New SAS auditing fair value estimates
Abstract
The main aim of the study is to provide an in-depth view of the revised scope standards that outline how fair value estimates are audited. Notably, the comprehensive picture of the ne SAS auditing framework mainly focuses on five aspects of auditing fair value estimates. Firstly, identification and assessment of the risks of material misstatement and other procedural risks involved in developing fair value estimates. Secondly, responding to material misstatement risks through evaluation of the conformity of accounting estimates to the financial reporting model. Thirdly, testing the reliability and applicability of the fair value estimates through testing the reasonableness of the method used by the company to develop accounting estimates. Thirdly, the process and factors involved in establishing an independent accounting estimation that is compared to the organizational accounting estimation to establish congruence. Lastly, ascertaining the business events and transactions reported after the development of an accounting estimation for financial reporting. Due to the complexity of the factors involved in the estimation of the fair value, a vast array of specialists can be used in developing a solid view of the benefits and obligations of organizational assets and liabilities. The methodology used by the study is a systematic review of literature highlighting the recent changes in fair value auditing standards.
Introduction
Since 1980, changes in the outlook of global business have exhibited inclination towards creating a globalized business environment. In the quest to globalize business, the scope of changes required to achieve a standardized corporate environment globally is vast. Notably, a significant array of literature explains how the global corporate environment has executed major approaches of globalizing corporate aspects like labour, capital, operations and the market. On the other hand, major accounting bodies like the public company accounting oversight board (PCAOB) have been at the forefront of balancing the design and application of accounting rules and standards. It is also important to note that the scope of application of the standards globally has mainly engulfed both public and private business and corporate entities.
(Reference) also explains the scope of changes in accounting standards made by international accounting bodies has included various aspects like accounting estimates. Accounting estimates are applied by auditors and certified public accounts (CPAs) in public and private corporations globally. (Reference) defines accounting estimates as the approximation of amounts that auditors and CPAs are supposed to credit or debit on the entry values in financial reports when the value of the entry cannot be precisely established. Furthermore, the statement on auditing standards (SAS) that define the scope of accounting and fair value estimates are updated frequently. Frequent update of the standards is particularly informed by a review on the applicability of the accounting methodology in the business environment.
This research uses a systematic review of secondary data from the public company accounting oversight board among others to create a comprehensive outlook of some of the recent changes in the auditing standards used by auditors and CPAs to audit the fair value. Particularly, the paper evaluates the scope of applicability of the changes in the following categories (1) Testing reasonableness and consistency of the approaches used by the management to establish an accounting estimate and whether the data applied in testing is accurate and relevant. (2) Establishment of the auditor’s independent estimate using management’s assumptions to find the comparison with the estimates reported in the financial reports. (3) Ascertaining the reasonableness of accounting estimates and financial reports by evaluating the accuracy of financial transactions and events that informed the entries in the financial reports.
In the discussion, the report establishes the suitability of the scope of changes to the business environment. The overall role of such standardization is to achieve consistency in the quality of financial reporting and auditing. The consistency is achieved through the accounting framework provided by the standards to auditors and CPAs. Therefore, the discussion also provides an evaluation of the potential implication of the changes in the role of the statement of accounting standards in strengthening auditing and accounting practices. Currently, a vast scope of literature has been proposed to address the diversity of contemporary accounting issues. Therefore, this study is also important since it not only depicts the changes in accounting estimates but also analyses the reliability and role of the estimates in the corporate environment. The literature of the report provides selected sources used to provide a critical view on the changes in SAS auditing fair value estimates. The discussion describes the implications of the changes in the ability of auditors to foster accurate valuation of assets and liabilities.
Literature review
(Reference) explains that accounting estimates like the fair value are based on the circumstances prevailing the business environment at the time of evaluation. Furthermore, he explains that determination and auditing of the accounting estimates are based on the income accrued and expenses incurred from the possession of the assets or liabilities. Fair value estimates emerge in aspects like the useful life of non-current assets, cushioning the impact of bad debts on financial reports, depreciation, and provision of pension benefits for employees. The need to promote a standardized and updated statement of auditing fair value estimates is important due to the role of the fair value estimates in accounting and financial reporting. For instance, the fair value estimate in accounting is important. Notably, it enhances the accuracy of financial information reported by enabling organizational auditors and CPAs to accurately value company assets and liabilities during reporting. Besides the advantages, some literature like (reference) has also established the disadvantages of fair value estimates on the valuation of assets of liabilities. For instance, the use of fair value accounting may affect down market adversely. For example, after an asset has been valued downwards due to the drop in the existing market trading prices, the reduced value of the asset can prompt a potentially depressed selling price
The new requirements for auditing fair value estimates put forward by the public company accounting oversight board (PCAOB) are supposed to start implementation by auditors in the fiscal year ending on or after Dec 2020. The major aim of the revision in the standards is to harmonize the three (PCAOB) standards into a single uniform, risk-based approach to auditing accounting estimates like the face value estimates. The auditing standards mainly focus on the following key aspects
- Identification and assessment of Risks
- Responding to risks
- Substantive testing of fair value estimates through testing the corporate process, assumptions and information involved in designing fair value estimates. Secondly, developing and independent expectation, and thirdly, evaluating the events and transactions of financial reports that provide an estimation of the fair accounting estimate.
Identifying and assessing risks
In the revised fair value estimate accounting framework, three approaches have been established to foster the risk assessment processes of organizational account estimates in three ways.
Understanding the process involved in developing estimates.
Notably, when familiarizing with the organizational informational systems, auditors are supposed to categorize corporate accounts basing on if they’re subject to accounting estimates. If they are subject to accounting estimates, the auditors are also supposed to comprehend the process used to develop the accounting estimates. According to the new standards, the organizational process used in developing accounting estimates can be evaluated through establishing the following aspects in the process; the methods and models used, the financial data and assumptions (and sources from which the sources and assumptions have been derived) used in the process of establishing estimates. Thirdly, the role of third parties like specialists and other third parties regarding how they use company data and assumptions (Reference).
Collective Team brainstorming
The discussion on the collective team brainstorming efforts is mainly anticipated to focus on the financial reporting areas that can are vulnerable to manipulation bias through accounting estimates. Therefore, through the collective team brainstorming efforts, the ability of auditors to prevent material misstatement due to fraud is enhanced.
Risk factors for identifying significant accounts and disclosures.
Besides the existing risk factors in the risk assessment standards, the new accounting standards outlines factors to be considered by auditors when identifying major accounts and disclosures that are subject to accounting estimates. Firstly, the degree of uncertainty associated with future outcomes of events under a vast scope of assumptions the complexity involved in the process of establishing accounting estimates, the number and degree of complexity of the major assumptions associated with the process of designing fair value estimates. The degree of subjectivity affiliated to the major assumptions (for example because of significant changes in the related conditions and events). Lastly, if the forecasts are also important to the accounting estimates in the organization, the length of the forecast period and magnitude of uncertainty regarding the trends affecting the forecast should be evaluated (Reference). The risk factors established in this subcategory provide a scope of the characteristics that enable the auditors to determine the potential of misstatement in accounting estimates.
Responding to Assessed Risks of Material misstatement
The new estimates also clearly illustrate responding to risks of material misstatement as involving the auditor’s capacity to ascertain the conformity of accounting estimates with the existing financial reporting frameworks. Furthermore, besides testing the reasonableness of the accounting estimates to the accounting standards as a way of responding to risks, the scope of response to risks or involves the auditor’s obligation to evaluate the potential occurrence of management bias in the process of accounting estimates and the effect of the potential risk on the outlook of the financial statements. Lastly, due to the vast scope and components of the estimates, the resulting scope of misstatement risk is also vast (Reference). Therefore the new standards also task auditors and CPAs with the role depicting diversity in creating responses for the identified risks.
Selecting an approach for testing the company accounting estimates including their face value estimate
According to the outlines of the new accounting standards, the major approaches of testing accounting estimates emerge three dimensions. Firstly, testing the company’s process of determining accounting estimates. Developing an independent accounting estimate and drawing a comparison with the organizational estimates. Thirdly, evaluating audit evidence from events and transactions related to the accounting estimates. The selection of the approach of testing accounting estimates is motivated by the auditor’s comprehension of the company’s process and relevant controls involved in the development of accounting estimates.
Testing the Companies Process
Testing the company’s process particularly involves an in-depth evaluation of the methods, data and major assumptions involved in the development of the company accounting estimates.
Evaluating the company’s methods
In most instances, the method applied by the company directly depends on the estimate. For instance, the development of the fair value estimates mainly depends on the valuation methods such as the model based on future cash flow. However, other estimates like the obsolescence reserves can be tested using other approaches like based on historical data and trends. Nevertheless, the major role of auditor or CPA is therefore to ascertain two aspects of the method; Firstly, conformity to applicable financial reporting framework and if the method is suitable for the related accounts or disclosure.
Conformity to the exiting financial standards
In most instances, financial standards tend to outline a cross-cutting and consistent method of developing estimates. Furthermore, alternative methods of developing the estimates may also be allowed depending on the related accounts and outlook of the financial standards. The standards may also guide on the applicability of a certain method including the criteria of selecting data and assumptions involved in developing estimates.
Evaluating suitability for the account or disclosure
Evaluating this aspect is based on the auditor’s knowledge of the business environment used by the company. Important factors of the business environment that may affect how the auditor determines the appropriateness of the estimates for the account or disclosure include the regulatory framework and outlook of the relevant industry.
Testing Data used by the company
For internal data, the sufficiency and suitability of internal data for auditing purposes are evaluated through testing the accuracy and completeness of the information. Furthermore, internal data sources are also audited through evaluating whether the information is precise and detailed enough for purposes of the audit. On the other hand, the external sources of data used in the process can be audited through evaluating the reliability and relevance of the data according to AS 1105. Audit Evidence. However, regardless of whether the data is internal or external, it is also audited through evaluating if the data is relevant to the measurement objective of the accounting estimate and if the data is internally consistent with its applications by the company in other major accounts and disclosures.
Identifying the major assumptions used by the company
Significant assumptions to the accounting estimates are established through factoring the nature of the accounting estimate and risks associated, the outlined specifications of the applicable financial standards and lastly, the auditor’s comprehension of the method used by the company to develop accounting estimates. Particularly, significant or major assumptions of the method are essential assumptions that are key to the determination of the accounting estimates. In most cases, significant assumptions relate to the manipulation and bias of data or the method and unobservable data that is subject to potential modifications by the management.
Developing an independent Expectation
The process particularly involves the auditor using their method, data and assumptions in developing accounting estimates that are subsequently compared with the organizational accounting estimates. Notably, the auditor’s independent expectation is also required to conform to the stipulations of the applicable financial models and organizational process of developing accounting estimates including the assumptions involved. Considering factors relevant to the corporate estimates also minimizes the potential of deviation from the expected range of the estimate. During configuration of the assumptions to be recognized in the calculation of independent estimates, it is important for auditors to also provide a basis for the assumptions made in the process. The scope of the basis can include factors like nature of the estimate, the relevant scope of financial reporting outlines applicable, the auditor’s comprehension of the organization, its business environment and other relevant audit evidence.
On the other hand, developing an independent estimate can also involve a combination of data, significant assumptions and methods.
Evaluating subsequent events and transactions
Under this category of testing the accounting estimates, the auditor is required to evaluate whether audit evidence from transactions reported from the date of measurement data is reliable, sufficient and conforms to the company’s accounting estimates. The process can begin by establishing pertinent information and records from the measurement date. Secondly, evaluating subsequent transactions also involves considering the organizational changes that have taken place since the date of measurement and date of transactions or events. Additionally, the likelihood of organizational changes also increases as the time gap between the date of measurement and date of transactions widens.
The role of a specialist in developing accounting estimates
Besides the auditors and Certified public accountants involved in determining accounting estimates like the fair value estimate, there are also other specialists involved in the process. The involvement of other specialists objectively promotes the accuracy of the estimates. Furthermore, the need for experts is also promoted by the diversity of components involved in the estimation of accounting estimates. Since the specialists are not subject to Audit training, it is also paramount for Auditors to provide direct help to the specialists to minimize incidences of Misstatement. Some of the experts involved in the process include Actuaries (who help in the determination of the employee benefit obligations). Appraisers provide help in determining the value of intangible assets and real estate. Geologists provide mineral deposit and oil reserve estimation mainly for mining and petrochemical business entities. Lastly, lawyers also help the establishment of the potential losses affiliated to legal proceedings or lawsuits involving the company.
Discussion and conclusion
From the literature review provided by the research, the role of the statement on accounting standards in strengthening accounting practices is vivid. Notably, the major area of focus of the research is fair value estimates and particularly how the new changes in standards for auditing accounting estimates promote the accuracy and reliability of auditing accounting estimates. The literature review also clearly indicates the major dimensions of accounting estimate auditing procedures that are affected by the update of standards. From the findings of the research, the changes in the fair value auditing standards (which are supposed to be implemented in the fiscal year ending on or after Dec 2020) are mainly focused on elaborating on the key modifications of fair value estimates auditing. The modifications are mainly prudent in five major aspects of auditing fair value estimates.
Firstly, the scope of risk assessment measures has been enhanced to focus on the diversity of risks involved in developing estimates. Besides the misstatement of material risk, other risks addressed by the standards emerge in the process of determining accounting estimates. Notably, risks are assessed by understanding the process involved in developing fair value estimates. Engaging team brainstorming and identifying risk factors involved in significant accounts and disclosure (reference)
Furthermore, from the literature review, it is also prudent that responding to determining risks of material misstatement is done through evaluating if the estimates are parallel with the requirements of the financial reporting model applicable. Lastly, the new standards also expand on the three major techniques adapted for testing or measuring the accuracy and reliability of accounting estimates like the fair value estimate. The major approaches discussed include testing the management’s process of establishing accounting controls, developing independent estimate values for comparison and lastly using specialists in the process of evaluating the transactions after the measurement date to determination congruence or deviation.
By enlarging and updating the scope of accounting estimates auditing, various factors are achieved. Firstly, the Auditors and CPAs are assured of the ability to enhance accuracy in financial reporting and auditing due to the availability of an updated guide to developing accounting estimates (reference). Furthermore, it enhances the accuracy of accounting standards due to the vast scope of revised standards that helps auditors to identify and respond to misstatement material risks and other risks in the process that can jeopardize the fair value estimates.