management Bias – A lack of neutrality by management in the preparation of

information.

 Public Company Accounting Oversight Board (PCAOB)- is a non-profit

organization that regulates audits of publicly traded companies to minimize audit
risk. It was established at the same time as the Sarbanes-Oxley Act of 2002 to
address the accounting scandals of the late 1990s.
V. DISCUSSION AND REVIEW OF RELATED LITERATURE

1. Estimation involves judgments based on information available when the financial

statements are prepared. For many accounting estimates, these include making
assumptions about matters that are uncertain at the time of estimation. The auditor is not
responsible for predicting future conditions, transactions or events that, if known at the
time of the audit, might have significantly affected management’s actions or the
assumptions used by management. (International Standards on Auditing (ISA) 540.A8)
The auditor should put emphasizes on assertions pertaining to significant assumptions
that are sensitive, susceptible to manipulation or bias, involve unobservable data or
company adjustments, and/or are dependent upon the company’s intent to carry out a
particular course of action The standard encourage auditors to identify key inputs and
significant assumptions in relation to estimates and evaluate the reasonableness of these
assumptions. .
According to AS 2501.16, The auditor should evaluate the reasonableness of the
significant assumptions used by the company to develop the estimate, both individually
and in combination. This includes evaluating whether:

a.The company has a reasonable basis for the significant assumptions used and, when
applicable, for its selection of assumptions from a range of potential assumptions; and
b. The significant assumptions are consistent with the following, when applicable:
1. Relevant industry, regulatory, and other external factors, including economic
conditions;
2. The company's objectives, strategies, and related business risks;17

3. Existing market information;

4. Historical or recent experience, taking into account changes in conditions and
events affecting the company; and
5. Other significant assumptions used by the company in other estimates tested.
Note:  If the auditor evaluates the reasonableness of a significant assumption by
developing an expectation of that assumption, the auditor should have a reasonable basis
for that expectation

Under ISA (540.24) Revised, in applying the requirements of paragraph 22, with
respect to significant assumptions, the auditor’s further audit procedures shall address:

(a) Whether the significant assumptions are appropriate in the context of the
applicable financial reporting framework, and, if applicable, changes from prior periods
are appropriate; (Ref: Para. A95, A102–A103)
 (b) Whether judgments made in selecting the significant assumptions give rise to
indicators of possible management bias; (Ref: Para. A96)

(c) Whether the significant assumptions are consistent with each other and with those
used in other accounting estimates, or with related assumptions used in other areas of the
entity’s business activities, based on the auditor’s knowledge obtained in the audit; and
(Ref: Para. A104)

(d) When applicable, whether management has the intent to carry out specific courses
of action and has the ability to do so. (Ref: Para. A105)

Assumptions may be made or identified by an expert to assist management in

making the accounting estimates. Such assumptions, when used by management, become
management’s assumptions. "Auditor should identify which of the assumptions used by
the company are significant assumptions to the accounting estimate, that is, the
assumptions that are important to the recognition or measurement of the accounting
estimate in the financial statements. In identifying the significant assumptions, the auditor
should take into account the nature of the accounting estimate, including related risk
factors, the requirements of the applicable financial reporting framework, and the
auditor's understanding of the company's process for developing the estimate.AS
(2501.15)
In accordance with Philippine Standards on Auditing (PSA) 540.15, for accounting
estimates that give rise to significant risks, in addition to other substantive procedures
performed to meet the requirements of PSA 330, the auditor shall evaluate the following;
(a) How management has considered alternative assumptions or outcomes, and
why it has rejected them, or how management has otherwise addressed estimation
uncertainty in making the accounting estimate.
(b) Whether the significant assumptions used by management are reasonable.
(c) Where relevant to the reasonableness of the significant assumptions used by
management or the appropriate application of the applicable financial reporting
framework, management’s intent to carry out specific courses of action and its
ability to do so.
Moreover, Securities and Exchange Commission (SEC) FR-72 noted that many
estimates and assumptions involved in the application of GAAP have a material impact
on reported financial condition and operating performance and on the comparability of
such reported information over different reporting periods. When preparing disclosure
under the current requirements, companies should consider whether they have made
accounting estimates or assumptions where: the nature of the estimates or assumptions is
material due to the levels of subjectivity and judgment necessary to account for highly
uncertain matters or the susceptibility of such matters to change; and the impact of the
estimates and assumptions on financial condition or operating performance is material.
"For critical accounting estimates, the auditor should obtain an understanding of how
management analyzed the sensitivity of its significant assumptions to change, based on
other reasonably likely outcomes that would have a material effect on its financial
condition or operating performance. AS (2501.18), the auditor should take that
understanding into account when evaluating the reasonableness of the significant
assumptions and potential management bias.
Auditors should be inclined to systematically evaluate management’s
assumptions and whether such estimate assumptions are reasonable in the context of
financial framework. Auditors should address accounting estimates or assumptions that
bear the risk of material misstatements. The reason may be that there is an uncertainty
attached to the estimate or assumption, or it just may be difficult to measure or value.
Equally important, that auditors should address to management questions once critical
accounting estimate or assumption has been identified, by analyzing, to the extent
material, such factors as how they arrived at the estimate, how accurate the estimate or
assumption has been in the past, how much the assumption has changed in the past, and
whether the assumption is reasonably likely to change in the future. Since accounting
estimates and assumptions are based on matters that are highly uncertain, an auditor
should analyze their specific sensitivity to change, based on other outcomes that are
reasonably likely to occur and would have a material effect.
On the other hand, The auditor shall evaluate, based on the audit evidence, whether
the accounting estimates in the financial statements are either reasonable in the context of
the applicable financial reporting framework, or are misstated (PSA (540.18) Revised ).
Auditors should also examine inconsistent and contrary evidence relating to management
assertions.
In accordance with ISA (540.A1), audit evidence is necessary to support the
auditor’s opinion and report. It is cumulative in nature and is primarily obtained from
audit procedures performed during the course of the audit. It may, however, also include
information obtained from other sources such as previous audits provided the auditor has
determined whether changes have occurred since the previous audit that may affect its
relevance to the current audit or a firm’s quality control procedures for client acceptance
and continuance. In addition to other sources inside and outside the entity, the entity’s
accounting records and other sources internal to the entity are an important sources of
audit evidence. Also, information that may be used as audit evidence may have been
prepared using the work of a management’s expert. or be obtained from an external
information source. Audit evidence comprises both information that supports and
corroborates management’s assertions, and any information that contradicts such
assertions. In addition, in some cases the absence of information (for example,
management’s refusal to provide a requested representation) is used by the auditor, and
therefore, also constitutes audit evidence.
If the audit evidence obtained from one source is inconsistent with that obtained
from another, or if the auditor has doubts about the reliability of information to be used as
audit evidence, the auditor should perform the audit procedures necessary to resolve the
matter and should determine the effect, if any, on other aspects of the audit. (AS
(1105.29) )
 Environmental factors and practical limitations often restrict the degree of
evidential support available to auditors, thus increasing inconsistencies in audit evidence
to support reasonable estimates or assumptions. The conventional presumption in
auditing standards and most audit research is that greater evidentiary support reduces
uncertainty and thus auditor reasonableness assessments should increase when greater
evidence is available to support the estimate. The determination of what constitutes
sufficient, appropriate evidence when auditing an uncertain estimate is subjective, and
likely influenced by various contextual features. Gathering sufficient, appropriate
evidence is a growing issue in auditing, due in part to the increased use of estimates.
2. Management may use both internal company data and data from external sources
when developing accounting estimates. (When using information produced by the
company as audit evidence, to evaluate whether the information is sufficient and
appropriate for purposes of the audit by performing procedures to (1) test the accuracy
and completeness of the information or test the controls over the accuracy and
completeness of that information, and (2) evaluate whether the information is sufficiently
precise and detailed for purposes of the audit (AS 1105.10). Consequently, Under AS
(2501.13) If the company uses data from an external source, the auditor should evaluate
the relevance and reliability of the data in accordance with AS 1105.
AS (2501.14) also emphasizes that auditor should also evaluate whether the data is
appropriately used by the company in developing the accounting estimate by evaluating
whether:
a. The data is relevant to the measurement objective for the accounting estimate;
b. The data is internally consistent with its use by the company in other significant
accounts and disclosures; and
c. The source of the company's data has changed from the prior year and, if so,
whether the change is appropriate.
AU Sec. 336, The appropriateness and reasonableness of methods and
assumptions used and their application are the responsibility of the specialist. The
auditor should (a) obtain an understanding of the methods and assumptions used by
the specialist, (b) make appropriate tests of data provided to the specialist, taking into
account the auditor's assessment of control risk, and (c) evaluate whether the
specialist's findings support the related assertions in the financial statements.
Ordinarily, the auditor would use the work of the specialist unless the auditor's
procedures lead him or her to believe the findings are unreasonable in the
circumstances. If the auditor believes the findings are unreasonable, he or she should
apply additional procedures, which may include obtaining the opinion of another
specialist.
3. Under Statement on Auditing Standards (SAS) 130.4, the objectives of the auditor in
an audit of Internal Control over Financial Reporting are to;
 a. obtain reasonable assurance about whether material weaknesses exist as of
the date specified in management’s assessment about the effectiveness of ICFR
(as of date) and
b. express an opinion on the effectiveness of ICFR in a written report, and
communicate with management and those charged with governance as required
by this SAS, based on the auditor’s findings. (Ref: par. A2–A4)
Internal control over financial reporting may also be audited by auditors to
determine whether internal control is accurate. The aim of an auditor is to have a view on
the company's overall internal control over financial statements. This helps the auditor to
change the information gathered about the efficacy of particular controls chosen for
testing based on the risk associated with that regulation.
The auditor's objective in an audit of internal control over financial reporting is to
express an opinion on the effectiveness of the company's internal control over financial
reporting. Since company's internal control cannot be considered effective if one or more
material weaknesses exist, to form a basis for expressing an opinion, the auditor must
plan and perform the audit to obtain appropriate evidence that is sufficient to obtain
reasonable assurance about whether material weaknesses exist as of the date specified in
management's assessment. A material weakness in internal control over financial
reporting may exist even when financial statements are not materially misstated. (AS
(2201.3)).Often lost on auditors is that one of the key objectives of understanding each
component of internal control over financial reporting is to identify the types of potential
misstatements that could occur. This is an important understanding for an auditor to have
in order to be able to identify the key controls to test.
It can be difficult for management to retain control over forecasts because they are
based on both subjective and objective variables. Also, where qualified professionals use
relevant and credible evidence in management's assessment process, subjective
considerations have the ability to bias the results. As a result, when preparing and
carrying out processes to review accounting estimates, the auditor should have both
subjective and quantitative considerations in mind, while maintaining a professional
skepticism. The auditor is responsible for evaluating the reasonableness of accounting
estimates made by management in the context of the financial statements taken as a
whole (PICPA 200.29). The auditor is responsible for evaluating management's decisions
and assessments in preparing their estimates and assessing whether there are any signs of
potential management bias. While signs of potential management bias do not constitute
misstatements in and of themselves, auditors should consider whether they influence their
risk evaluation and the consequences for the remainder of their audit if they are found.
PSA (540.21) Revised , requires the auditor to review the judgments and decisions
made by management in the making of accounting estimates to identify whether there are
indicators of possible management bias If the auditor develops a range to test the
reasonableness of management's point estimate using the auditor's own assumptions, the
auditor may form an opinion on whether management's judgments in choosing the
significant assumptions used in making the accounting estimate give rise to indicators of
potential management bias. "When the auditor identifies indicators of possible
management bias, the auditor may need a further discussion with management and may
need to reconsider whether sufficient appropriate audit evidence has been obtained that
the method, assumptions and data used were appropriate and supportable in the
circumstances (ISA 540.A96) Ref: Para. 23(b), 24(b), 25(b))

4. According to Franzel , (2013)"Auditor Objectivity and Skepticism -What's

Next?,PCAOB (2013)) the framework for auditor objectivity and professional skepticism
is reflected in PCAOB professional standards. The standards demand the appropriate
application of professional skepticism throughout the audit process, and emphasize that
professional skepticism:
a. is a component of the auditor's general duty of care that applies throughout the
audit;
b. is an attitude that includes a questioning mind and a critical assessment of the
appropriateness and sufficiency of audit evidence;
c. and comprises three elements — auditor attributes, mindset, and actions.
The three elements of professional skepticism — auditor attributes, auditor mindset,
and auditor actions — permeate the entire audit process and are integral to audit quality.
These elements of professional skepticism interact dynamically as auditors respond to
conditions and pressures that change or arise during the audit. As a result of skeptical
judgments made during the planning and performance of the audit, for example, the level
of skill and expertise needed, as well as other auditor actions and audit work conducted
are likely to change during the audit.
The exercise of professional skepticism in relation to accounting estimates is
affected by the auditor’s consideration of inherent risk factors, and its importance
increases when accounting estimates are subject to a greater degree of estimation
uncertainty or are affected to a greater degree by complexity, subjectivity or other
inherent risk factors. Similarly, the exercise of professional skepticism is important when
there is greater susceptibility to misstatement due to management bias or fraud. ISA
540.8 Revised   (Ref: Para. A11)
Professional skepticism is especially important in dealing with matters of
judgement.The risk of inherent factors may be decreased if the independent auditors
approach the audit with an attitude of professional skepticism. This attitude implies a
questioning mind and a critical assessment of audit evidence. All significant estimates
should be reviewed with professional skepticism and the reason for changes in
assumptions should be determined and justified by the internal auditor. An attitude of
professional skepticism should be maintained throughout the audit, notwithstanding the
auditor’s past experience with the entity. Auditing accounting estimates and related
disclosures introduces the concept of inherent risk factors and requires the auditor to
consider the degree to which accounting estimates are affected by these factors in
identifying and assessing the risks of material misstatement. This Audit and Assurance
guide explains what inherent risk factors are and how they may influence your audit of
accounting estimates.
Under (AS 1015.8), gathering and objectively evaluating audit evidence requires
the auditor to consider the competency and sufficiency of the evidence. Since evidence is
gathered and evaluated throughout the audit, professional skepticism should be exercised
throughout the audit process. (AS 1015.9), the auditor neither assumes that management
is dishonest nor assumes unquestioned honesty. In exercising professional skepticism, the
auditor should not be satisfied with less than persuasive evidence because of a belief that
management is honest.
5. The risk material misstatement of an estimate is a combination of the
“complexity and subjectivity associated with the process, the availability and reliability
of relevant data, the number and significance of assumptions that are made, and the
degree of uncertainty associated with the assumptions. (AU-C Sec. 540, (AICPA,
Professional Standards)) .A seemingly immaterial accounting estimate may have the
potential to result in a material misstatement due to the estimation uncertainty associated
with the estimation (that is, the size of the amount recognized or disclosed in the financial
statements for an accounting estimate may not be an indicator of its estimation
uncertainty).,(AU-C Sec. 540.A48 , (AICPA, Professional Standards)). An estimate can
provide relevant information, even if the estimate is subject to a high level of
measurement uncertainty. Nevertheless, if measurement uncertainty is high, an estimate
is less relevant than it would be if it were subject to low measurement uncertainty.
The new standard is designed to be scalable, meaning that more audit evidence is
required for estimates with a higher risk of material misstatement. It builds on prior
requirements within the auditing standards dealing with risk assessment and addresses
how the responsibilities of the auditor apply to auditing estimates.
(AS 2501.4) states that identifying and assessing risks of material misstatement,
establishes requirements regarding the process of identifying and assessing risks of
material misstatement. This process includes
(1) identifying accounting estimates in significant accounts and disclosures;
(2) understanding the process by which accounting estimates are developed;1 and;
(3) identifying and assessing the risks of material misstatement related to
accounting estimates, which includes determining whether the components of estimates
in significant accounts and disclosures are subject to significantly differing risks, and
which accounting estimates are associated with significant risks.
Under (AS 2501.5) “ the auditor's responses to the risks of material
misstatement, requires the auditor to design and implement appropriate responses that
address risks of material misstatement. This includes applying substantive procedures to
accounting estimates in significant accounts and disclosures. Responding to the risks of
material misstatement involves evaluating whether the accounting estimates are in
conformity with the applicable financial reporting framework and reasonable in the
circumstances, as well as evaluating potential management bias in accounting estimates
and its effect on the financial statements”. The components on the balance sheet are to a
significant extent influenced by accounting estimates and the risk of material
misstatement in the financial statement could influence the reliability of the financial
information. The failure to focus appropriate attention and thoughtfulness on risk
assessment, would lead to a less effective audit that could be subject to significant
challenge by regulators.
VI. APPLICABILITY TO LOCAL SETTINGS
Auditing accounting estimates has been proven challenging for auditors. Reports and
inspections continue to identify deficiencies at both larger and smaller audit firms in
auditing accounting estimates. The International Forum of Independent Audit
Regulators (IFIR) performs a global survey of audit inspection findings annually. Their
2018 survey results, release in May 2019, noted auditing accounting estimates, including
fair value measurements, as the most troublesome audit area.. The following are
permitted approaches in auditing accounting estimates.

a. Test the company’s process by evaluating the reasonableness and consistency of

assumptions used by management and testing the sufficiency, accuracy, and
reliability of the information used in the estimate.

b. Develop an independent expectation of the estimate. This approach generally

involves the auditor using some or all of the auditor’s own methods, data, and
assumptions to develop the expectation and compare it with the company’s
expectation

c. Review subsequent events or transactions and compare to the company’s

estimate. This approach generally involves using events or transactions occurring
subsequent to the balance sheet date, but prior to the date of the auditor’s report,
to provide evidence that either confirms or contradicts the reasonableness of the
company estimates.

Auditors in the local settings are recommend to perform walkthrough procedures to

gauge the reliability of estimates Auditors in the local settings must take note that while
performing audit they must exercise adequate professional skepticism. The heart of a
quality audit is the exercise of professional skepticism. Auditors must not over rely on
information’s provided by management. Auditors should “not be satisfied with less-than
persuasive audit evidence. Local auditors should also consider all the issues discussed in
this article such as identify the reasonableness of assumptions, consideration of potential
management bias, inconsistencies of evidences, and risk assessment. Moreover,
auditors in the local setting should recommend auditing management's internal control
over financial statements to determine the effectiveness of that control. It will help the
auditor in obtaining fair assurance about the effectiveness of management's internal
control. Effective internal control over financial reporting means that no material
weaknesses exist. With this, the auditor can provide reasonable assurance that the
estimates or the financial statements are in conformity with all generally accepted
standards and fairly presented in all material respects. Thus provide quality audit.
 References

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December 15), “Auditing Accounting Estimates, Including Fair Value Accounting

Estimates, and Related Disclosures”.. https://www.aicpa.org/au-c-00540.pdf

Auditing and Assurance Standards Council. (2008, April 28). PSA 540 (Revised and

Redrafted), “Auditing Accounting Estimates, Including Fair Value Accounting

Estimates, and Related Disclosures”.https://aasc.org.ph//PSA/PDFs

Franzel (2013) "Auditor Objectivity and Skepticism – What’s Next?. PCAOB (2013) )

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_A120_ISA_500

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International Auditing and Assurance Standards Board (IAASB) International Standard

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:https://pcaobus.org/oversight/AS1015

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