Statement on Auditing Standards 143 Auditing Accounting Estimates

Statement on July 2020

Auditing Standards 143

Issued by the Auditing Standards Board

Auditing Accounting Estimates and Related Disclosures

(Supersedes Statement on Auditing Standards (SAS) No. 122, Statements on Auditing Standards:

Clarification and Recodification, as amended, section 540, Auditing Accounting Estimates,

Including Fair Value Accounting Estimates, and Related Disclosures [AICPA, Professional

Standards, AU-C sec. 540]; Amends:

• SAS No. 122, as amended

— Section 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit

in Accordance With Generally Accepted Auditing Standards [AICPA, Professional

Standards, AU-C sec. 200]

— Section 230, Audit Documentation [AICPA, Professional Standards, AU-C sec. 230]

— Section 240, Consideration of Fraud in a Financial Statement Audit [AICPA, Professional

Standards, AU-C sec. 240]

— Section 260, The Auditor’s Communication With Those Charged With Governance

[AICPA, Professional Standards, AU-C sec. 260]

— Section 501, Audit Evidence — Specific Considerations for Selected Items [AICPA,

Professional Standards, AU-C sec. 501]

— Section 580, Written Representations [AICPA, Professional Standards, AU-C sec. 580]

• SAS No. 134, Auditor Reporting and Amendments, Including Amendments Addressing

Disclosures in the Audit of Financial Statements, as amended

— Section 700, Forming an Opinion and Reporting on Financial Statements [AICPA,

Professional Standards, AU-C sec. 700]

— Section 701, Communicating Key Audit Matters in the Independent Auditor’s Report

[AICPA, Professional Standards, AU-C sec. 701]

• SAS No. 136, Forming an Opinion and Reporting on Financial Statements of Employee

Benefit Plans Subject to ERISA, as amended [AICPA, Professional Standards, AU-C sec.703])

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Auditing Standards Board

(2019–2020)

Michael J. Santay, Chair Audrey A. Gramling

Brad C. Ames Gaylen R. Hansen

Monique Booker Tracy W. Harding

Patricia Bottomly Jon Heath

Jay D. Brodish, Jr. Kristen A. Kociolek

Dora A. Burzenski G. Alan Long

Joseph S. Cascio Sara Lord

Harry Cohen Marcia L. Marien

Jeanne M. Dee Aaron Saito

Lawrence M. Gill

Estimates Task Force

Dora A. Burzenski, Chair Mike Lundberg

Jeanne M. Dee Martin Hurden

Doug Bennett Laura Schuetze

Ilene Kassman

AICPA Staff

Robert Dohrer

Chief Auditor

Professional Standards and Services

Linda Delahanty

Senior Manager

Audit and Attest Standards —

Public Accounting

Teighlor S. March

Assistant General Counsel —

Office of General Counsel

Note: Statements on Auditing Standards are issued by the Auditing Standards Board, the senior technical

body of the AICPA designated to issue pronouncements on auditing matters. The “Compliance With

Standards Rule” (ET sec. 1.310.001)

of the AICPA Code of Professional Conduct requires compliance

with these standards in an audit of a nonissuer.

All ET sections can be found in AICPA Professional Standards.

CONTENTS

Paragraph

Introduction

Scope of This Statement on Auditing Standards ..................................................................... 1

Nature of Accounting Estimates .......................................................................................... 2–3

Key Concepts of This SAS .................................................................................................. 4–8

Effective Date .......................................................................................................................... 9

Objective ..................... ................................................................................................................10

Definitions ................................................................................................................................... 11

Requirements

Risk Assessment Procedures and Related Activities ....................................................... 12–14

Identifying and Assessing the Risks of Material Misstatement ....................................... 15–16

Responses to the Assessed Risks of Material Misstatement ............................................ 17–30

Disclosures Related to Accounting Estimates ....................................................................... 31

Indicators of Possible Management Bias ............................................................................... 32

Overall Evaluation Based on Audit Procedures Performed ............................................. 33–36

Communication With Those Charged With Governance, Management, or Other

Relevant Parties ..................................................................................................................... 37

Documentation ....................................................................................................................... 38

Application and Other Explanatory Material

Nature of Accounting Estimates .................................................................................... A1–A7

Key Concepts of This SAS .......................................................................................... A8–A13

Definitions.................................................................................................................. A14–A18

Risk Assessment Procedures and Related Activities ................................................. A19–A63

Identifying and Assessing the Risks of Material Misstatement ................................. A64–A80

Responses to the Assessed Risks of Material Misstatement .................................... A81–A132

Indicators of Possible Management Bias ............................................................... A133–A136

Overall Evaluation Based on Audit Procedures Performed ................................... A137–A144

Written Representations .................................................................................................... A145

Communication With Those Charged With Governance, Management, or Other

Relevant Parties ..................................................................................................... A146–A147

Documentation ....................................................................................................... A148–A151

Appendix A — Inherent Risk Factors ................................................................................ A152

Appendix B — Communications With Those Charged With Governance ..................... A153

Appendix C —Amendments to Various Sections in SAS No. 122, Statements on

Auditing Standards: Clarification and Recodification, as Amended; SAS No.

134, Auditor Reporting and Amendments, Including Amendments Addressing

Disclosures in the Audit of Financial Statements, as Amended; and SAS No.

136, Forming an Opinion and Reporting on Financial Statements of Employee

Benefit Plans Subject to ERISA, as Amended ..................................................................... A154

Statement on Auditing Standards, Auditing

Accounting Estimates and Related Disclosures

Introduction

Scope of This Statement on Auditing Standards

1. This Statement on Auditing Standards (SAS) addresses the auditor’s responsibilities

relating to accounting estimates, including fair value accounting estimates and related disclosures,

in an audit of financial statements. Specifically, it includes requirements and guidance that refer to

or expand on how AU-C section 315,

Understanding the Entity and Its Environment and Assessing

the Risks of Material Misstatement;

AU-C section 330,

Performing Audit Procedures in Response

to Assessed Risks and Evaluating the Audit Evidence Obtained; AU-C section 450, Evaluation of

Misstatements Identified During the Audit; and AU-C section 500,

Audit Evidence, and other

relevant AU-C sections are to be applied with regard to accounting estimates and related

disclosures. It also includes requirements and guidance related to the evaluation of misstatements

of accounting estimates and related disclosures, and indicators of possible management bias.

Nature of Accounting Estimates

2. Accounting estimates vary widely in nature and are required to be made by management

when the monetary amounts cannot be directly observed. The measurement of these monetary

amounts is subject to estimation uncertainty, which reflects inherent limitations in knowledge or

data. These limitations give rise to inherent subjectivity and variation in the measurement

outcomes. The process of making accounting estimates involves selecting and applying a method

using assumptions and data, which requires judgment by management and can give rise to

complexity in measurement. The effects of complexity, subjectivity, or other inherent risk factors

on the measurement of these monetary amounts affects their susceptibility to misstatement. (Ref:

par. A1–A6 and app. A)

3. Although this SAS applies to all accounting estimates, including fair value accounting

estimates,

the degree to which an accounting estimate is subject to estimation uncertainty will

vary substantially. The nature, timing, and extent of the risk assessment and further audit

procedures required by this SAS will vary in relation to the estimation uncertainty and the

assessment of the related risks of material misstatement. For certain accounting estimates,

estimation uncertainty may be very low, based on their nature, and the complexity and subjectivity

involved in making them may also be very low. For such accounting estimates, the risk assessment

procedures and further audit procedures required by this SAS would not be expected to be

extensive. When estimation uncertainty, complexity, or subjectivity are very high, such procedures

All AU-C sections can be found in AICPA Professional Standards.

For purposes of generally accepted auditing standards, a fair value measurement is a form of accounting estimate.

would be expected to be much more extensive. This SAS contains guidance on how the

requirements of this SAS can be scaled. (Ref: par. A7)

Key Concepts of This SAS

4. AU-C section 315 requires the auditor to assess the risk of material misstatement at the

relevant assertion level. For this purpose, this SAS requires inherent risk and control risk to be

assessed separately for accounting estimates. Depending on the nature of a particular accounting

estimate, the susceptibility of an assertion to a misstatement that could be material may be subject

to or affected by estimation uncertainty, complexity, subjectivity, or other inherent risk factors,

and the interrelationship among them. As explained in AU-C section 200, Overall Objectives of

the Independent Auditor and the Conduct of an Audit in Accordance With Generally Accepted

Auditing Standards,

inherent risk is higher for some assertions and related classes of transactions,

account balances, and disclosures than for others. Accordingly, the assessment of inherent risk

depends on the degree to which the inherent risk factors affect the likelihood or magnitude of

misstatement and varies on a scale that is referred to in this SAS as the spectrum of inherent risk.

In assessing control risk, the auditor takes into account whether the auditor’s further audit

procedures contemplate planned reliance on the operating effectiveness of controls. If the auditor

does not perform tests of controls, the auditor’s assessment of the risk of material misstatement at

the relevant assertion level cannot be reduced for the effective operation of controls with respect

to the particular assertion.

(Ref: par. A8–A10, A65–A66, and app. A)

5. This SAS refers to relevant requirements in AU-C sections 315 and 330 and provides

related guidance to emphasize the importance of the auditor’s decisions about controls relating to

accounting estimates, including decisions about whether

• there are controls relevant to the audit, for which the auditor is required to evaluate

their design and determine whether they have been implemented.

• to test the operating effectiveness of relevant controls.

6. This SAS emphasizes that the auditor’s further audit procedures (including, when

appropriate, tests of controls) need to be responsive to the reasons for the assessed risks of material

misstatement at the relevant assertion level, taking into account the effect of one or more inherent

risk factors and the auditor’s assessment of control risk.

7. 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. (Ref: par. A11)

8. This SAS requires the auditor to evaluate, based on the audit procedures performed and

the audit evidence obtained, whether the accounting estimates and related disclosures are

Paragraph .A42 of AU-C section 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit

in Accordance With Generally Accepted Auditing Standards.

reasonable

in the context of the applicable financial reporting framework or are misstated. For

purposes of this SAS, reasonable, in the context of the applicable financial reporting framework,

means that the relevant requirements of the applicable financial reporting framework have been

applied appropriately, including those that address the following: (Ref: par. A12–A13 and A139–

A144)

• The development of the accounting estimate, including the selection of the method,

assumptions, and data in view of the nature of the accounting estimate and the facts

and circumstances of the entity

• The selection of management’s point estimate

• The disclosures about the accounting estimate, including disclosures about how the

accounting estimate was developed and that explain the nature, extent, and sources

of estimation uncertainty

Effective Date

9. This SAS is effective for audits of financial statements for periods ending on or after

December 15, 2023.

Objective

10. The objective of the auditor is to obtain sufficient appropriate audit evidence about whether

accounting estimates and related disclosures in the financial statements are reasonable, in the

context of the applicable financial reporting framework.

Definitions

11. For purposes of generally accepted auditing standards (GAAS), the following terms have

the meanings attributed as follows:

Accounting estimate. A monetary amount for which the measurement, in accordance with the

requirements of the applicable financial reporting framework, is subject to estimation

uncertainty. (Ref: par. A14)

Auditor’s point estimate or auditor’s range. An amount, or range of amounts, respectively,

developed by the auditor in evaluating management’s point estimate. (Ref: par. A15)

Estimation uncertainty. Susceptibility to an inherent lack of precision in measurement. (Ref:

par. A16 and app. A)

Management bias. A lack of neutrality by management in the preparation of information. (Ref:

par. A17)

See also paragraph .15c of AU-C section 700, Forming an Opinion and Reporting on Financial Statements, or

paragraph .40c of AU-C section 703, Forming an Opinion and Reporting on Financial Statements of Employee

Benefit Plans Subject to ERISA.

Management’s point estimate. The amount selected by management for recognition or

disclosure in the financial statements as an accounting estimate.

Outcome of an accounting estimate. The actual monetary amount that results from the

resolution of the transactions, events, or conditions addressed by an accounting estimate.

(Ref: par. A18)

Requirements

Risk Assessment Procedures and Related Activities

12. When obtaining an understanding of the entity and its environment, including the entity’s

internal control, as required by AU-C section 315,

the auditor should obtain an understanding of

the following matters related to the entity’s accounting estimates. The auditor’s procedures to

obtain the understanding should be performed to the extent necessary to provide an appropriate

basis for the identification and assessment of risks of material misstatement at the financial

statement and relevant assertion levels.

(Ref: par. A19–A23)

The Entity and Its Environment

a. The entity’s transactions and other events and conditions that may give rise to the need

for or changes in accounting estimates to be recognized or disclosed in the financial

statements (Ref: par. A24)

b. The requirements of the applicable financial reporting framework related to accounting

estimates (including the recognition criteria, measurement bases, and the related

presentation and disclosure requirements) and how they apply in the context of the

nature and circumstances of the entity and its environment, including how transactions

and other events or conditions are subject to or affected by inherent risk factors. (Ref:

par. A25–A26)

c. Regulatory factors relevant to the entity’s accounting estimates, including, when

applicable, regulatory frameworks (Ref: par. A27)

d. The nature of the accounting estimates and related disclosures that the auditor expects

to be included in the entity’s financial statements, based on the auditor’s understanding

of the matters in paragraph 12a–c of this SAS (Ref: par. A28)

The Entity’s Internal Control

Paragraphs .05–.06 and .12–.13 of AU-C section 315, Understanding the Entity and Its Environment and

Assessing the Risks of Material Misstatement.

 
 
e.  The nature and extent of oversight and governance that the entity has in place over 
management’s financial reporting process relevant to accounting estimates (Ref: par. 
A29–A31) 
f.  How management identifies the need for and applies specialized skills or knowledge 
related to accounting estimates, including with respect to the use of a management’s 
specialist (Ref: par. A32) 
g.  How  the  entity’s  risk  assessment  process  identifies  and  addresses  risks  relating  to 
accounting estimates (Ref: par. A33–A34) 
h.  The  entity’s  information  system  as  it  relates  to  accounting  estimates, including the 
following: 
i.  The classes of  transactions,  events, and  conditions  that are  significant  to the 
financial statements and that give rise to the need for or changes in accounting 
estimates and related disclosures (Ref: par. A20 and A35) 
ii.   For such accounting estimates and related disclosures, how management 
(1) identifies the relevant methods, assumptions, or sources of data, and the need 
for changes in them, that are appropriate in the context of the applicable 
financial reporting framework, including how management (Ref: par. A36– 
A37) 
(a) selects or designs, and applies, the methods used, including the use of 
models (Ref: par. A38–A39) 
(b) selects  the  assumptions  to  be  used,  including  consideration  of 
alternatives, and identifies significant assumptions (Ref: par. A40–A43) 
(c) selects the data to be used (Ref: par. A44) 
(2) understands the degree of estimation uncertainty, including by considering 
the range of possible measurement outcomes (Ref: par. A45) 
(3) addresses the estimation uncertainty, including selecting a point estimate and 
related disclosures for inclusion in the financial statements (Ref: par. A46–
A49) 
i.  Control  activities  relevant  to  the  audit  over  management’s  process  for  making 
accounting estimates as described in paragraph 12h(ii) of this SAS (Ref: par. A50–A54) 
j.  How management reviews the outcomes of previous accounting estimates and responds 
to the results of that review 
13.  The  auditor  should  review  the  outcome  of  previous  accounting  estimates  or,  when 
applicable, their subsequent re-estimation to assist in identifying and assessing the risks of material 
misstatement in the current period. The auditor should take into account the characteristics of the 
accounting  estimates  in  determining  the  nature  and  extent  of  that  review.  The  review  is  not 

 
 
intended to call into question judgments about previous-period accounting estimates that were 
appropriate based on the information available at the time they were made. (Ref: par. A55–A60) 
14.  With  respect  to  accounting  estimates,  the  auditor  should  determine  whether  the 
engagement  team  requires  specialized  skills  or  knowledge  to  perform  the  risk  assessment 
procedures, to identify and assess the risks of material misstatement, to design and perform audit 
procedures to respond to those risks, or to evaluate the audit evidence obtained. (Ref: par. A61–
A63) 
Identifying and Assessing the Risks of Material Misstatement 
15.  In identifying and assessing the risks of material misstatement relating to an accounting 
estimate and related disclosures at the relevant assertion level, as required by AU-C section 315,
5
 
the auditor should separately assess inherent risk and control risk. The auditor should take the 
following into account in identifying the risks of material misstatement and assessing inherent risk: 
(Ref: par. A64–A71) 
a.  The degree to which the accounting estimate is subject to estimation uncertainty (Ref: 
par. A72–A75) 
b.  The  degree  to  which  one  or  both  of  the  following  are  affected  by  complexity, 
subjectivity, or other inherent risk factors: (Ref: par. A76–A79) 
i.  The selection and application of the method, assumptions, and data in making the 
accounting estimate 
ii.  The selection of management’s point estimate and related disclosures for inclusion 
in the financial statements 
16.  The auditor should determine whether any of the risks of material misstatement identified 
and assessed in accordance with paragraph 15 are, in the auditor’s judgment, a significant risk.
6
 
If the auditor has determined that a significant risk exists, the auditor should obtain an understanding 
of  the  entity’s  controls,  including  control  activities,  relevant  to  that  risk,  and,  based  on  that 
understanding, evaluate whether such controls have been suitably designed and implemented to 
mitigate such risks.
7
 (Ref: par. A80) 
Responses to the Assessed Risks of Material Misstatement 
17.  As  required  by  AU-C  section  330,
8
 
the  auditor’s  further  audit  procedures  should  be 
responsive  to  the  assessed  risks  of  material  misstatement  at  the  relevant  assertion  level,
9
 
considering  the  reasons  for  the  assessment  given  to  those  risks.  The  auditor’s  further  audit 
procedures should include one or more of the following approaches: 
 
5
 Paragraphs .26–.27 of AU-C section 315. 
6
 Paragraph .28 of AU-C section 315. 
7
 Paragraph .30 of AU-C section 315. 
8
 Paragraphs .06–.15 and .18 of AU-C section 330, Performing Audit Procedures in Response to Assessed Risks and 
Evaluating the Audit Evidence Obtained. 
9
 Paragraphs .06–.07 and .22 of AU-C section 330. 

 
 
a.  Obtaining audit evidence from events occurring up to the date of the auditor’s report 
(see paragraph 20 of this SAS) 
b.  Testing how management made the accounting estimate (see paragraphs 21–26 of this 
SAS) 
c.  Developing an auditor’s point estimate or range (see paragraphs 27–28 of this SAS) 
The auditor’s further audit procedures should take into account that the higher the assessed risk of 
material misstatement, the more persuasive the audit evidence needs to be.
10
 The auditor should 
design and perform further audit procedures in a manner that is not biased toward obtaining audit 
evidence that may be corroborative or toward excluding audit evidence that may be contradictory. 
(Ref: par. A81–A84) 
18.  As required by AU-C section 330,
11
 
the auditor should design and perform tests to obtain 
sufficient appropriate audit evidence about the operating effectiveness of relevant controls, if 
a.  the auditor’s assessment of risks of material misstatement at the  relevant assertion 
level includes an expectation that the controls are operating effectively, or 
b.  substantive procedures alone cannot provide sufficient appropriate audit evidence at 
the relevant assertion level. 
In relation to accounting estimates, the auditor’s tests of such controls should be responsive to the 
reasons for the assessment given to the risks of material misstatement. In designing and performing 
tests of controls, the auditor should obtain more persuasive audit evidence the greater the reliance 
the auditor places on the effectiveness of a control.
12
 (Ref: par. A85–A89) 
19.  For  a  significant  risk  relating  to  an  accounting  estimate,  the  auditor’s  further  audit 
procedures should include tests of controls in the current period if the auditor plans to rely on those 
controls. When the approach to a significant risk consists only of substantive procedures, those 
procedures should include tests of details.
13
 (Ref: par. A90) 
Obtaining Audit Evidence From Events Occurring Up to the Date of the Auditor’s Report 
20.  When the auditor’s further audit procedures include obtaining audit evidence from events 
occurring up to the date of the auditor’s report, the auditor should evaluate whether such audit 
evidence is sufficient and appropriate to address the risks of material misstatement relating to the 
accounting  estimate,  taking  into  account  that  changes  in  circumstances  and  other  relevant 
conditions between the event and the measurement date may affect the relevance of such audit 
evidence in the context of the applicable financial reporting framework. (Ref: par. A91–A93) 
Testing How Management Made the Accounting Estimate 
 
10
 Paragraph .07b of AU-C section 330. 
11
 Paragraph .08 of AU-C section 330. 
12
 Paragraph .09 of AU-C section 330. 
13
 Paragraphs .15 and .22 of AU-C section 330. 

 
 
21.  When testing how management made the accounting estimate, the auditor’s further audit 
procedures should include procedures, designed and performed in accordance with paragraphs 22–
25, to obtain sufficient appropriate audit evidence regarding the risks of material misstatement
14
 
relating to the following: (Ref: par. A94) 
a.  The selection and application of the methods, significant assumptions, and data used 
by management in making the accounting estimate 
b.  How management selected the point estimate and developed related disclosures about 
estimation uncertainty 
Methods 
22.  In applying the requirements of paragraph 21, with respect to methods, the auditor’s further 
audit procedures should address the following: 
a.  Whether the method selected is appropriate in the context of the applicable financial 
reporting framework and, if applicable, changes from the method used in prior periods 
are appropriate (Ref: par. A95 and A97) 
b.  Whether judgments made in selecting the method give rise to indicators of possible 
management bias (Ref: par. A96) 
c.  Whether  the  calculations  are  applied  in  accordance  with  the  method  and  are 
mathematically accurate 
d.  When management’s application of the method involves complex modeling, whether 
judgments have been applied consistently, and whether, when applicable (Ref: par. 
A98–A100) 
i.  the design of the model meets the measurement objective of the applicable 
financial  reporting  framework,  is  appropriate  in  the  circumstances,  and,  if 
applicable,  changes  from  the  prior  period’s  model  are  appropriate  in  the 
circumstances. 
ii.  adjustments to the output of the model are consistent with the measurement 
objective of the applicable financial reporting framework and are appropriate 
in the circumstances. 
e.  Whether the integrity of the significant assumptions and the data has been maintained 
in applying the method (Ref: par. A101) 
Significant Assumptions 
23.  In applying the requirements of paragraph 21, with respect to significant assumptions, the 
auditor’s further audit procedures should address the following: 
 
14
 See paragraph 17 of this Statement on Auditing Standards (SAS) for discussion regarding the responses to the 
assessed risk of material misstatement. 

 
 
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: par. A95 and A102–A103) 
b.  Whether  judgments  made  in  selecting  the  significant  assumptions  give  rise  to 
indicators of possible management bias (Ref: par. 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 
(Ref: par. A104) 
d.  When applicable, whether management has the intent to carry out specific courses of 
action and has the ability to do so (Ref: par. A105) 
Data 
24.  In applying the requirements of paragraph 21, with respect to data, the auditor’s further 
audit procedures should address the following: 
a.  Whether the data is  appropriate  in  the  context  of  the  applicable  financial  reporting 
framework and, if applicable, changes from prior periods are appropriate (Ref: par. A95 
and A106) 
b.  Whether  judgments  made  in  selecting  the  data  give  rise  to  indicators  of  possible 
management bias (Ref: par. A96) 
c.  Whether the data is relevant and reliable in the circumstances (Ref: par. A107) 
d.  Whether the data has been appropriately understood or  interpreted by  management, 
including with respect to contractual terms (Ref: par. A108) 
Management’s  Selection  of  a  Point  Estimate  and  Related  Disclosures  About  Estimation 
Uncertainty 
25.  In applying the requirements of paragraph 21, the auditor’s further audit procedures should 
address whether, in the context of the applicable financial reporting framework, management has 
taken appropriate steps to do the following: 
a.  Understand estimation uncertainty (Ref: par. A109) 
b.  Address  estimation  uncertainty  by  selecting  an  appropriate  point  estimate  and  by 
developing related disclosures about estimation uncertainty (Ref: par. A110–A114) 
26.  When, in the auditor’s judgment based on the audit evidence obtained, management has 
not taken appropriate steps to understand or address estimation uncertainty, the auditor should 
(Ref: par. A115–A117) 
a.  request  management  to  perform  additional  procedures  to  understand  estimation 
uncertainty  or  address  it  by  reconsidering  the  selection  of  management’s  point 

 
 
estimate or considering providing additional disclosures relating to the estimation 
uncertainty, and evaluate management’s responses in accordance with paragraph 25 
of this SAS. 
b.  to the extent practicable, develop an auditor’s point estimate or range in accordance 
with paragraphs  27–28 of this SAS,  if  the  auditor  determines  that  management’s 
response to the auditor’s request does not sufficiently address estimation uncertainty. 
c.  evaluate whether a deficiency in internal control exists and, if so, communicate in 
accordance with AU-C section 265, Communicating Internal Control Related Matters 
Identified in an Audit. 
Developing an Auditor’s Point Estimate or Range 
27.  When  the  auditor  develops  a  point  estimate  or  range  to  evaluate  management’s  point 
estimate  and  related  disclosures  about  estimation  uncertainty,  including  when  required  by 
paragraph  26b,  the  auditor’s  further  audit  procedures  should  include  procedures  to  evaluate 
whether the methods, assumptions, or data used are appropriate in the context of the applicable 
financial  reporting  framework.  Regardless  of  whether  the  auditor  uses  management’s  or  the 
auditor’s own methods, assumptions, or data, these further audit procedures should be designed 
and performed to address the matters in paragraphs 22–24. (Ref: par. A118–A123) 
28.  If the auditor develops an auditor’s range, the auditor should 
a.  determine  that  the  range  includes  only  amounts  that  are  supported  by  sufficient 
appropriate audit evidence and have been evaluated by the auditor to be reasonable in 
the context of the measurement objectives and other requirements of the applicable 
financial reporting framework. (Ref: par. A124–A125) 
b.  design  and  perform  further  audit  procedures  to  obtain  sufficient  appropriate  audit 
evidence  regarding  the  assessed  risks  of  material  misstatement  relating  to  the 
disclosures in the financial statements that describe the estimation uncertainty. 
Other Considerations Relating to Audit Evidence 
29.  In  obtaining  audit  evidence  regarding  the  risks  of  material  misstatement  relating  to 
accounting estimates, irrespective of the sources of information to be used as audit evidence, the 
auditor should comply with the relevant requirements in AU-C section 500 and AU-C section 501, 
Audit Evidence — Specific Considerations for Selected Items. 
30.  When using the work of a management’s specialist, the requirements in paragraphs 20–28 
of this SAS may assist the auditor in evaluating the appropriateness of the specialist’s work as 
audit evidence for a relevant assertion in accordance with AU-C section 501.
15
 In evaluating the 
work of the management’s specialist, the nature, timing, and extent of the further audit procedures 
are affected by the auditor’s evaluation of the specialist’s competence, capabilities, and objectivity; 
 
15
 Paragraph .26c of AU-C section 501, Audit Evidence—Specific Considerations for Selected Items, as amended by 
SAS No. 142, Audit Evidence. (Refer to paragraph .A68 of SAS No. 142 for the amended text.) 

 
 
the auditor’s understanding of the nature of the work performed by the specialist; and the auditor’s 
familiarity with the specialist’s field of expertise. (Ref: par. A126–A132) 
Disclosures Related to Accounting Estimates 
31.  The  auditor  should  design  and  perform  further  audit  procedures  to  obtain  sufficient 
appropriate audit evidence regarding the assessed risks of material misstatement at the relevant 
assertion level for disclosures related to an accounting estimate, including those procedures related 
to estimation uncertainty addressed in paragraphs 25b and 28b. 
Indicators of Possible Management Bias 
32.  The auditor should evaluate whether judgments and decisions made by management in 
making the accounting estimates included in the financial statements, even if they are individually 
reasonable, are indicators of possible management bias. When indicators of possible management 
bias  are  identified,  the  auditor  should  evaluate  the  implications  for  the  audit.  When  there  is 
intention to mislead, management bias is fraudulent in nature. (Ref: par. A133–A136) 
Overall Evaluation Based on Audit Procedures Performed 
33.  In applying AU-C section 330 to accounting estimates,
16
 the auditor should evaluate, based 
on the audit procedures performed and audit evidence obtained, whether (Ref: par.  A137–A138) 
a.  the assessments of the risks of material misstatement at the relevant assertion level 
remain appropriate, including when indicators of possible management bias have been 
identified; 
b.  management’s decisions relating to the recognition, measurement, presentation, and 
disclosure of these accounting estimates in the financial statements are in accordance 
with the applicable financial reporting framework; and 
c.  sufficient appropriate audit evidence has been obtained. 
34.  In making the evaluation required by paragraph 33c of this SAS, the auditor should take 
into account all relevant audit evidence obtained, whether corroborative or contradictory.
17
 If the 
auditor is unable to obtain sufficient appropriate audit evidence, the auditor should evaluate the 
implications for the audit or the auditor’s opinion on the financial statements in accordance with 
AU-C section 705, Modifications to the Opinion in the Independent Auditor’s Report.
 
  
Determining Whether the Accounting Estimates Are Reasonable or Misstated 
35.  The auditor should determine whether the accounting estimates and related disclosures are 
reasonable in the context of the applicable financial reporting framework or are misstated. AU-C 
section  450
18
 
provides  guidance  on  how  the  auditor  may  distinguish  misstatements  (whether 
 
16
 Paragraphs .27–.28 of AU-C section 330. 
 
17
 Paragraph .28 of AU-C section 330. 
 
18
 Paragraph .A3 of AU-C section 450, Evaluation of Misstatements Identified During the Audit. 

factual, judgmental, or projected) for the auditor’s evaluation of the effect of uncorrected

misstatements on the financial statements. (Ref: par. A12–A13 and A139–A145)

36. In relation to accounting estimates, the auditor should evaluate whether management has

included disclosures, beyond those specifically required by the framework, that are necessary to

achieve the fair presentation of the financial statements as a whole.

Communication With Those Charged With Governance, Management, or Other Relevant

Parties

37. In applying AU-C section 260, The Auditor’s Communication With Those Charged With

Governance,

and AU-C section 265,

the auditor is required to communicate with those charged

with governance or management about certain matters, including significant qualitative aspects of

the entity’s significant accounting practices and significant deficiencies and material weaknesses

in internal control identified during the audit, respectively. In doing so, the auditor should consider

the matters, if any, to communicate regarding accounting estimates and take into account whether

the reasons given to the risks of material misstatement relate to estimation uncertainty or the effects

of complexity, subjectivity, or other inherent risk factors in making accounting estimates and related

disclosures. In addition, in certain circumstances, the auditor is required by law or regulation to

communicate about certain matters with other relevant parties, such as regulators. (Ref: par. A146–

A147)

Documentation

38. The auditor should include the following in the audit documentation:

(Ref: par. A148–

A151)

a. Key elements of the auditor’s understanding of the entity and its environment,

including the entity’s internal control related to the entity’s accounting estimates

b. The linkage of the auditor’s further audit procedures with the assessed risks of

material misstatement at the relevant assertion level,

taking into account the reasons

given to the assessment of those risks

c. The auditor’s responses when management has not taken appropriate steps to

understand and address estimation uncertainty

d. Indicators of possible management bias related to accounting estimates, if any, and

the auditor’s evaluation of the implications for the audit, as required by paragraph 32

See also paragraphs .16 and .A16 of AU-C section 700 or paragraphs .41 and .A71 of AU-C section 703.

Paragraph .12a of AU-C section 260, The Auditor’s Communication With Those Charged With Governance.

Paragraph .11 of AU-C section 265, Communicating Internal Control Related Matters Identified in an Audit.

Paragraphs.08–.12 and .A8 of AU-C section 230, Audit Documentation.

Paragraph .30b of AU-C section 330.

e. Significant judgments relating to the auditor's determination of whether the

accounting estimates and related disclosures are reasonable in the context of the

applicable financial reporting framework or are misstated

Application and Other Explanatory Material

Nature of Accounting Estimates

Examples of Accounting Estimates

A1. Examples of accounting estimates related to classes of transactions, account balances, and

disclosures include the following:

• Inventory obsolescence

• Depreciation of property and equipment

• Valuation of infrastructure assets, such as buildings and roadways

• Valuation of financial instruments

• Outcome of pending litigation

• Provision for expected credit losses

• Valuation of insurance contract liabilities

• Warranty obligations

• Employee retirement benefits liabilities

• Share-based payments

• Fair value of assets or liabilities acquired in a business combination, including the

determination of goodwill and intangible assets

• Impairment of long-lived assets or property or equipment held for disposal

• Nonmonetary exchanges of assets or liabilities between independent parties

• Revenue recognized for long-term contracts

Methods

A2. A method is a measurement technique used by management to make an accounting estimate

in accordance with the required measurement basis. For example, one recognized method used to

make accounting estimates relating to share-based payment transactions is to determine a

theoretical option call price using the Black-Scholes option-pricing formula. A method is applied

using a computational tool or process, sometimes referred to as a model, and involves applying

assumptions and data and taking into account a set of relationships between them.

Assumptions and Data

A3. Assumptions involve judgments based on available information about matters such as the

choice of an interest rate, a discount rate, or judgments about future conditions or events. An

assumption may be selected by management from a range of appropriate alternatives. Assumptions

that may be made or identified by a management’s expert become management’s assumptions when

used by management in making an accounting estimate.

A4. For purposes of this SAS, data is information that can be obtained through direct

observation or from a party external to the entity. Information obtained by applying analytical or

interpretive techniques to data is referred to as derived data when such techniques have a well-

established theoretical basis and, therefore, less need for management judgment. Otherwise, such

information is an assumption.

A5. Examples of data include one or more of the following:

• Prices generated by market transactions

• Operating times or quantities of output from a production machine

• Historical prices or other terms included in contracts, such as a contracted interest rate,

a payment schedule, and term included in a loan agreement

• Forward-looking information, such as economic or earnings forecasts obtained from

an external information source

• A future interest rate determined using interpolation techniques from forward interest

rates (derived data)

A6. Data can come from a wide range of sources. For example, data can be

• generated within the organization or externally,

• obtained from a system that is either within or outside the general or subsidiary

ledgers,

• observable in contracts, or

• observable in legislative or regulatory pronouncements.

Scalability (Ref: par. 3)

A7. Examples of paragraphs that include guidance on how the requirements of this SAS can

be scaled include paragraphs A21–A23, A64, A68, and A85.

Key Concepts of This SAS

Inherent Risk Factors (Ref: par. 4)

A8. Inherent risk factors are characteristics of conditions and events that may affect the

susceptibility of an assertion to misstatement before consideration of controls. Appendix A,

“Inherent Risk Factors,” further explains the nature of these inherent risk factors, and their

interrelationships, in the context of making accounting estimates and their presentation in the

financial statements.

A9. In addition to the inherent risk factors of estimation uncertainty, complexity, or

subjectivity, other inherent risk factors that the auditor may consider in identifying and assessing

the risks of material misstatement may include the extent to which the accounting estimate is

subject to or affected by

• a change in the nature or circumstances of the relevant financial statement items, or

requirements of the applicable financial reporting framework, which may give rise

to the need for changes in the method, assumptions, or data used to make the

accounting estimate.

• susceptibility to misstatement due to management bias or fraud in making the

accounting estimate.

Control Risk

A10. An important consideration for the auditor in assessing control risk at the relevant assertion

level is the effectiveness of the design of the controls that the auditor intends to rely on and the

extent to which the controls address the assessed inherent risks at the relevant assertion level. The

auditor’s evaluation that controls are effectively designed and have been implemented supports an

expectation about the operating effectiveness of the controls in determining whether to test them.

Professional Skepticism (Ref: par. 7)

A11. Paragraphs A60, A95–A96, A137, and A139 are examples of paragraphs that describe

ways in which the auditor can exercise professional skepticism. Paragraph A151 provides guidance

on ways in which the auditor’s exercise of professional skepticism may be documented and

includes examples of specific paragraphs in this SAS for which documentation may provide

evidence of the exercise of professional skepticism.

Concept of “Reasonable” (Ref: par. 8 and 35)

A12. Other considerations that may be relevant to the auditor’s consideration of whether the

accounting estimates and related disclosures are reasonable in the context of the applicable

financial reporting framework include whether

• the data and assumptions used in making the accounting estimate are consistent with

each other and with those used in other accounting estimates or areas of the entity’s

business activities, and

• the accounting estimate takes into account appropriate information as required by the

applicable financial reporting framework.

A13. The term applied appropriately as used in paragraph 8 means in a manner that not only

complies with the requirements of the applicable financial reporting framework but, in doing so,

reflects judgments that are consistent with the objective of the measurement basis in that

framework.

 
 
Definitions  
Accounting Estimate (Ref: par. 11)    
A14.  Accounting estimates are monetary amounts that may be related to classes of transactions 
or account balances recognized or disclosed in the financial statements. Accounting estimates also 
include monetary amounts included in disclosures or used to make judgments about recognition 
or disclosure relating to a class of transactions or account balances. For purposes of GAAS, a fair 
value measurement is a form of accounting estimate.  
Auditor’s Point Estimate or Auditor’s Range (Ref: par. 11) 
A15.  An  auditor’s  point  estimate  or  range  may  be  used to  evaluate  an  accounting  estimate 
directly (for example, an impairment provision or the fair value of different types of financial 
instruments) or indirectly (for example, an amount to be used as a significant assumption for an 
accounting estimate). A similar approach may be taken by the auditor in developing an amount or 
range of amounts in evaluating a nonmonetary item of data or an assumption (for example, an 
estimated useful life of an asset).   
Estimation Uncertainty (Ref: par. 11) 
A16.  Not all accounting estimates are subject to a high degree of estimation uncertainty. For 
example, some financial statement items may have an active and open market that provides readily 
available  and reliable information  on  the  prices  at which actual  exchanges occur.  Estimation 
uncertainty may exist even when the valuation method and data are well-defined. In addition, 
general economic circumstances prevailing at the time, for example, illiquidity in a particular 
market, may affect estimation uncertainty.   
Management Bias (Ref: par. 11) 
A17.  Financial  reporting  frameworks  often  call  for  neutrality,  that  is,  freedom  from  bias. 
Estimation uncertainty gives rise to subjectivity in making an accounting estimate. The presence 
of  subjectivity  gives  rise  to  the  need  for  judgment  by  management  and  the  susceptibility  to 
unintentional or  intentional management bias. The susceptibility  of an  accounting estimate to 
management bias increases with the extent to which there is subjectivity in making the accounting 
estimate.     
Outcome of an Accounting Estimate (Ref: par. 11) 
A18.  Some accounting estimates, by their nature, do not have an outcome that is relevant for the 
auditor’s work performed in accordance with this SAS. For example, an accounting estimate may 
be based on perceptions of market participants at a point in time. Accordingly, the price realized 
when an asset is sold or a liability is transferred may differ from the related accounting estimate 
made at the reporting date because, with the passage of time, the market participants’ perceptions 
of value have changed. 
Risk Assessment Procedures and Related Activities 
Obtaining an Understanding of the Entity and Its Environment (Ref: par. 12) 

A19. AU-C section 315

requires the auditor to obtain an understanding of certain matters about

the entity and its environment, including the entity’s internal control. The requirements in

paragraph 12 of this SAS relate more specifically to accounting estimates and build on the broader

requirements in AU-C section 315.

A20. The classes of transactions, events, and conditions within the scope of paragraph 12h of

this SAS are the same as the classes of transactions, events, and conditions relating to accounting

estimates and related disclosures that are subject to AU-C section 315.

In obtaining the

understanding of the entity’s information system as it relates to accounting estimates, the auditor

may consider

• whether the accounting estimates arise from the recording of routine and recurring

transactions or whether they arise from nonrecurring or unusual transactions.

• how the information system addresses the completeness of accounting estimates and

related disclosures, in particular, for accounting estimates related to liabilities.

Scalability

A21. The nature, timing, and extent of the auditor’s procedures to obtain the understanding of the

entity and its environment, including the entity’s internal control, related to the entity’s accounting

estimates, may depend, to a greater or lesser degree, on the extent to which the individual matters

apply in the circumstances. For example, the entity may have few transactions or other events and

conditions that give rise to the need for accounting estimates; the applicable financial reporting

requirements may be simple to apply; and there may be no relevant regulatory factors. Further, the

accounting estimates may not require significant judgments, and the process for making the

accounting estimates may be less complex. In these circumstances, the accounting estimates may

be subject to or affected by estimation uncertainty, complexity, subjectivity, or other inherent risk

factors to a lesser degree, and there may be fewer controls relevant to the audit. If so, the auditor’s

risk assessment procedures are likely to be less extensive and may be performed primarily through

inquiries of management with appropriate responsibilities for the financial statements and

observation of management’s process for making the accounting estimate.

A22. By contrast, the accounting estimates may require significant judgments by management,

and the process for making the accounting estimates may be complex and involve the use of

complex models. In addition, the entity may have a more sophisticated information system and

more extensive controls over accounting estimates. In these circumstances, the accounting

estimates may be subject to or affected by estimation uncertainty, subjectivity, complexity, or other

inherent risk factors to a greater degree. If so, the nature or timing of the auditor’s risk assessment

procedures are likely to be different, or more extensive, than in the circumstances in paragraph

A21.

A23. The following considerations may be relevant for entities with only simple businesses,

which may include many smaller entities: (Ref: par. A72 and A149)

Paragraphs .12–.25 of AU-C section 315.

Paragraph .19a and d of AU-C section 315.

• Processes relevant to accounting estimates may be uncomplicated because the

business activities are simple or the required estimates may have a lesser degree of

estimation uncertainty.

• Accounting estimates may be generated outside of the general and subsidiary ledgers,

controls over their development may be limited, and an owner-manager may have

significant influence over their determination. The owner-manager’s role in making

the accounting estimates may need to be taken into account by the auditor both when

identifying the risks of material misstatement and when considering the risk of

management bias.

The Entity and Its Environment

The Entity’s Transactions and Other Events and Conditions (Ref: par. 12a)

A24. Changes in circumstances that may give rise to the need for or changes in accounting

estimates may include, for example, whether

• the entity has engaged in new types of transactions,

• terms of transactions have changed, or

• new events or conditions have occurred.

The Requirements of the Applicable Financial Reporting Framework (Ref: par. 12b)

A25. Obtaining an understanding of the requirements of the applicable financial reporting

framework provides the auditor with a basis for discussion with management and, when applicable,

those charged with governance about how management has applied those requirements relevant to

the accounting estimates, and about the auditor’s determination of whether they have been applied

appropriately. This understanding also may assist the auditor in communicating with those charged

with governance when the auditor considers a significant accounting practice that is acceptable

under the applicable financial reporting framework to not be the most appropriate in the

circumstances of the entity.

A26. In obtaining this understanding, the auditor may seek to understand whether

• the applicable financial reporting framework

— prescribes certain criteria for the recognition, or methods for the measurement

of, accounting estimates,

— specifies certain criteria that permit or require measurement at a fair value, for

example, by referring to management’s intentions to carry out certain courses of

action with respect to an asset or liability, or

— specifies required or suggested disclosures, including disclosures concerning

judgments, assumptions, or other sources of estimation uncertainty relating to

Paragraph .12a of AU-C section 260.

accounting estimates, and

• changes in the applicable financial reporting framework require changes to the entity’s

accounting policies relating to accounting estimates.

Regulatory Factors (Ref: par. 12c)

A27. Obtaining an understanding of regulatory factors, if any, that are relevant to accounting

estimates may assist the auditor in identifying applicable regulatory frameworks and in

determining whether such regulatory frameworks

• address conditions for the recognition, or methods for the measurement, of accounting

estimates or provides related guidance thereon,

• specify or provide guidance about disclosures in addition to the requirements of the

applicable financial reporting framework,

• provide an indication of areas for which there may be a potential for management bias

to meet regulatory requirements, or

• contain requirements for regulatory purposes that are not consistent with requirements

of the applicable financial reporting framework, which may indicate potential risks of

material misstatement. For example, some regulators may seek to influence minimum

levels for expected credit loss provisions that exceed those required by the applicable

financial reporting framework.

The Nature of the Accounting Estimates and Related Disclosures That the Auditor Expects to Be

Included in the Financial Statements (Ref: par. 12d)

A28. Obtaining an understanding of the nature of accounting estimates and related disclosures

that the auditor expects to be included in the entity’s financial statements assists the auditor in

understanding the measurement basis of such accounting estimates and the nature and extent of

disclosures that may be relevant. Such an understanding provides the auditor with a basis for

discussion with management about how management makes the accounting estimates.

The Entity’s Internal Control Relevant to the Audit

The Nature and Extent of Oversight and Governance (Ref: par. 12e)

A29. In applying AU-C section 315,

the auditor’s understanding of the nature and extent of

oversight and governance that the entity has in place over management’s process for making

accounting estimates may be important to the auditor’s required evaluation as it relates to whether

• management, with the oversight of those charged with governance, has created and

maintained a culture of honesty and ethical behavior, and

Paragraph .15 of AU-C section 315.

• the strengths in the control environment elements collectively provide an appropriate

foundation for the other components of internal control and whether those other

components are undermined by deficiencies in the control environment.

A30. The auditor may obtain an understanding of whether those charged with governance

• have the skills or knowledge to understand the characteristics of a particular method or

model to make accounting estimates, or the risks related to the accounting estimate, for

example, risks related to the method or IT used in making the accounting estimates, or

the susceptibility of the accounting estimate to misstatement due to management bias

or fraud,

• have the skills and knowledge to understand whether management made the accounting

estimates in accordance with the applicable financial reporting framework,

• have the information required to evaluate on a timely basis how management made the

accounting estimates and the authority to call into question management’s actions when

those actions appear to be inadequate or inappropriate,

• oversee management’s process for making the accounting estimates, including the use

of models, or

• oversee the monitoring activities undertaken by management. This may include

supervision and review procedures designed to detect and correct any deficiencies in

the design or operating effectiveness of controls over the accounting estimates.

A31. Obtaining an understanding of the oversight by those charged with governance may be

important when there are accounting estimates that

• require significant judgment by management to address subjectivity,

• have high estimation uncertainty,

• are complex to make, for example, because of the extensive use of IT, large volumes of

data, or the use of multiple data sources or assumptions with complex interrelationships,

• had or ought to have had a change in the method, assumptions, or data compared to

previous periods, or

• involve significant assumptions.

Management’s Application of Specialized Skills or Knowledge, Including the Use of

Management’s Specialists (Ref: par. 12f)

A32. The auditor may consider whether the following circumstances increase the likelihood that

management needs to engage a specialist:

See paragraph .26 of AU-C section 501 as amended by SAS No. 142, Audit Evidence. (Refer to paragraph A68 of

SAS No. 142 for the amended text).

• The specialized nature of the matter requiring estimation, for example, the accounting

estimate may involve measurement of mineral or hydrocarbon reserves in extractive

industries or the evaluation of the likely outcome of applying complex contractual terms

• The complex nature of the models required to apply the relevant requirements of the

applicable financial reporting framework, as may be the case in certain measurements,

such as level 3 fair values

• The unusual or infrequent nature of the condition, transaction, or event requiring an

accounting estimate

The Entity’s Risk Assessment Process (Ref: par. 12g)

A33. Understanding how the entity’s risk assessment process identifies and addresses risks

relating to accounting estimates may assist the auditor in considering changes in the following:

• The requirements of the applicable financial reporting framework related to the

accounting estimates

• The availability or nature of data sources that are relevant to making the accounting

estimates or that may affect the reliability of the data used

• The entity’s information system or IT environment

• Key personnel

A34. Matters that the auditor may consider in obtaining an understanding of how management

identifies and addresses the susceptibility to misstatement due to management bias or fraud in

making accounting estimates, include whether, and if so, how, management does the following:

• Pays particular attention to selecting or applying the methods, assumptions, and data

used in making accounting estimates

• Monitors key performance indicators that may indicate unexpected or inconsistent

performance compared with historical or budgeted performance or with other known

factors

• Identifies financial or other incentives that may be a motivation for bias

• Monitors the need for changes in the methods, significant assumptions, or the data used

in making accounting estimates

• Establishes appropriate oversight and review of models used in making accounting

estimates

• Requires documentation of the rationale for or an independent review of significant

judgments made in making accounting estimates

The Entity’s Information System Relating to Accounting Estimates (Ref: par. 12h(i))

See, for example, FASB Accounting Standards Codification (ASC) 820, Fair Value Measurement.

A35. During the audit, the auditor may identify classes of transactions, events, and conditions

that give rise to the need for accounting estimates and related disclosures that management failed

to identify. AU-C section 315 addresses circumstances in which the auditor identifies risks of

material misstatement that management failed to identify, including determining whether there is

a significant deficiency or material weakness in internal control with regard to the entity’s risk

assessment process.

Management’s Identification of the Relevant Methods, Assumptions, and Sources of Data (Ref:

par. 12h(ii)(1))

A36. If management has changed the method for making an accounting estimate, considerations

may include whether the new method is, for example, more appropriate; is itself a response to

changes in the environment or circumstances affecting the entity or to changes in the requirements

of the applicable financial reporting framework or regulatory environment; or whether

management has another valid reason.

A37. If management has not changed the method for making an accounting estimate,

considerations may include whether the continued use of the previous methods, assumptions, and

data is appropriate in view of the current environment or circumstances.

Methods (Ref: par. 12h(ii)(1)(a))

A38. The applicable financial reporting framework may prescribe the method to be used in

making an accounting estimate. In many cases, however, the applicable financial reporting

framework does not prescribe a single method, or the required measurement basis prescribes, or

allows, the use of alternative methods.

Models

A39. Management may design and implement specific controls around models used for making

accounting estimates, whether it’s management’s own model or an external model. When the model

itself has an increased level of complexity or subjectivity, such as an expected credit loss model or

a fair value model using level 3 inputs, controls that address such complexity or subjectivity may

be more likely to be identified as relevant to the audit. When complexity in relation to models is

present, controls over data integrity are also more likely to be relevant to the audit. Factors that may

be appropriate for the auditor to consider in obtaining an understanding of the model and control

activities relevant to the audit include the following:

• How management determines the relevance and accuracy of the model.

— The validation or back-testing of the model, including whether the model is

validated prior to use and revalidated at regular intervals to determine whether it

remains suitable for its intended use. The entity’s validation of the model may

include evaluation of

• the model’s theoretical soundness,

Paragraph .18 of AU-C section 315.

• the model’s mathematical integrity, and

• the accuracy and completeness of the data and the appropriateness of data

and assumptions used in the model.

• How the model is appropriately changed or adjusted on a timely basis for changes in

market or other conditions and whether there are appropriate change control policies

over the model.

• Whether adjustments, also referred to as overlays in certain industries, are made to the

output of the model and whether such adjustments are appropriate in the circumstances

in accordance with the requirements of the applicable financial reporting framework.

When the adjustments are not appropriate, such adjustments may be indicators of

possible management bias.

• Whether the model is adequately documented, including its intended applications,

limitations, key parameters, required data and assumptions, and the results of any

validation performed on it and the nature of and basis for any adjustments made to its

output.

Examples of valuation models may include the present value of expected future cash flows, option-

pricing models, matrix pricing, option-adjusted spread models, and fundamental analysis.

Assumptions (Ref: par. 12h(ii)(1)(b))

A40. Matters that the auditor may consider in obtaining an understanding of how management

selected the assumptions used in making the accounting estimates include, for example, the

following:

• The basis for management’s selection and the documentation supporting the selection

of the assumption. The applicable financial reporting framework may provide criteria

or guidance to be used in the selection of an assumption.

• How management assesses whether the assumptions are relevant and complete.

• When applicable, how management determines that the assumptions are consistent with

each other, with those used in other accounting estimates or areas of the entity’s business

activities, or with other matters that are

— within the control of management (for example, assumptions about the

maintenance programs that may affect the estimation of an asset’s useful life)

and whether they are consistent with the entity’s business plans and the external

environment, and

— outside the control of management (for example, assumptions about interest

rates, mortality rates, or potential judicial or regulatory actions).

• The requirements of the applicable financial reporting framework related to the

disclosure of assumptions.

A41. With respect to fair value accounting estimates, assumptions vary in terms of the sources

of the data and the basis for the judgments to support them, as follows:

a. Those that reflect what market participants would use in pricing an asset or liability,

developed based on market data obtained from sources independent of the reporting

entity

b. Those that reflect the entity’s own judgments about what assumptions market

participants would use in pricing the asset or liability, developed based on the best data

available in the circumstances

In practice, however, the distinction between (a) and (b) may not always be apparent, and

distinguishing between them depends on understanding the sources of data and the basis for the

judgments that support the assumption. Further, it may be necessary for management to select from

a number of different assumptions used by different market participants.

A42. Assumptions used in making an accounting estimate are referred to as significant

assumptions in this SAS if a reasonable variation in the assumption would materially affect the

measurement of the accounting estimate. A sensitivity analysis may be useful in demonstrating the

degree to which the measurement varies based on one or more assumptions used in making the

accounting estimate.

Inactive or Illiquid markets

A43. When markets are inactive or illiquid, the auditor’s understanding of how management

selects assumptions may include understanding the following:

• Whether management has implemented appropriate policies for adapting the application

of the method in such circumstances. Such adaptation may include making model

adjustments or developing new models that are appropriate in the circumstances.

• Whether management has resources with the necessary skills or knowledge to adapt or

develop a model, if necessary, on an urgent basis, including selecting the valuation

technique that is appropriate in such circumstances.

• Whether management has the resources to determine the range of outcomes, given the

uncertainties involved, for example, by performing a sensitivity analysis.

• Whether management has the means to assess how, when applicable, the deterioration

in market conditions has affected the entity’s operations, environment, and relevant

business risks and the implications for the entity’s accounting estimates, in such

circumstances.

• Whether management has an appropriate understanding of how the price data, and the

relevance thereof, from particular external information sources may vary in such

circumstances.

Data (Ref: par. 12h(ii)(1)(c))

A44. Matters that the auditor may consider in obtaining an understanding of how management

selects the data on which the accounting estimates are based include the following:

• The nature and source of the data, including information obtained from an external

information source

• How management evaluates whether the data is appropriate

• The accuracy and completeness of the data

• The consistency of the data used with data used in previous periods

• The complexity of the IT systems used to obtain and process the data, including when

this involves handling large volumes of data

• How the data is obtained, transmitted, and processed and how its integrity is maintained

How Management Understands and Addresses Estimation Uncertainty (Ref: par. 12h(2)–(3))

A45. Matters that may be appropriate for the auditor to consider relating to whether and how

management understands the degree of estimation uncertainty include, for example, the following:

• Whether, and if so, how, management identified alternative methods, significant

assumptions, or sources of data that are appropriate in the context of the applicable

financial reporting framework

• Whether, and if so, how, management considered alternative outcomes by, for example,

performing a sensitivity analysis to determine the effect of changes in the significant

assumptions or the data used in making the accounting estimate

A46. The requirements of the applicable financial reporting framework may specify the

approach to selecting management’s point estimate from the reasonably possible measurement

outcomes. Financial reporting frameworks may recognize that the appropriate amount is one that

is appropriately selected from the reasonably possible measurement outcomes and, in some cases,

may indicate that the most relevant amount may be in the central part of that range.

A47. For example, with respect to fair value estimates, FASB Accounting Standards Codification

(ASC) 820, Fair Value Measurment,

indicates that if multiple valuation techniques are used to

measure fair value, the results (that is, respective indications of fair value) should be evaluated

considering the reasonableness of the range of values indicated by those results. A fair value

measurement is the point within that range that is most representative of fair value in the

circumstances. In other cases, such as estimates for loss contingencies, FASB ASC 450,

Contingencies,

indicates that when recognition criteria are met and the reasonably estimable loss is a

range, if no amount in the range is a better estimate than any other amount, the minimum amount in the

range is required to be accrued.

A48. The applicable financial reporting framework may prescribe disclosures or disclosure

objectives related to accounting estimates, and some entities may choose to disclose additional

Paragraph 24B of FASB ASC 820-10-35.

Paragraph 1 of FASB ASC 450-20-30.

information. These disclosures or disclosure objectives may address, for example, the following:

• The method of estimation used, including any applicable model and the basis for its

selection

• Information that has been obtained from models, or from other calculations used to

determine estimates recognized or disclosed in the financial statements, including

information relating to the underlying data and assumptions used in those models, such

— assumptions developed internally, or

— data, such as interest rates, that are affected by factors outside the control of

the entity

• The effect of any changes to the method of estimation from the prior period

• The sources of estimation uncertainty

• Fair value information

• Information about sensitivity analyses derived from financial models that demonstrates

that management has considered alternative assumptions

A49. In some cases, the applicable financial reporting framework may require specific

disclosures regarding estimation uncertainty. Examples follow:

• The disclosure of information about the assumptions made about the future and other

major sources of estimation uncertainty that give rise to a higher likelihood or

magnitude of material adjustment to the carrying amounts of assets and liabilities after

the period end. Such requirements may be described using terms such as key sources of

estimation uncertainty or critical accounting estimates. They may relate to accounting

estimates that require management’s most difficult, subjective, or complex judgments.

Such judgments may be more subjective and complex, and accordingly, the potential

for a consequential material adjustment to the carrying amounts of assets and liabilities

may increase, with the number of items of data and assumptions affecting the possible

future resolution of the estimation uncertainty. Information that may be disclosed

includes the following:

— The nature of the assumption or other source of estimation uncertainty

— The sensitivity of carrying amounts to the methods and assumptions used,

including the reasons for the sensitivity

— The expected resolution of an uncertainty and the range of reasonably possible

outcomes in respect of the carrying amounts of the assets and liabilities affected

— An explanation of changes made to past assumptions concerning those assets

and liabilities, if the uncertainty remains unresolved

• The disclosure of the range of possible outcomes and the assumptions used in

determining the range.

• The disclosure of specific information, such as

— information regarding the significance of fair value accounting estimates to the

entity’s financial position and performance, and

— disclosures regarding market inactivity or illiquidity.

• Qualitative disclosures, such as the exposures to risk, and how they arise; the entity’s

objectives, policies, and procedures for managing the risk and the methods used to

measure the risk; and any changes from the previous period of these qualitative

concepts.

• Quantitative disclosures, such as the extent to which the entity is exposed to risk, based

on information provided internally to the entity’s key management personnel, including

credit risk, liquidity risk, and market risk.

Control Activities Relevant to the Audit Over Management’s Process for Making Accounting

Estimates (Ref: par. 12i)

A50. The auditor’s judgment in identifying controls relevant to the audit and, therefore, the need

to evaluate the design of those controls and determine whether they have been implemented, relates

to management’s process described in paragraph 12h(ii). The auditor may not identify relevant

control activities in relation to all the elements of paragraph 12h(ii), depending on the complexity

associated with the accounting estimate.

A51. As part of obtaining an understanding of the control activities relevant to the audit, the

auditor may consider the following:

• How management determines the appropriateness of the data used to develop the

accounting estimates, including when management uses an external information source

or data from outside the general and subsidiary ledgers.

• The review and approval of accounting estimates, including the assumptions or data

used in their development, by appropriate levels of management and, where appropriate,

those charged with governance.

• The segregation of duties between those responsible for making the accounting

estimates and those committing the entity to the related transactions, including whether

the assignment of responsibilities appropriately takes account of the nature of the entity

and its products or services. For example, in the case of a large financial institution,

relevant segregation of duties may consist of an independent function responsible for

estimation and validation of fair value pricing of the entity’s financial products staffed

by individuals whose remuneration is not tied to such products.

• The effectiveness of the design of the control activities. Generally, it may be more

difficult for management to design controls that address subjectivity and estimation

uncertainty in a manner that effectively prevents, or detects and corrects, material

misstatements than it is to design controls that address complexity. Controls that address

subjectivity and estimation uncertainty may need to include more manual elements,

which may be less reliable than automated controls as they can be more easily bypassed,

ignored, or overridden by management. The design effectiveness of controls addressing

complexity may vary depending on the reason for and the nature of the complexity. For

example, it may be easier to design more effective controls related to a method that is

routinely used or over the integrity of data.

A52. When management makes extensive use of IT in making an accounting estimate, controls

relevant to the audit are likely to include general IT controls and application controls. Such controls

may address risks related to the following:

• Whether the IT system has the capability and is appropriately configured to process

large volumes of data.

• Complex calculations in applying a method. When diverse systems are required to

process complex transactions, regular reconciliations between the systems are made, in

particular, when the systems do not have automated interfaces or may be subject to

manual intervention.

• Whether the design and calibration of models is periodically evaluated.

• The complete and accurate extraction of data regarding accounting estimates from the

entity’s records or from external information sources.

• Data, including the complete and accurate flow of data through the entity’s information

system, the appropriateness of any modification to the data used in making accounting

estimates, and the maintenance of the integrity and security of the data. When using

external information sources, risks related to processing or recording the data.

• Whether management has controls around access, change, and maintenance of

individual models to maintain a strong audit trail of the accredited versions of models

and to prevent unauthorized access or amendments to those models.

• Whether there are appropriate controls over the transfer of information relating to

accounting estimates into the general ledger, including appropriate controls over journal

entries.

A53. In some entities, the term governance may be used to describe activities within the control

environment, monitoring of controls, and other components of internal control, as described in AU-

C section 315.

A54. For entities with an internal audit function, its work may be particularly helpful to the

auditor in obtaining an understanding of the following:

Paragraph .A78 of AU-C section 315.

• The nature and extent of management’s use of accounting estimates

• The design and implementation of control activities that address the risks related to the

data, assumptions, and models used to make the accounting estimates

• The aspects of the entity’s information system that generate the data on which the

accounting estimates are based

• How new risks relating to accounting estimates are identified, assessed, and managed

Reviewing the Outcome or Re-Estimation of Previous Accounting Estimates (Ref: par. 13)

A55. A review of the outcome or re-estimation of previous accounting estimates (retrospective

review) assists in identifying and assessing the risks of material misstatement when previous

accounting estimates have an outcome through transfer or realization of the asset or liability in the

current period or are re-estimated for the purpose of the current period. Through performing a

retrospective review, the auditor may obtain the following:

• Information regarding the effectiveness of management’s previous estimation process,

from which the auditor can obtain audit evidence about the likely effectiveness of

management’s current process.

• Audit evidence of matters, such as the reasons for changes that may be required to be

disclosed in the financial statements.

• Information regarding the complexity, subjectivity, or estimation uncertainty pertaining

to the accounting estimates.

• Information regarding the susceptibility of accounting estimates to, or that may be an

indicator of, possible management bias. The auditor’s professional skepticism assists in

identifying such circumstances or conditions and in determining the nature, timing, and

extent of further audit procedures.

A56. A retrospective review may provide audit evidence that supports the identification and

assessment of the risks of material misstatement in the current period. Such a retrospective review

may be performed for accounting estimates made for the prior period’s financial statements or may

be performed over several periods or a shorter period (such as half-yearly or quarterly). In some

cases, a retrospective review over several periods may be appropriate when the outcome of an

accounting estimate is resolved over a longer period, or when a history of outcomes provides

meaningful information or evidence of a trend.

A57. A retrospective review of management judgments and assumptions related to significant

accounting estimates is required by AU-C section 240, Consideration of Fraud in a Financial

Statement Audit.

As a practical matter, the auditor’s review of previous accounting estimates as

a risk assessment procedure in accordance with this SAS may be carried out in conjunction with

the review required by AU-C section 240.

A58. Based on the auditor’s previous assessment of the risks of material misstatement, for

Paragraph .32b(ii) of AU-C section 240, Consideration of Fraud in a Financial Statement Audit.

example, if inherent risk is assessed as higher for one or more risks of material misstatement, the

auditor may judge that a more detailed retrospective review is required. As part of the detailed

retrospective review, the auditor may pay particular attention, when practicable, to the effect of

data and significant assumptions used in making the previous accounting estimates. On the other

hand, for example, for accounting estimates that arise from the recording of routine and recurring

transactions, the auditor may judge that the application of analytical procedures as risk assessment

procedures is sufficient for purposes of the review.

A59. The measurement objective for fair value accounting estimates and other accounting

estimates, based on current conditions at the measurement date, deals with perceptions about value

at a point in time, which may change significantly and rapidly as the environment in which the

entity operates changes. The auditor may, therefore, focus the review on obtaining information that

may be relevant to identifying and assessing risks of material misstatement. For example, in some

cases, obtaining an understanding of changes in market participant assumptions that affected the

outcome of a previous period’s fair value accounting estimates may be unlikely to provide relevant

audit evidence. In this case, audit evidence may be obtained by understanding the outcomes of

assumptions (such as a cash flow projection) and understanding the effectiveness of management’s

prior estimation process that supports the identification and assessment of the risk of material

misstatement in the current period.

A60. A difference between the outcome of an accounting estimate and the amount recognized in

the previous period’s financial statements does not necessarily represent a misstatement of the

previous period’s financial statements. For example, an entity assumed a forecasted unemployment

rate in the development of a loan loss estimate, and the actual losses and unemployment rate

differed from that assumed. A difference may represent a misstatement if, for example, the

difference arises from information that was available to management when the previous period’s

financial statements were finalized or that could reasonably be expected to have been obtained and

taken into account in the context of the applicable financial reporting framework.

Such a

difference may call into question management’s process for taking information into account in

making the accounting estimate. As a result, the auditor may need to reconsider his or her risk

assessment or may determine that more persuasive audit evidence needs to be obtained about the

matter. Many financial reporting frameworks contain guidance on distinguishing between changes

in accounting estimates that constitute misstatements and changes that do not, and the accounting

treatment required to be followed in each case.

Specialized Skills or Knowledge (Ref: par. 14)

A61. Matters that may affect the auditor’s determination of whether the engagement team

requires specialized skills or knowledge, include, for example, the following:

• The nature of the accounting estimates for a particular business or industry (for example,

mineral deposits, agricultural assets, complex financial instruments, and insurance

contract liabilities)

Paragraph .15 of AU-C section 560, Subsequent Events.

Paragraph .16 of AU-C section 220, Quality Control for an Engagement Conducted in Accordance With

Generally Accepted Auditing Standards, and paragraph .08e of AU-C section 300, Planning an Audit.

• The degree of estimation uncertainty

• The complexity of the method or model used

• The complexity of the requirements of the applicable financial reporting framework

relevant to accounting estimates, including whether there are areas known to be subject

to differing interpretation or practice or areas where there are inconsistencies in how

accounting estimates are made

• The procedures that the auditor intends to undertake in responding to assessed risks of

material misstatement

• The need for judgment about matters not specified by the applicable financial reporting

framework

• The degree of judgment needed to select data and assumptions

• The complexity and extent of the entity’s use of IT in making accounting estimates

The nature, timing, and extent of the involvement of individuals with specialized skills and

knowledge may vary throughout the audit.

A62. The auditor may not possess the specialized skills or knowledge necessary when the matter

involved is in a field other than accounting or auditing (for example, valuation skills) and may

need to use an auditor’s specialist.

A63. Many accounting estimates do not require the application of specialized skills or

knowledge. For example, specialized skills or knowledge may not be needed for a simple inventory

obsolescence calculation. However, for example, for expected credit losses of a banking institution

or an insurance contract liability for an insurance entity, the auditor is likely to conclude that it is

necessary to apply specialized skills or knowledge.

Identifying and Assessing the Risks of Material Misstatement (Ref: par. 4 and 15)

A64. Identifying and assessing risks of material misstatement at the relevant assertion level

relating to accounting estimates includes not only accounting estimates that are recognized in the

financial statements but also those that are included in the notes to the financial statements.

A65. AU-C section 200

states that GAAS do not ordinarily refer to inherent risk and control

risk separately. However, this SAS requires a separate assessment of inherent risk and control risk

to provide a basis for designing and performing further audit procedures to respond to the risks of

material misstatement, including significant risks, at the relevant assertion level for accounting

estimates in accordance with AU-C section 330.

See paragraphs A148–A149 of this SAS for

discussion about documentation of inherent risk factors.

A66. As discussed in paragraph 4 of this SAS, AU-C section 200

explains that inherent risk is

See AU-C section 620, Using the Work of an Auditor’s Specialist.

Paragraph .A44 of AU-C section 200.

Paragraph .07b of AU-C section 330.

Paragraph .A42 of AU-C section 200.

higher for some assertions and related classes of transactions, account balances, and disclosures

than for others. In identifying the risks of material misstatement and in assessing inherent risk, the

auditor is required to take into account the degree to which the accounting estimate is subject to or

affected by estimation uncertainty, complexity, subjectivity, or other inherent risk factors. The

auditor’s consideration of the inherent risk factors may also provide information to be used in

determining the following:

• Where inherent risk is assessed on the spectrum of inherent risk

• The reasons for the assessment given to the risks of material misstatement at the

relevant assertion level, and that the auditor’s further audit procedures in accordance

with paragraph 18 of this SAS are responsive to those reasons

The interrelationships between the inherent risk factors are further explained in appendix A.

A67. The reasons for the auditor’s assessment of inherent risk at the relevant assertion level may

result from one or more of the inherent risk factors of estimation uncertainty, complexity,

subjectivity, or other inherent risk factors. Examples follow:

• Accounting estimates of expected credit losses are likely to be complex because the

expected credit losses cannot be directly observed and may require the use of a complex

model. The model may use a complex set of historical data and assumptions about

future developments in a variety of entity-specific scenarios that may be difficult to

predict. Accounting estimates for expected credit losses are also likely to be subject to

high estimation uncertainty and significant subjectivity in making judgments about

future events or conditions. Similar considerations apply to insurance contract

liabilities.

• An accounting estimate for an obsolescence provision for an entity with a wide range

of different inventory types may require complex systems and processes but may

involve little subjectivity, and the degree of estimation uncertainty may be low,

depending on the nature of the inventory.

• Other accounting estimates may not be complex to make but may have high estimation

uncertainty and require significant judgment, for example, an accounting estimate that

requires a single critical judgment about a liability, the amount of which is contingent

on the outcome of the litigation.

A68. The relevance and significance of inherent risk factors may vary from one estimate to

another. Accordingly, the inherent risk factors may, either individually or in combination, affect

simple accounting estimates to a lesser degree, and the auditor may identify fewer risks or assess

inherent risk at the lower end of the spectrum of inherent risk.

A69. Conversely, the inherent risk factors may, either individually or in combination, affect

complex accounting estimates to a greater degree and may lead the auditor to assess inherent risk at

the higher end of the spectrum of inherent risk. For these accounting estimates, the auditor’s

consideration of the effects of the inherent risk factors is likely to directly affect the number and

nature of identified risks of material misstatement, the assessment of such risks, and ultimately, the

persuasiveness of the audit evidence needed in responding to the assessed risks. Also, for these

accounting estimates, the auditor’s application of professional skepticism may be particularly

important.

A70. Events occurring after the date of the financial statements may provide additional

information relevant to the auditor’s assessment of the risks of material misstatement at the relevant

assertion level. For example, the outcome of an accounting estimate may become known during

the audit. In such cases, the auditor may assess or revise the assessment of the risks of material

misstatement at the relevant assertion level,

regardless of the degree to which the accounting

estimate was subject to or affected by estimation uncertainty, complexity, subjectivity, or other

inherent risk factors. Events occurring after the date of the financial statements also may influence

the auditor’s selection of the approach to testing the accounting estimate in accordance with

paragraph 18. For example, for a simple bonus accrual that is based on a straightforward percentage

of compensation for selected employees, the auditor may conclude that there is relatively little

complexity or subjectivity in making the accounting estimate and, therefore, may assess inherent

risk at the relevant assertion level at the lower end of the spectrum of inherent risk. The payment

of the bonuses subsequent to period-end may provide sufficient appropriate audit evidence

regarding the assessed risks of material misstatement at the relevant assertion level.

A71. The auditor’s assessment of control risk may be done in different ways depending on

preferred audit techniques or methodologies. The control risk assessment may be expressed using

qualitative categories (for example, control risk assessed as maximum, moderate, or minimum) or

in terms of the auditor’s expectation of how effective the controls are in addressing the identified

risk, that is, the planned reliance on the effective operation of controls. For example, if control risk

is assessed as maximum, the auditor contemplates no reliance on the effective operation of

controls. If control risk is assessed at less than maximum, the auditor contemplates reliance on the

effective operation of controls.

Estimation Uncertainty (Ref: par. 15a)

A72. In taking into account the degree to which the accounting estimate is subject to estimation

uncertainty, the auditor may consider the following:

• Whether the applicable financial reporting framework requires

— the use of a method to make the accounting estimate that inherently has a high

level of estimation uncertainty. For example, the financial reporting framework

may require the use of unobservable inputs.

— the use of assumptions that inherently have a high level of estimation

uncertainty, such as assumptions with a long forecast period, assumptions that

are based on data that are unobservable and, therefore, difficult for management

to develop, or the use of various assumptions that are interrelated.

— disclosures about estimation uncertainty.

Paragraph .32 of AU-C section 315.

 
 
•  The business environment. An entity may be active in a market that experiences turmoil 
or  possible  disruption  (for  example,  from  major  currency  movements  or  inactive 
markets) and the accounting estimate may, therefore, be dependent on data that is not 
readily observable. 
•  Whether it is possible (or practicable, insofar as permitted by the applicable financial 
reporting framework) for management 
—  to make a precise and reliable prediction about the future realization of a past 
transaction  (for  example,  the  amount  that  will  be  paid  under  a  contingent 
contractual term) or about the incidence and impact of future events or conditions 
(for example, the amount of a future credit loss or the amount at which an insurance 
claim will be settled and the timing of its settlement), or 
—  to obtain precise and complete information about a present condition (for example, 
information about valuation attributes that would reflect the perspective of market 
participants at the date of the financial statements, to develop a fair value estimate). 
A73.  The size of the amount recognized or disclosed in the financial statements for an accounting 
estimate is not, in itself, an indicator of its susceptibility to misstatement because, for example, the 
accounting estimate may be understated. 
A74.  In  some  circumstances,  the  estimation  uncertainty  may  be  so  high  that  a  reasonable 
accounting estimate cannot be made. The applicable financial reporting framework may preclude 
recognition of an item in the financial statements or its measurement at fair value. In such cases, 
there may be risks of material misstatement that relate not only to whether an accounting estimate 
should be recognized, or whether it should be measured at fair value, but also to the reasonableness 
of the disclosures. With respect to such accounting estimates, the applicable financial reporting 
framework may require disclosure  of the accounting estimates  and the estimation uncertainty 
associated with them (see paragraphs A112–A113 and A143–A144). 
A75.  In  some  cases, the estimation  uncertainty  relating to an  accounting estimate may  cast 
significant doubt about the entity’s ability to continue as a going concern. AU-C section 570, The 
Auditor's  Consideration  of  an  Entity's  Ability  to  Continue  as  a  Going  Concern,  establishes 
requirements and provides guidance in such circumstances. 
Complexity or Subjectivity (Ref: par. 15b) 
The Degree to Which Complexity Affects the Selection and Application of the Method 
A76.  In taking into account the degree to which the selection and application of the method used 
in  making  the  accounting  estimate  are  affected  by  complexity,  the  auditor  may  consider  the 
following: 
•  The need for specialized skills or knowledge by management, which may indicate that the 
method used to make an accounting estimate is inherently complex and, therefore, the 
accounting estimate may have a greater susceptibility to material misstatement. There may 
be a greater susceptibility to material misstatement when management has developed a 

model internally and has relatively little experience in doing so or uses a model that applies

a method that is not established or commonly used in a particular industry or environment.

• The nature of the measurement basis required by the applicable financial reporting

framework, which may result in the need for a complex method that requires multiple

sources of historical and forward-looking data or assumptions, with multiple

interrelationships between them. For example, an expected credit loss provision may

require judgments about future credit repayments and other cash flows, based on

consideration of historical experience data and the application of forward-looking

assumptions. Similarly, the valuation of an insurance contract liability may require

judgments about future insurance contract payments to be projected based on historical

experience and current and assumed future trends.

The Degree to Which Complexity Affects the Selection and Application of the Data

A77. In taking into account the degree to which the selection and application of the data used in

making the accounting estimate are affected by complexity, the auditor may consider the following:

• The complexity of the process to derive the data, taking into account the relevance and

reliability of the data source. Data from certain sources may be more reliable than from

others. Also, for confidentiality or proprietary reasons, some external information sources

will not (or not fully) disclose information that may be relevant in considering the

reliability of the data they provide, such as the sources of the underlying data they used or

how it was accumulated and processed.

• The inherent complexity in maintaining the integrity of the data. When there is a high

volume of data and multiple sources of data, there may be inherent complexity in

maintaining the integrity of data that is used to make an accounting estimate.

• The need to interpret complex contractual terms. For example, the determination of cash

inflows or outflows arising from a commercial supplier or customer rebates may depend

on very complex contractual terms that require specific experience or competence to

understand or interpret.

The Degree to Which Subjectivity Affects the Selection and Application of the Method,

Assumptions, or Data

A78. In taking into account the degree to which the selection and application of method,

assumptions, or data are affected by subjectivity, the auditor may consider the following:

• The degree to which the applicable financial reporting framework does not specify the

valuation approaches, concepts, techniques, and factors to use in the estimation method.

• The uncertainty regarding the amount or timing, including the length of the forecast

period. The amount and timing is a source of inherent estimation uncertainty and gives

rise to the need for management judgment in selecting a point estimate, which, in turn,

creates an opportunity for management bias. For example, an accounting estimate that

incorporates forward-looking assumptions may have a high degree of subjectivity,

which may be susceptible to management bias.

Other Inherent Risk Factors (Ref: par. 15b)

A79. The degree of subjectivity associated with an accounting estimate influences the

susceptibility of the accounting estimate to misstatement due to management bias or fraud. For

example, when an accounting estimate is subject to a high degree of subjectivity, the accounting

estimate is likely to be more susceptible to misstatement due to management bias or fraud, and this

may result in a wide range of possible measurement outcomes. Management may select a point

estimate from that range that is inappropriate in the circumstances, or that is inappropriately

influenced by unintentional or intentional management bias, and that is, therefore, misstated. For

continuing audits, indicators of possible management bias identified during the audit of preceding

periods may influence the planning and risk assessment procedures in the current period.

Significant Risks (Ref: par. 16)

A80. The auditor’s assessment of inherent risk, which takes into account the degree to which an

accounting estimate is subject to or affected by estimation uncertainty, complexity, subjectivity, or

other inherent risk factors, assists the auditor in determining whether any of the risks of material

misstatement identified and assessed are a significant risk.

Responses to the Assessed Risks of Material Misstatement

The Auditor’s Further Audit Procedures (Ref: par. 17)

A81. In designing and performing further audit procedures, the auditor may use any of the three

testing approaches (individually or in combination) listed in paragraph 17. For example, when

several assumptions are used to make an accounting estimate, the auditor may decide to use a

different testing approach or combination of testing approaches for each assumption tested.

Obtaining Relevant Audit Evidence, Whether Corroborative or Contradictory

A82. Audit evidence comprises both information that supports and corroborates management’s

assertions and any information that contradicts such assertions.

Obtaining audit evidence in an

unbiased manner may involve obtaining evidence from multiple sources within and outside the

entity. However, the auditor is not required to perform an exhaustive search to identify all possible

sources of audit evidence.

A83. AU-C section 330 requires the auditor to obtain more persuasive audit evidence the higher

the auditor’s assessment of the risk.

Therefore, the consideration of the nature or quantity of the

audit evidence may be more important when inherent risks relating to an accounting estimate is

assessed at the higher end of the spectrum of inherent risk.

Scalability

Paragraphs A35–A38 of SAS No. 142, Audit Evidence.

Paragraph .07b and .A20 of AU-C section 330.

A84. The nature, timing, and extent of the auditor’s further audit procedures are affected by, for

example, the following:

• The assessed risks of material misstatement, which affect the persuasiveness of the audit

evidence needed and influence the approach the auditor selects to audit an accounting

estimate. For example, the assessed risks of material misstatement relating to the

existence or valuation assertions may be lower for a straightforward accrual for bonuses

that are paid to employees shortly after period-end. In this situation, it may be more

practical for the auditor to obtain sufficient appropriate audit evidence by evaluating

events occurring up to the date of the auditor’s report, rather than through other testing

approaches.

• The reasons for the assessed risks of material misstatement.

When the Auditor Intends to Rely on the Operating Effectiveness of Relevant Controls (Ref:

par. 18)

A85. Testing the operating effectiveness of relevant controls may be appropriate when inherent

risk is assessed as higher on the spectrum of inherent risk, including for significant risks. This may

be the case when the accounting estimate is subject to or affected by a high degree of complexity.

When the accounting estimate is affected by a high degree of subjectivity and, therefore, requires

significant judgment by management, inherent limitations in the effectiveness of the design of

controls may lead the auditor to focus more on substantive procedures than on testing the operating

effectiveness of controls.

A86. In determining the nature, timing, and extent of testing of the operating effectiveness of

controls relating to accounting estimates, the auditor may consider factors such as the following:

• The nature, frequency, and volume of transactions

• The effectiveness of the design of the controls, including whether controls are

appropriately designed to respond to the assessed inherent risk, and the strength of

governance

• The importance of particular controls to the overall control objectives and processes in

place at the entity, including the sophistication of the information system to support

transactions

• The monitoring of controls and identified deficiencies in internal control

• The nature of the risks the controls are intended to address, for example, controls related

to the exercise of judgment compared with controls over supporting data

• The competency of those involved in the control activities

• The frequency of performance of the control activities

• The evidence of performance of control activities

AU-C section 940, An Audit of Internal Control Over Financial Reporting That Is Integrated With

an Audit of Financial Statements, establishes requirements and provides guidance that applies only

when an auditor is engaged to perform an audit of internal control over financial reporting that is

integrated with an audit of financial statements. However, AU-C section 940 includes guidance

and examples of factors that affect the risk associated with a control that may be useful information

when determining the nature, timing, and extent of testing of the operating effectiveness of controls

relating to accounting estimates.

Substantive Procedures Alone Cannot Provide Sufficient Appropriate Audit Evidence

A87. When management makes extensive use of IT to conduct business, it may be more likely

that there are risks related to certain accounting estimates for which substantive procedures alone

cannot provide sufficient appropriate audit evidence.

A88. Circumstances when risks for which substantive procedures alone cannot provide sufficient

appropriate audit evidence at the relevant assertion level may exist include

• when controls are necessary to mitigate risks relating to the initiation, recording,

processing, or reporting of information obtained from outside of the general and

subsidiary ledgers.

• information supporting one or more assertions is electronically initiated, recorded,

processed, or reported. This is likely to be the case when there is a high volume of

transactions or data, or a complex model is used, requiring the extensive use of IT to

ensure the accuracy and completeness of the information. A complex expected credit

loss provision may be required for a financial institution or utility entity. For example,

in the case of a utility entity, the data used in developing the expected credit loss

provision may comprise many small balances resulting from a high volume of

transactions. In these circumstances, the auditor may conclude that sufficient

appropriate audit evidence cannot be obtained without testing controls around the model

used to develop the expected credit loss provision.

In such cases, the sufficiency and appropriateness of the audit evidence may depend on the

effectiveness of controls over the accuracy and completeness of the information.

A89. As part of the audit of the financial statements for certain entities, the auditor also may be

required by law or regulation to undertake additional procedures in relation to, or to provide an

assurance conclusion on, internal control. In these and other similar circumstances, the auditor

may be able to use information obtained in performing such procedures as audit evidence, subject

to determining whether subsequent changes have occurred that may affect its relevance to the

audit.

Significant Risks (Ref: par. 19)

A90. When the auditor’s further audit procedures in response to a significant risk consist only

Paragraph .A66 of AU-C section 940, An Audit of Internal Control Over Financial Reporting That Is Integrated

With an Audit of Financial Statements.

of substantive procedures, AU-C section 330

requires that those procedures include tests of

details. Such tests of details may be designed and performed under each of the approaches

described in paragraph 17 of this SAS based on the auditor’s professional judgment in the

circumstances. Examples of tests of details for significant risks related to accounting estimates

include the following:

• Examination, for example, examining contracts to corroborate terms or assumptions

• Recalculation, for example, verifying the mathematical accuracy of a model

• Agreeing assumptions used to supporting documentation, such as third-party published

information

Obtaining Audit Evidence From Events Occurring Up to the Date of the Auditor’s Report (Ref:

par. 20)

A91. In some circumstances, obtaining audit evidence from events occurring up to the date of

the auditor’s report may provide sufficient appropriate audit evidence to address the risks of

material misstatement. For example, sale of the complete inventory of a discontinued product

shortly after the period-end may provide sufficient appropriate audit evidence relating to the

estimate of its net realizable value at the period-end. In other cases, it may be necessary to use this

testing approach in connection with another approach in paragraph 17.

A92. For some accounting estimates, events occurring up to the date of the auditor’s report are

unlikely to provide sufficient appropriate audit evidence regarding the accounting estimate. For

example, the conditions or events relating to some accounting estimates develop only over an

extended period. Also, because of the measurement objective of fair value accounting estimates,

information after the period-end may not reflect the events or conditions existing at the balance

sheet date and, therefore, may not be relevant to the measurement of the fair value accounting

estimate.

A93. Even if the auditor decides not to undertake this testing approach in respect of specific

accounting estimates, the auditor is required to comply with AU-C section 560, Subsequent Events

and Subsequently Discovered Facts. AU-C section 560 requires the auditor to perform audit

procedures designed to obtain sufficient appropriate audit evidence that all subsequent events that

require adjustment of or disclosure in the financial statements have been identified

and

appropriately reflected in the financial statements in accordance with the applicable financial

reporting framework.

Because the measurement of many accounting estimates, other than fair

value accounting estimates, usually depends on the outcome of future conditions, transactions, or

events, the auditor’s work under AU-C section 560 is particularly relevant.

Testing How Management Made the Accounting Estimate (Ref: par. 21)

A94. Testing how management made the accounting estimate may be an appropriate approach

Paragraph .22 of AU-C section 330.

Paragraph .09 of AU-C section 560.

Paragraph .11 of AU-C section 560.

 
 
when, for example 
•  the auditor’s review of similar accounting estimates made in the prior-period financial 
statements suggests that management’s current period process is appropriate. 
•  the accounting estimate is based on a large population of items of a similar nature that 
individually are not significant. 
•  the applicable financial reporting framework specifies how management is expected to 
make the accounting estimate. For example, this may be the case for an expected credit 
loss provision. 
•  the accounting estimate is derived from the routine processing of data. 
Testing how management made the accounting estimate may also be an appropriate approach when 
neither of the other testing approaches is practical to perform or may be an appropriate approach 
in combination with one of the other testing approaches. 
Changes in Methods, Significant Assumptions, and the Data From Prior Periods (Ref: par. 22a, 
23a, and 24a) 
A95.  The auditor may need to have further discussions with management about the following 
circumstances  and,  in  doing  so,  challenge  management  regarding  the  appropriateness  of  the 
assumptions used:  
•  When there is a change from prior periods in a method, or significant assumption  
•  When the data is not based on new circumstances or new information  
•  When significant assumptions are inconsistent 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 
Indicators of Management Bias (Ref: par. 22b, 23b, and 24b) 
A96.  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, indicating that the method, assumptions, and data used were 
appropriate and supportable in the circumstances. An example of an indicator of management bias 
for a particular accounting estimate may be when management has developed an appropriate range 
for several different assumptions, and in each case, the assumption used was from the end of the 
range that resulted in the most favorable measurement outcome. 
Methods 
The Selection of the Method (Ref: par. 22a) 
A97.  Relevant  considerations  for  the  auditor  regarding  the  appropriateness  of  the  method 
selected  in  the context of the applicable financial  reporting framework  and, if applicable, the 

appropriateness of changes from the prior period may include the following:

• Whether management’s rationale for the method selected is appropriate.

• Whether the method is appropriate in the circumstances given the nature of the

accounting estimate, the requirements of the applicable financial reporting framework,

other available valuation concepts or techniques, regulatory requirements, and the

business, industry, and environment in which the entity operates.

• When management has determined that different methods result in a range of

significantly different estimates, how management has investigated the reasons for these

differences.

• Whether the change is based on new circumstances or new information. When this is

not the case, the change may not be reasonable or in compliance with the applicable

financial reporting framework. Arbitrary changes result in inconsistent financial

statements over time and may give rise to financial statement misstatements or may be

an indicator of possible management bias. (See also paragraphs A133–A136).

These matters are important when the applicable financial reporting framework does not prescribe

the method of measurement or allows multiple methods.

Complex Modeling (Ref: par. 22d)

A98. A model, and the related method, is more likely to be complex when

• understanding and applying the method, including designing the model and selecting

and using appropriate data and assumptions, requires specialized skills or knowledge;

• it is difficult to obtain data needed for use in the model because there are restrictions on

the availability or observability of, or access to, data; or

• it is difficult to maintain the integrity (for example, accuracy, consistency, or

completeness) of the data and assumptions in using the model due to multiple valuation

attributes, multiple relationships between them, or multiple iterations of the calculation.

A99. Matters that the auditor may consider when management uses a complex model include,

for example, the following:

• Whether the model is validated prior to usage or when there has been a change to the

model, with periodic reviews to ensure it is still suitable for its intended use. The entity’s

validation process may include evaluation of

— the model’s theoretical soundness,

— the model’s mathematical integrity,

— the accuracy and completeness of the model’s data and assumptions, and

— the model’s output as compared to actual transactions.

• Whether appropriate change control policies and procedures exist.

• Whether management uses appropriate skills and knowledge in using the model.

A100. Management may make adjustments to the output of the model to meet the requirements of

the applicable financial reporting framework. In some industries these adjustments are referred to

as overlays. In the case of fair value accounting estimates, it may be relevant to consider whether

adjustments to the output of the model, if any, reflect the assumptions market participants would

use in similar circumstances.

Maintenance of Integrity of Significant Assumptions and the Data Used in Applying the Method

(Ref: par. 22e)

A101. Maintaining the integrity of significant assumptions and the data in applying the method

refers to the maintenance of the accuracy and completeness of the data and assumptions through

all stages of information processing. A failure to maintain such integrity may result in corruption

of the data, and assumptions and may give rise to misstatements. In this regard, relevant

considerations for the auditor may include whether the data and assumptions are subject to all

changes intended by management, and not subject to any unintended changes, during activities

such as input, storage, retrieval, transmission, or processing.

Significant Assumptions (Ref: par. 23)

A102. Relevant considerations for the auditor regarding the appropriateness of the significant

assumptions in the context of the applicable financial reporting framework and, if applicable, the

appropriateness of changes from the prior period may include the following:

• Management’s rationale for the selection of the assumption.

• Whether the assumption is appropriate in the circumstances given the nature of the

accounting estimate, the requirements of the applicable financial reporting framework,

and the business, industry, and environment in which the entity operates.

• Whether a change from prior periods in selecting an assumption is based on new

circumstances or new information. When it is not, the change may not be reasonable

nor in compliance with the applicable financial reporting framework. Arbitrary changes

in an accounting estimate may give rise to material misstatements of the financial

statements or may be an indicator of possible management bias. (See paragraphs A133–

A136.)

A103. Management may evaluate alternative assumptions or outcomes of accounting estimates,

which may be accomplished through a number of approaches depending on the circumstances.

One possible approach is a sensitivity analysis. This might involve determining how the monetary

amount of an accounting estimate varies with different assumptions. Even for accounting estimates

measured at fair value, there may be variation because different market participants will use

different assumptions. A sensitivity analysis may lead to the development of a number of outcome

scenarios, sometimes characterized as a range of outcomes by management, including

“pessimistic” and “optimistic” scenarios.

A104. Through the knowledge obtained in performing the audit, the auditor may become aware

of or may have obtained an understanding of assumptions used in other areas of the entity’s

business. Such matters may include, for example, business prospects, assumptions in strategy

documents, and future cash flows. Also, if the engagement partner has performed other

engagements for the entity, AU-C section 315

requires the engagement partner to consider

whether information obtained from those other engagements is relevant to identifying risks of

material misstatement. This information may also be useful to consider in addressing whether

significant assumptions are consistent with each other and with those used in other accounting

estimates.

A105. The appropriateness of the significant assumptions in the context of the requirements of the

applicable financial reporting framework may depend on management’s intent and ability to carry

out certain courses of action. Management often documents plans and intentions relevant to

specific assets or liabilities, and the applicable financial reporting framework may require

management to do so. The nature and extent of audit evidence to be obtained about management’s

intent and ability is a matter of professional judgment. When applicable, the auditor’s procedures

may include the following:

• Review of management’s history of carrying out its stated intentions

• Inspection of written plans and other documentation, including, when applicable,

formally approved budgets, authorizations, or minutes

• Inquiry of management about its reasons for a particular course of action

• Review of events occurring subsequent to the date of the financial statements and up to

the date of the auditor’s report

• Evaluation of the entity’s ability to carry out a particular course of action given the

entity’s economic circumstances, including the implications of its existing

commitments and legal, regulatory, or contractual restrictions that could affect the

feasibility of management’s actions

• Consideration of whether management has met the applicable documentation

requirements, if any, of the applicable financial reporting framework

Certain financial reporting frameworks, however, may not permit management’s intentions or

plans to be taken into account when making an accounting estimate. This is often the case for fair

value accounting estimates because their measurement objective requires that significant

assumptions reflect those used by market participants.

Data (Ref: par. 24a)

A106. Relevant considerations for the auditor regarding the appropriateness of the data selected

for use in the context of the applicable financial reporting framework and, if applicable, the

appropriateness of the changes from the prior period may include the following:

Paragraph .08 of AU-C section 315.

• Management’s rationale for the selection of the data.

• Whether the data is appropriate in the circumstances given the nature of the accounting

estimate, the requirements of the applicable financial reporting framework, and the

business, industry, and environment in which the entity operates.

• Whether the change from prior periods in the sources or items of data selected or data

selected is based on new circumstances or new information. When it is not, it is unlikely

to be reasonable nor in compliance with the applicable financial reporting framework.

Arbitrary changes in an accounting estimate result in inconsistent financial statements

over time and may give rise to financial statement misstatements or may be an indicator

of possible management bias. (See paragraphs A133–A136.)

Relevance and Reliability of the Data (Ref: par. 24c)

A107. AU-C section 500 requires the auditor to evaluate information to be used as audit evidence

by taking into account, among other things, the relevance and reliability of the information,

including its source. The auditor’s evaluation of such information to be used as audit evidence is

required to include evaluating whether the information is sufficiently precise and detailed for the

auditor’s purposes and obtaining audit evidence about the accuracy and completeness of the

information, as necessary.

Complex Legal or Contractual Terms (Ref: par. 24d)

A108. Procedures that the auditor may consider when the accounting estimate is based on

complex legal or contractual terms include the following:

• Considering whether specialized skills or knowledge are needed to understand or

interpret the contract

• Inquiring of the entity’s legal counsel regarding the legal or contractual terms

• Inspecting the underlying contracts to

— evaluate the underlying business purpose for the transaction or agreement, and

— consider whether the terms of the contracts are consistent with management’s

explanations.

Management’s Selection of a Point Estimate and Related Disclosures About Estimation

Uncertainty

Management’s Steps to Understand and Address Estimation Uncertainty (Ref: par. 25a)

A109. Estimation uncertainty is the susceptibility to an inherent lack of precision in measurement.

This arises when the required monetary amount for a financial statement item cannot be measured

with precision through direct observation of the cost or price. The susceptibility to a lack of

Paragraphs 7–8 of SAS No. 142, Audit Evidence.

precision in measurement is often referred to in accounting frameworks as measurement

uncertainty. Relevant considerations regarding whether management has taken appropriate steps

to understand and address estimation uncertainty may include whether management has

a. understood the estimation uncertainty, by identifying the sources, and assessing the

degree of inherent variability in the measurement outcomes and the resulting range of

reasonably possible measurement outcomes;

b. identified the degree to which, in the measurement process, complexity or subjectivity

affect the risk of material misstatement, and addressed the resulting potential for

misstatement by applying

i. appropriate skills and knowledge in making accounting estimates, and

ii. professional judgment, including identifying and addressing susceptibility to

management bias; and

c. addressed estimation uncertainty through appropriately selecting management’s point

estimate and related disclosures that describe the estimation uncertainty.

The Selection of Management’s Point Estimate and Related Disclosures of Estimation Uncertainty

(Ref: par. 25b)

A110. Matters that may be relevant regarding the selection of management’s point estimate and

the development of related disclosures about estimation uncertainty include whether

• the methods and data used were selected appropriately, including when alternative

methods for making the accounting estimate and alternative sources of data were

available.

• valuation attributes used were appropriate and complete.

• the assumptions used were selected from a range of reasonably possible amounts and

were supported by appropriate data that is relevant and reliable.

• the data used was appropriate, relevant, and reliable, and the integrity of that data was

maintained.

• the calculations were applied in accordance with the method and were mathematically

accurate.

• management’s point estimate is appropriately chosen from the reasonably possible

measurement outcomes.

• the related disclosures appropriately describe the amount as an estimate and explain the

nature and limitations of the estimation process, including the variability of the

reasonably possible measurement outcomes.

A111. Relevant considerations for the auditor regarding the appropriateness of management’s

point estimate may include the following:

• When the requirements of the applicable financial reporting framework prescribe the

point estimate that is to be used after consideration of the alternative outcomes and

assumptions, or prescribes a specific measurement method, whether management has

followed the requirements of the applicable financial reporting framework

• When the applicable financial reporting framework has not specified how to select an

amount from reasonably possible measurement outcomes, whether management has

exercised judgment, taking into account the requirements of the applicable financial

reporting framework

A112. Relevant considerations for the auditor regarding management’s disclosures about

estimation uncertainty include the requirements of the applicable financial reporting framework,

which may require disclosures

• that describe the amount as an estimate and explain the nature and limitations of the

process for making it, including the variability in reasonably possible measurement

outcomes. The framework also may require additional disclosures to meet a disclosure

objective.

• about significant accounting policies related to accounting estimates. Depending on the

circumstances, relevant accounting policies may include matters such as the specific

principles, bases, conventions, rules, and practices applied in preparing and presenting

accounting estimates in the financial statements.

• about significant or critical judgments (for example, those that had the most significant

effect on the amounts recognized in the financial statements) as well as significant

forward-looking assumptions or other sources of estimation uncertainty.

In certain circumstances, additional disclosures beyond those explicitly required by the financial

reporting framework may be needed in order to achieve fair presentation, or in the case of a

compliance framework, for the financial statements not to be misleading.

A113. The greater the degree to which an accounting estimate is subject to estimation uncertainty,

the more likely the risks of material misstatement will be assessed as higher and, therefore, the

more persuasive the audit evidence needs to be to determine, in accordance with paragraph 35,

whether management’s point estimate and related disclosures about estimation uncertainty are

reasonable in the context of the applicable financial reporting framework, or are misstated.

A114. If the auditor’s consideration of estimation uncertainty associated with an accounting

estimate, and its related disclosure, is a matter that required significant auditor attention, then this

may constitute a key audit matter.

When Management Has Not Taken Appropriate Steps to Understand and Address Estimation

Paragraph 1A of FASB ASC 820-10-50.

See AU-C section 701, Communicating Key Audit Matters in the Independent Auditor’s Report.

Uncertainty (Ref: par. 26)

A115. When the auditor determines that management has not taken appropriate steps to

understand and address estimation uncertainty, additional procedures that the auditor may request

management to perform to understand estimation uncertainty may include, for example,

consideration of alternative assumptions or the performance of a sensitivity analysis.

A116. In considering whether it is practicable to develop a point estimate or range, matters that

the auditor may need to take into account include whether the auditor could do so without

impairing independence.

This may include relevant ethical requirements that address

prohibitions on assuming management responsibilities.

A117. If, after considering management’s response, the auditor determines that it is not

practicable to develop an auditor’s point estimate or range, the auditor is required to evaluate the

implications for the audit or the auditor’s opinion on the financial statements in accordance with

paragraph 34.

Developing an Auditor’s Point Estimate or Using an Auditor’s Range (Ref: par. 27–28)

A118. Developing an auditor’s point estimate or range to evaluate management’s point estimate

and related disclosures about estimation uncertainty may be an appropriate approach when, for

example

• the auditor’s review of similar accounting estimates made in the prior-period financial

statements suggests that management’s current period process is not expected to be

effective.

• the entity’s controls within and over management’s process for making accounting

estimates are not well-designed or properly implemented.

• events or transactions between the period-end and the date of the auditor’s report have

not been properly taken into account, when it is appropriate for management to do so,

and such events or transactions appear to contradict management’s point estimate.

• there are appropriate alternative assumptions or sources of relevant data that can be used

in developing an auditor’s point estimate or a range.

• management has not taken appropriate steps to understand or address the estimation

uncertainty (see paragraph 26).

A119. The decision to develop a point estimate or range also may be influenced by the applicable

financial reporting framework, which may prescribe the point estimate that is to be used after

consideration of the alternative outcomes and assumptions, or prescribe a specific measurement

method (for example, the use of a discounted probability-weighted expected value or the most

See management responsibilities in the “Nonattest Services” interpretation (ET sec. 1.295) under the

“Independence Rule” (ET sec. 1.200) of the AICPA Code of Professional Conduct.

likely outcome).

A120. The auditor’s decision about whether to develop a point estimate, rather than a range, may

depend on the nature of the estimate and the auditor’s judgment in the circumstances. For example,

the nature of the estimate may be such that there is expected to be less variability in the reasonably

possible outcomes. In these circumstances, developing a point estimate may be an effective

approach, particularly when it can be developed with a higher degree of precision.

A121. The auditor may develop a point estimate or a range in a number of ways, for example, by

• using a different model than the one used by management, for example, one that is

commercially available for use in a particular sector or industry, or a proprietary or

auditor-developed model.

• using management’s model but developing alternative assumptions or data sources to

those used by management.

• using the auditor’s own method but developing alternative assumptions to those used

by management.

• employing or engaging a person with specialized expertise to develop or execute a

model, or to provide relevant assumptions.

• considering other comparable conditions, transactions, or events, or, where relevant,

markets for comparable assets or liabilities.

A122. The auditor also may develop a point estimate or range for only part of the accounting

estimate (for example, for a particular assumption or when only a certain part of the accounting

estimate is giving rise to the risk of material misstatement).

A123. When using the auditor’s own methods, assumptions, or data to develop a point estimate or

range, the auditor may obtain evidence about the appropriateness of management’s methods,

assumptions, or data. For example, if the auditor uses the auditor’s own assumptions in developing

a range to evaluate the reasonableness of management’s point estimate, the auditor may also

develop a view about whether management’s judgments in selecting the significant assumptions

used in making the accounting estimate give rise to indicators of possible management bias.

A124. The requirement in paragraph 28a for the auditor to determine that the range includes only

amounts that are supported by sufficient appropriate audit evidence does not mean that the auditor

is expected to obtain audit evidence to support each possible outcome in the range individually.

Rather, the auditor is likely to obtain evidence to determine that the points at both ends of the range

are reasonable in the circumstances, thereby supporting that amounts falling between those two

points also are reasonable.

A125. The size of the auditor’s range may be multiples of materiality for the financial statements

as a whole, particularly when materiality is based on operating results (for example, pre-tax

income), and this measure is relatively small in relation to assets or other balance sheet measures.

This situation is more likely to arise in circumstances in which the estimation uncertainty associated

with the accounting estimate is itself multiples of materiality, which is more common for certain

types of accounting estimates in which a high degree of estimation uncertainty is more typical, and

there may be specific requirements in the applicable financial reporting framework in that regard.

Based on the procedures performed and audit evidence obtained in accordance with the

requirements of this SAS, the auditor may conclude that a range that is multiples of materiality is,

in the auditor’s judgment, appropriate in the circumstances. When this is the case, the auditor’s

evaluation of the reasonableness of the disclosures about estimation uncertainty becomes

increasingly important, particularly whether such disclosures appropriately convey the high degree

of estimation uncertainty and the range of possible outcomes. Paragraphs A139–A144 include

additional considerations that may be relevant in these circumstances.

Other Considerations Relating to Audit Evidence (Ref: par. 30)

A126. Information to be used as audit evidence, regarding risks of material misstatement relating

to accounting estimates, may have been produced by the entity, prepared using the work of a

management’s specialist, or provided by an external information source.

External Information Sources

A127. As explained in AU-C section 500, the reliability of evidence depends on the nature and

source of the audit evidence and the circumstances under which it is obtained. Generally, the

reliability of audit evidence increases when it is obtained from external parties because the

information is less susceptible to management bias.

Consequently, the nature and extent of the

auditor’s further audit procedures to consider the reliability of the information used in making an

accounting estimate may vary depending on the nature of these factors. Examples follow:

• When market or industry data, prices, or pricing-related data are obtained from a single

external information source specializing in such information, the auditor may seek a

price from an alternative independent source with which to compare.

• When market or industry data, prices, or pricing-related data are obtained from multiple

independent external information sources and points to consensus across those sources,

the auditor may need to obtain less evidence about the reliability of the data from an

individual source.

• When information obtained from multiple information sources points to divergent

market views, the auditor may seek to understand the reasons for the diversity in views.

The diversity may result from the use of different methods, assumptions, or data. For

example, one source may be using current prices, and another may be using future

prices. When the diversity relates to estimation uncertainty, the auditor is required by

paragraph 26b of this SAS to obtain sufficient appropriate audit evidence about whether,

in the context of the applicable financial reporting framework, the disclosures in the

financial statements that describe the estimation uncertainty are reasonable. In such

cases, professional judgment is also important in considering information about the

methods, assumptions, or data applied.

Paragraph A22 and appendix A, “Considerations Regarding the Use of External Information Sources,” of SAS

No. 142, Audit Evidence.

• When information obtained from an external information source has been developed by

that source using its own models (for example, for a derivative instrument or security, a

pricing model or cash flow projection model), SAS No. 142, Audit Evidence

provides

relevant guidance for the auditor.

• When, for derivative instruments or securities, a pricing source has a relationship with

an entity that might impair its objectivity, such as an affiliate or a counterparty involved

in selling or structuring the product, the auditor may determine that it is necessary to

obtain estimates from more than one pricing source.

A128. For fair value accounting estimates, additional considerations of the relevance and

reliability of information obtained from external information sources may include the following:

a. Whether fair values are based on trades of the same instrument or active market

quotations

b. When the fair values are based on transactions of comparable assets or liabilities, how

those transactions are identified and considered comparable

c. When there are no transactions either for the asset or liability or comparable assets or

liabilities, how the information was developed, including whether the inputs

developed and used represent the assumptions that market participants would use

when pricing the asset or liability, if applicable

d. When the fair value measurement is based on a broker quote, whether the broker quote

i. is from a market maker who transacts in the same type of financial instrument,

ii. is binding or nonbinding, with more weight placed on quotes based on binding

offers, and

iii. reflects market conditions as of the date of the financial statements, when

required by the applicable financial reporting framework.

Examples of sources relating to (a) and (b) for derivative instruments and securities listed on

national exchanges or over-the-counter (OTC) markets include financial publications, the

exchanges, NASDAQ, or pricing services based on sources such as those. For derivative

instruments and securities, if quoted market prices are not available, estimates of fair value

frequently may be obtained from, for example, broker-dealers or other third-party sources, based

on proprietary valuation models, or from the entity, based on internally or externally developed

valuation models (for example, the Black-Scholes option-pricing model). Examples of broker

quotes for certain derivative instruments and securities include quoted market prices obtained from

broker-dealers who are market makers in such derivative instruments and securities or through

electronic quotation and trading systems for OTC securities. However, using such a price quote to

test valuation assertions may require special knowledge to understand the circumstances in which

the quote was developed. For example, quotations published by electronic quotation and trading

systems for OTC securities may not be based on recent trades and may be only an indication of

Appendix A, “Considerations Regarding the Use of External Information Sources,” of SAS No. 142, Audit

Evidence.

interest and not an actual price for which a counterparty will purchase or sell the underlying

derivative instrument or security.

A129. When information from an external information source is used as audit evidence, a relevant

consideration for the auditor may be whether information can be obtained, or whether the

information is sufficiently detailed, to understand the methods, assumptions, and other data used

by the external information source. This may be limited in some respects and consequently

influence the auditor’s consideration of the nature, timing, and extent of procedures to perform.

For example, pricing services often provide information about their methods and assumptions by

asset class, rather than individual securities. Brokers often provide only limited information about

their inputs and assumptions when providing broker-indicative quotes for individual securities.

SAS No. 142

provides guidance with respect to restrictions placed by the external information

source on the provision of supporting information.

Management’s Specialist

A130. Assumptions relating to accounting estimates that are made or identified by a

management’s specialist become management’s assumptions when used by management in making

an accounting estimate. Accordingly, the auditor applies the relevant requirements in this SAS to

those assumptions.

A131. If the work of a management’s specialist involves the use of methods or sources of data

relating to accounting estimates, or developing or providing findings or conclusions relating to a

point estimate or related disclosures for inclusion in the financial statements, the requirements in

paragraphs 21–29 of this SAS may assist the auditor in applying the requirements in AU-C section

501 relating to the use of management’s specialists.

Service Organizations

A132. AU-C section 402, Audit Considerations Relating to an Entity Using a Service

Organization,

deals with the auditor’s understanding of the services provided by a service

organization, including internal control, as well as the auditor’s responses to assessed risks of

material misstatement. When the entity uses the services of a service organization in making

accounting estimates, the requirements and guidance in AU-C section 402 may assist the auditor in

applying the requirements of this SAS.

Indicators of Possible Management Bias (Ref: par. 32)

A133. Management bias may be difficult to detect at an account level and may only be identified

by the auditor when considering groups of accounting estimates, all accounting estimates in

aggregate, or when observed over a number of accounting periods. For example, if accounting

estimates included in the financial statements are considered to be individually reasonable but

management’s point estimates consistently trend toward one end of the auditor’s range of

reasonable outcomes that provide a more favorable financial reporting outcome for management,

Appendix A, “Considerations Regarding the Use of External Information Sources,” of SAS No. 142, Audit

Evidence.

Paragraph .26c of AU-C section 501, as amended by SAS No. 142. (Refer to paragraph A68 of SAS No. 142 for

the amended text.)

such circumstances may indicate possible bias by management.

A134. Examples of indicators of possible management bias with respect to accounting estimates

include the following:

• Changes in an accounting estimate, or the method for making it, when management has

made a subjective assessment that there has been a change in circumstances

• Selection or development of significant assumptions or the data that yield a point

estimate favorable for management objectives

• Selection of a point estimate that may indicate a pattern of optimism or pessimism

When such indicators are identified, there may be a risk of material misstatement either at the

assertion or financial statement level. Indicators of possible management bias themselves do not

constitute misstatements for purposes of drawing conclusions about the reasonableness of

individual accounting estimates. However, in some cases, the audit evidence may point to a

misstatement, rather than simply an indicator of management bias.

A135. Indicators of possible management bias may affect the auditor’s conclusion about whether

the auditor’s risk assessment and related responses remain appropriate. The auditor may also need

to consider the implications for other aspects of the audit, including the need to further question

the appropriateness of management’s judgments in making accounting estimates. Further,

indicators of possible management bias may affect the auditor’s conclusion about whether the

financial statements as a whole are free from material misstatement, as discussed in AU-C section

700, Forming an Opinion and Reporting on Financial Statements, or AU-C section 703, Forming

an Opinion and Reporting on Financial Statements of Employee Benefit Plans Subject to ERISA.

A136. In addition, in applying AU-C section 240, the auditor is required to evaluate whether

management’s judgments and decisions in making the accounting estimates included in the

financial statements indicate a possible bias that may represent a material misstatement due to

fraud.

Fraudulent financial reporting is often accomplished through intentional misstatement of

accounting estimates, which may include intentionally understating or overstating accounting

estimates. Indicators of possible management bias that may also be a fraud risk factor may cause

the auditor to reassess whether the auditor’s risk assessments, in particular, the assessment of fraud

risks, and related responses remain appropriate.

Overall Evaluation Based on Audit Procedures Performed (Ref: par. 33)

A137. As the auditor performs planned audit procedures, the audit evidence obtained may cause

the auditor to modify the nature, timing, or extent of other planned audit procedures.

In relation

to accounting estimates, information may come to the auditor’s attention through performing

procedures to obtain audit evidence that differs significantly from the information on which the

risk assessment was based. For example, the auditor may have identified that the only reason for

an assessed risk of material misstatement is the subjectivity involved in making the accounting

Paragraph .14 of AU-C section 700 or paragraph .39 of AU-C section 703.

Paragraph .32b of AU-C section 240.

Paragraph .A73 of AU-C section 330.

estimate. However, while performing procedures to respond to the assessed risks of material

misstatement, the auditor may discover that the accounting estimate is more complex than

originally contemplated, which may call into question the assessment of the risk of material

misstatement (for example, the inherent risk may need to be re-assessed on the higher end of the

spectrum of inherent risk due to the effect of complexity) and, therefore, the auditor may need to

perform additional further audit procedures to obtain sufficient appropriate audit evidence.

A138. With respect to accounting estimates that have not been recognized, a particular focus of

the auditor’s evaluation may be on whether the recognition criteria of the applicable financial

reporting framework have, in fact, been met. When an accounting estimate has not been

recognized, and the auditor concludes that this treatment is appropriate, some financial reporting

frameworks may require disclosure of the circumstances in the notes to the financial statements.

Determining Whether the Accounting Estimates Are Reasonable or Misstated (Ref: par. 35)

A139. In determining whether, based on the audit procedures performed and evidence obtained,

management’s point estimate and related disclosures are reasonable or are misstated

• when the audit evidence supports a range, the size of the range may be wide and, in some

circumstances, may be multiples of materiality for the financial statements as a whole (see

also paragraph A125). Although a wide range may be appropriate in the circumstances, it

may indicate that it is important for the auditor to reconsider whether sufficient appropriate

audit evidence has been obtained regarding the reasonableness of the amounts within the

range.

• the audit evidence may support a point estimate that differs from management’s point

estimate. In such circumstances, the difference between the auditor’s point estimate and

management’s point estimate constitutes a misstatement.

• the audit evidence may support a range that does not include management’s point estimate.

In such circumstances, the misstatement is the difference between management’s point

estimate and the nearest point of the auditor’s range.

A140. Paragraphs A110–A114 provide guidance to assist the auditor in evaluating management’s

selection of a point estimate and related disclosures to be included in the financial statements.

A141. When the auditor’s further audit procedures include testing how management made the

accounting estimate or developing an auditor’s point estimate or range, the auditor is required to

obtain sufficient appropriate audit evidence about disclosures that describe estimation uncertainty

in accordance with paragraphs 25b and 28b and other disclosures in accordance with paragraph

31. The auditor then considers the audit evidence obtained about disclosures as part of the overall

evaluation, in accordance with paragraph 35, of whether the accounting estimates and related

disclosures are reasonable in the context of the applicable financial reporting framework or are

misstated.

See also paragraph .32 of AU-C section 315.

A142. AU-C section 450 also provides guidance regarding qualitative disclosures

and when

misstatements in disclosures could be indicative of fraud.

A143. The auditor’s evaluation about whether the financial statements achieve fair presentation

includes the consideration of the overall presentation, structure, and content of the financial

statements and whether the financial statements, including the related notes, represent the

transactions and events in a manner that achieves fair presentation. The auditor’s professional

judgment concerning the fairness of the presentation of the financial statements is applied within

the context of the financial reporting framework. For example, when an accounting estimate is

subject to a higher degree of estimation uncertainty, the auditor may determine that additional

disclosures are necessary to achieve fair presentation. If management does not include such

additional disclosures, the auditor may conclude that the financial statements are materially

misstated.

A144. AU-C section 705

provides guidance on the implications for the auditor’s opinion when

the auditor believes that management’s disclosures in the financial statements are inadequate or

misleading, including, for example, with respect to estimation uncertainty.

Written Representations

A145. Part of the auditor’s audit evidence related to accounting estimates, as required by AU-C

section 580, Written Representations, includes representations obtained from management about

whether management believes the methods, significant assumptions, and the data used in making

the accounting estimates and the related disclosures are appropriate to achieve recognition,

measurement, or disclosure that is in accordance with the applicable financial reporting

framework.

Communication With Those Charged With Governance, Management, or Other Relevant

Parties (Ref: par. 37)

A146. In applying AU-C section 260, the auditor communicates with those charged with

governance the auditor’s views about significant qualitative aspects of the entity’s accounting

practices relating to accounting estimates and related disclosures.

Appendix B,

“Communications With Those Charged With Governance,” includes matters specific to

accounting estimates that the auditor may consider communicating to those charged with

governance.

A147. AU-C section 265 requires the auditor to communicate in writing to those charged with

governance significant deficiencies and material weaknesses in internal control identified during

the audit.

Deficiencies in controls, which may also be significant deficiencies or material

Paragraph .A23 of AU-C section 450.

Paragraph .A24 of AU-C section 450.

Paragraph .16 of AU-C section 700 or paragraph .41 of AU-C section 703.

Paragraphs .23–.24 of AU-C section 705.

Paragraph .16 of AU-C section 580, Written Representations.

Paragraph .12a of AU-C section 260.

Paragraph .11 of AU-C section 265.

weaknesses, may include those related to controls over

a. the selection and application of significant accounting policies and the selection and

application of methods, assumptions, and data,

b. risk management and related systems,

c. data integrity, including when data is obtained from an external information source,

and

d. the use, development, and validation of models, including models obtained from an

external provider, and any adjustments that may be required.

Documentation (Ref: par. 38)

A148. AU-C section 315

and AU-C section 330

provide requirements and guidance on

documenting the auditor’s understanding of the entity, risk assessments, and responses to assessed

risks. This guidance is based on the requirements and guidance in AU-C section 230, Audit

Documentation.

In the context of auditing accounting estimates, the auditor is required to prepare

audit documentation about key elements of the auditor’s understanding of the entity and its

environment related to accounting estimates. In addition, the auditor’s judgments about the

assessed risks of material misstatement related to accounting estimates, and the auditor’s responses,

may likely be further supported by documentation of communications with those charged with

governance and management.

A149. In documenting the linkage of the auditor’s further audit procedures with the assessed risks

of material misstatement at the relevant assertion level, in accordance with AU-C section 330, this

SAS requires that the auditor take into account the reasons given to the risks of material

misstatement at the relevant assertion level. Those reasons may relate to one or more inherent risk

factors or the auditor’s assessment of control risk. However, the auditor is not required to document

how every inherent risk factor was taken into account in identifying and assessing the risks of

material misstatement in relation to each accounting estimate.

A150. The auditor also may consider documenting the following:

• When management’s application of the method involves complex modeling, whether

management’s judgments have been applied consistently and, when applicable, that

the design of the model meets the measurement objective of the applicable financial

reporting framework.

• When the selection and application of methods, significant assumptions, or the data is

affected by complexity to a higher degree, the auditor’s judgments in determining

whether specialized skills or knowledge are required to perform the risk assessment

procedures, to design and perform procedures responsive to those risks, or to evaluate

Paragraphs .33 and .A161–.A164 of AU-C section 315.

Paragraphs .30 and .A77 of AU-C section 330.

Paragraph .09c of AU-C section 230.

the audit evidence obtained. In these circumstances, the documentation also may

include how the required skills or knowledge were applied.

A151. AU-C section 230

notes that although there may be no single way in which the auditor’s

exercise of professional skepticism is documented, the audit documentation may, nevertheless,

provide evidence of the auditor’s exercise of professional skepticism. For example, in relation to

accounting estimates, when the audit evidence obtained includes evidence that both corroborates and

contradicts management’s assertions, the documentation may include how the auditor evaluated

that evidence, including the professional judgments made in forming a conclusion about the

sufficiency and appropriateness of the audit evidence obtained. Examples of other requirements in

this SAS for which documentation may provide evidence of the exercise of professional skepticism

by the auditor include the following:

• Paragraph 12d of this SAS, regarding how the auditor has applied an understanding in

developing the auditor’s own expectation of the accounting estimates and related

disclosures to be included in the entity’s financial statements and how that expectation

compares with the entity’s financial statements prepared by management

• Paragraph 17 of this SAS, which requires further audit procedures to be designed and

performed to obtain sufficient appropriate evidence in a manner that is not biased

toward obtaining audit evidence that may be corroborative or toward excluding audit

evidence that may be contradictory

• Paragraphs 22b, 23b, 24b, and 32 of this SAS, which address indicators of possible

management bias

• Paragraph 34 of this SAS, which addresses the auditor’s consideration of all relevant

audit evidence, whether corroborative or contradictory

Paragraph .A9 of AU-C section 230.

A152.

Appendix A — Inherent Risk Factors

Introduction

1. In identifying, assessing, and responding to the risks of material misstatement at the relevant

assertion level for an accounting estimate and related disclosures, this SAS requires the auditor to

take into account the degree to which the accounting estimate is subject to estimation uncertainty;

the degree to which the selection and application of the methods, assumptions, and data used in

making the accounting estimate; and the degree to which the selection of management’s point

estimate and related disclosures for inclusion in the financial statements are affected by complexity,

subjectivity, or other inherent risk factors.

2. Inherent risk related to an accounting estimate is the susceptibility of an assertion about the

accounting estimate to material misstatement, before consideration of controls. Inherent risk results

from inherent risk factors, which give rise to challenges in appropriately making the accounting

estimate. This appendix provides further explanation about the nature of the inherent risk factors of

estimation uncertainty, subjectivity, and complexity and their interrelationships in the context of making

accounting estimates and selecting management’s point estimate and related disclosures for

inclusion in the financial statements.

Measurement Basis

3. The measurement basis and the nature, condition, and circumstances of the financial

statement item give rise to relevant valuation attributes. When the cost or price of the item cannot

be directly observed, an accounting estimate is required to be made by applying an appropriate

method and using appropriate data and assumptions. The method may be specified by the applicable

financial reporting framework, or is selected by management, to reflect the available knowledge

about how the relevant valuation attributes would be expected to influence the cost or price of the

item on the measurement basis.

Estimation Uncertainty

4. Susceptibility to a lack of precision in measurement may be referred to in accounting

frameworks as measurement uncertainty. Estimation uncertainty is defined in this SAS as

susceptibility to an inherent lack of precision in measurement. It arises when the required monetary

amount for a financial statement item that is recognized or disclosed in the financial statements

cannot be measured with precision through direct observation of the cost or price. When direct

observation is not possible, the next most precise alternative measurement strategy is to apply a

method that reflects the available knowledge about cost or price for the item on the relevant

measurement basis, using observable data about relevant valuation attributes.

5. However, constraints on the availability of such knowledge or data may limit the

verifiability of such inputs to the measurement process and, therefore, limit the precision of

measurement outcomes. Furthermore, most accounting frameworks acknowledge that there are

practical constraints on the information that should be taken into account, such as when the cost

of obtaining it would exceed the benefits. The lack of precision in measurement arising from

these constraints is inherent because it cannot be eliminated from the measurement process.

Accordingly, such constraints are sources of estimation uncertainty. Other sources of

measurement uncertainty that may occur in the measurement process are, at least in principle,

capable of elimination if the method is applied appropriately and, therefore, are sources of potential

misstatement, rather than estimation uncertainty.

6. When estimation uncertainty relates to uncertain future inflows or outflows of economic

benefits that will ultimately result from the underlying asset or liability, the outcome of these flows

will only be observable after the date of the financial statements. Depending on the nature of the

applicable measurement basis and on the nature, condition, and circumstances of the financial

statement item, this outcome may be directly observable before the financial statements are

finalized or may only be directly observable at a later date. For some accounting estimates, there

may be no directly observable outcome at all.

7. Some uncertain outcomes may be relatively easy to predict with a high level of precision

for an individual item. For example, the useful life of a production machine may be easily predicted

if sufficient technical information is available about its average useful life. When it is not possible

to predict a future outcome, such as an individual’s life expectancy based on actuarial assumptions,

with reasonable precision, it may still be possible to predict that outcome for a group of individuals

with greater precision. Measurement bases may, in some cases, indicate a portfolio level as the

relevant unit of account for measurement purposes, which may reduce inherent estimation

uncertainty.

Complexity

8. Complexity (that is, the complexity inherent in the process of making an accounting

estimate, before consideration of controls) gives rise to inherent risk. Inherent complexity may

arise when

• there are many valuation attributes with many or nonlinear relationships between

them.

• determining appropriate values for one or more valuation attributes requires multiple

data sets.

• more assumptions are required in making the accounting estimate, or when there are

correlations between the required assumptions.

• the data used is inherently difficult to identify, capture, access, or understand.

9. Complexity may be related to the complexity of the method and the computational process

or model used to apply it. For example, complexity in the model may reflect the need to apply

probability-based valuation concepts or techniques, option pricing formulae, or simulation

techniques to predict uncertain future outcomes or hypothetical behaviors. Similarly, the

computational process may require data from multiple sources or multiple data sets to support the

making of an assumption or the application of sophisticated mathematical or statistical concepts.

10. The greater the complexity, the more likely it is that management will need to apply

specialized skills or knowledge in making an accounting estimate or engage a management’s

expert, for example, in relation to

• valuation concepts and techniques that could be used in the context of the

measurement basis and objectives or other requirements of the applicable financial

reporting framework and how to apply those concepts or techniques;

• the underlying valuation attributes that may be relevant given the nature of the

measurement basis and the nature, condition, and circumstances of the financial

statement items for which accounting estimates are being made; or

• identifying appropriate sources of data from internal sources (including from sources

outside the general or subsidiary ledgers) or from external information sources,

determining how to address potential difficulties in obtaining data from such sources

or in maintaining its integrity in applying the method, or understanding the relevance

and reliability of that data.

11. Complexity relating to data may arise, for example, in the following circumstances:

a. When data is difficult to obtain or when it relates to transactions that are not generally

accessible. Even when such data is accessible, for example, through an external

information source, it may be difficult to consider the relevance and reliability of the data,

unless the external information source discloses adequate information about the

underlying data sources it has used and about any data processing that has been

performed

b. When data reflecting an external information source’s views about future conditions or

events, which may be relevant in developing support for an assumption, is difficult to

understand without transparency about the rationale and information taken into account

in developing those views

c. When certain types of data are inherently difficult to understand because they require an

understanding of technically complex business or legal concepts, such as may be

required to properly understand data that comprises the terms of legal agreements about

transactions involving complex financial instruments or insurance products

Subjectivity

12. Subjectivity (that is, the subjectivity inherent in the process of making an accounting

estimate, before consideration of controls) reflects inherent limitations in the knowledge or data

reasonably available about valuation attributes. When such limitations exist, the applicable financial

reporting framework may reduce the degree of subjectivity by providing a required basis for making

certain judgments. Such requirements may, for example, set explicit or implied objectives relating

to measurement, disclosure, the unit of account, or the application of a cost constraint. The

applicable financial reporting framework may also highlight the importance of such judgments

through requirements for disclosures about those judgments.

13. Management judgment is generally needed in determining some or all of the following

matters, which often involve subjectivity:

• To the extent not specified under the requirements of the applicable financial

reporting framework, the appropriate valuation approaches, concepts, techniques,

and factors to use in the estimation method, having regard to available knowledge

• To the extent valuation attributes are observable when there are various potential

sources of data, the appropriate sources of data to use

• To the extent valuation attributes are not observable, the appropriate assumptions or

range of assumptions to make, considering the best available data, including, for

example, market views

• The range of reasonably possible outcomes from which to select management’s point

estimate, and the relative likelihood that certain points within that range would be

consistent with the objectives of the measurement basis required by the applicable

financial reporting framework

• The selection of management’s point estimate, and the related disclosures to be made,

in the financial statements

14. Making assumptions about future events or conditions involves the use of judgment, the

difficulty of which varies with the degree to which those events or conditions are uncertain. The

precision with which it is possible to predict uncertain future events or conditions depends on the

degree to which those events or conditions are determinable based on knowledge, including

knowledge of past conditions, events, and related outcomes. The lack of precision also contributes

to estimation uncertainty, as described previously.

15. With respect to future outcomes, assumptions will only need to be made for those features

of the outcome that are uncertain. For example, in considering the measurement of a possible

impairment of a receivable for a sale of goods at the balance sheet date, the amount of the receivable

may be unequivocally established and directly observable in the related transaction documents.

What may be uncertain is the amount, if any, for loss due to impairment. In this case, assumptions

may only be required about the likelihood of loss and the amount and timing of any such loss.

16. However, in other cases, the amounts of cash flows embodied in the rights relating to an

asset may be uncertain. In those cases, assumptions may have to be made about both the amounts

of the underlying rights to cash flows and about potential losses due to impairment.

17. It may be necessary for management to consider information about past conditions and

events, together with current trends and expectations about future developments. Past conditions

and events provide historical information that may highlight repeating historical patterns that can

be extrapolated in evaluating future outcomes. Such historical information may also indicate

changing patterns of such behavior over time (cycles or trends). These may suggest that the

underlying historical patterns of behavior have been changing in somewhat predictable ways that

may also be extrapolated in evaluating future outcomes. Other types of information may also be

available that indicate possible changes in historical patterns of such behavior or in related cycles or

trends. Difficult judgments may be needed about the predictive value of such information.

18. The extent and nature (including the degree of subjectivity involved) of the judgments taken

in making the accounting estimates may create opportunity for management bias in making

decisions about the course of action that, according to management, is appropriate in making the

accounting estimate. When there is also a high level of complexity or a high level of estimation

uncertainty, or both, the risk of and opportunity for management bias or fraud may also be

increased.

Relationship of Estimation Uncertainty to Subjectivity and Complexity

19. Estimation uncertainty gives rise to inherent variation in the possible methods, data sources,

and assumptions that could be used to make an accounting estimate. This gives rise to subjectivity

and, hence, the need for the use of judgment in making the accounting estimate. Such judgments

are required in selecting the appropriate methods and data sources, in making the assumptions, and

in selecting management’s point estimate and related disclosures for inclusion in the financial

statements. These judgments are made in the context of the recognition, measurement,

presentation, and disclosure requirements of the applicable financial reporting framework.

However, because there are constraints on the availability and accessibility of knowledge or

information to support these judgments, they are subjective in nature.

20. Subjectivity in such judgments creates the opportunity for unintentional or intentional

management bias in making them. Many accounting frameworks require that information

prepared for inclusion in the financial statements should be neutral (that is, it should not be

biased). Given that bias can, at least in principle, be eliminated from the estimation process,

sources of potential bias in the judgments made to address subjectivity are sources of potential

misstatement, rather than sources of estimation uncertainty.

21. The inherent variation in the possible methods, data sources, and assumptions that could be

used to make an accounting estimate (see paragraph 19) also gives rise to variation in the possible

measurement outcomes. The size of the range of reasonably possible measurement outcomes results

from the degree of estimation uncertainty and is often referred to as the sensitivity of the accounting

estimate. In addition to determining measurement outcomes, an estimation process also involves

analyzing the effect of inherent variations in the possible methods, data sources, and assumptions

on the range of reasonably possible measurement outcomes (referred to as sensitivity analysis).

22. Developing a financial statement presentation for an accounting estimate, which, when

required by the applicable financial reporting framework, achieves faithful representation (that is,

complete, neutral, and free from error) includes making appropriate judgments in selecting a

management point estimate that is appropriately chosen from within the range of reasonably

possible measurement outcomes and related disclosures that appropriately describe the estimation

uncertainty. These judgments may themselves involve subjectivity, depending on the nature of the

requirements in the applicable financial reporting framework that address these matters. For

example, the applicable financial reporting framework may require a specific basis (such as a

probability-weighted average or a best estimate) for the selection of the management point

estimate. Similarly, it may require specific disclosures or disclosures that meet specified disclosure

objectives or additional disclosures that are required to achieve fair presentation in the

circumstances.

23. Although an accounting estimate that is subject to a higher degree of estimation uncertainty

may be less precisely measurable than one subject to a lower degree of estimation uncertainty, the

accounting estimate may still have sufficient relevance for users of the financial statements to be

recognized in the financial statements if, when required by the applicable financial reporting

framework, a faithful representation of the item can be achieved. In some cases, estimation

uncertainty may be so great that the recognition criteria in the applicable financial reporting

framework are not met, and the accounting estimate cannot be recognized in the financial

statements. Even in these circumstances, there may still be relevant disclosure requirements, for

example, to disclose the point estimate or range of reasonably possible measurement outcomes and

information describing the estimation uncertainty and constraints in recognizing the item. The

requirements of the applicable financial reporting framework that apply in these circumstances

may be specified to a greater or lesser degree. Accordingly, in these circumstances, there may be

additional judgments that involve subjectivity to be made.

A153.

Appendix B — Communications With Those Charged With Governance

(Ref: par. A146)

1. AU-C section 260, The Auditor’s Communication With Those Charged With Governance,

requires the auditor to communicate with those charged with governance the auditor’s views about

the qualitative aspects of the entity’s significant accounting practices, including accounting

policies, accounting estimates, and financial statement disclosures.

AU-C section 260

also

identifies matters that may be communicated as part of this communication. The following is a list

of additional matters that the auditor may consider communicating with those charged with

governance with respect to the auditor’s views about significant qualitative aspects of the entity’s

accounting practices related to accounting estimates and related disclosures:

• How management identifies transactions, other events, and conditions that may give rise

to the need for or changes in accounting estimates and related disclosures

• Risks of material misstatement

• The relative materiality of the accounting estimates to the financial statements as a whole

• Management’s understanding (or lack thereof) regarding the nature and extent of and the

risks associated with accounting estimates

• Whether management has applied appropriate specialized skills or knowledge or engaged

appropriate experts

• The auditor’s views about differences between the auditor’s point estimate or range and

management’s point estimate

• The auditor’s views about the appropriateness of the selection of accounting policies related

to accounting estimates and presentation of accounting estimates in the financial statements

• Indicators of possible management bias

• Whether there has been or ought to have been a change from the prior period in the methods

for making the accounting estimates

• When there has been a change from the prior period in the methods for making the

accounting estimate, why, as well as the outcome of accounting estimates in prior periods

Paragraph .12 of AU-C section 260, The Auditor’s Communication With Those Charged With Governance.

The appendix, “Qualitative Aspects of Accounting Practices,” of AU-C section 260.

• Whether management’s methods for making the accounting estimates, including when

management has used a model, are appropriate in the context of the measurement

objectives; the nature, conditions, and circumstances; and other requirements of the

applicable financial reporting framework

• The nature and consequences of significant assumptions used in accounting estimates and

the degree of subjectivity involved in the development of the assumptions

• Whether significant assumptions are consistent with each other and with those used in other

accounting estimates or with assumptions used in other areas of the entity’s business

activities

• When relevant to the appropriateness of the significant assumptions or the appropriate

application of the applicable financial reporting framework, whether management has the

intent to carry out specific courses of action and has the ability to do so

• 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

• Whether the data and significant assumptions used by management in making the

accounting estimates are appropriate in the context of the applicable financial reporting

framework

• The relevance and reliability of information obtained from an external information source

• Significant difficulties encountered when obtaining sufficient appropriate audit evidence

relating to data obtained from an external information source or valuations performed by

management or management’s expert

• Significant differences in judgments between the auditor and management or management’s

expert regarding valuations

• The potential effects on the entity’s financial statements of material risks and exposures

required to be disclosed in the financial statements, including the estimation uncertainty

associated with accounting estimates

• The reasonableness of disclosures about estimation uncertainty in the financial statements

• Whether management’s decisions relating to the recognition, measurement, presentation,

and disclosure of the accounting estimates and related disclosures in the financial

statements are in accordance with the applicable financial reporting framework

A154.

Appendix C — Amendments to Various Sections in SAS No. 122, Statements on

Auditing Standards: Clarification and Recodification, as Amended; SAS No. 134,

Auditor Reporting and Amendments, Including Amendments Addressing

Disclosures in the Audit of Financial Statements, as Amended; and SAS No. 136,

Forming an Opinion and Reporting on Financial Statements of Employee Benefit

Plans Subject to ERISA, as Amended

This appendix addresses the amendments to certain AU-C sections. This table is a reference tool

for these amendments.

SAS No. 122

AU-C Section

Title

Paragraphs Amended

200

Overall Objectives of the Independent Auditor and

the Conduct of an Audit in Accordance With

Generally Accepted Auditing Standards

.A44

230

Audit Documentation

.A9, .A12, and .A30

240

Consideration of Fraud in a Financial Statement

Audit

.A53

260, as amended by

SAS No. 134

The Auditor’s Communication With Those Charged

With Governance

.A27–.A28 and .A56–

.A57

501

Audit Evidence — Specific Considerations for

Selected Items

.01, .04, .06–.10, .A1–

.A2, .A5–.A6, .A8, and

.A11–.A19

580

Written Representations

.16, .A13–.A14, and

.A35

SAS No. 134

AU-C Section

Title

Paragraphs Amended

700

Forming an Opinion and Reporting on Financial

Statements

.15c

701

Communicating Key Audit Matters in the

Independent Auditor’s Report

.08b, title before .A21

SAS No. 136

AU-C Section

Title

Paragraphs Amended

703

Forming an Opinion and Reporting on Financial

Statements of Employee Benefit Plans Subject to

ERISA

.40

Amendments to Various Sections in SAS No. 122, Statements on Auditing

Standards: Clarification and Recodification, as Amended

(Boldface italics denotes new language. Deleted text is in strikethrough.)

1. The amendment to each section is effective for audits of financial statements for periods

ending on or after December 15, 2023.

AU-C Section 200, Overall Objectives of the Independent Auditor and the Conduct of an

Audit in Accordance With Generally Accepted Auditing Standards

[No amendment to paragraphs .01–.A43.]

Risks of Material Misstatement

…

.A44 The assessment of the risks of material misstatement may be expressed in

quantitative terms, such as percentages or nonquantitative terms. In any case, the need for

the auditor to make appropriate risk assessments is more important than the different

approaches by which they may be made. GAAS do not ordinarily refer to inherent risk and

control risk separately, but rather to a combined assessment of the risks of material

misstatement. However, section 540, Auditing Accounting Estimates and Related

Disclosures,

requires a separate assessment of inherent risk and control risk to provide a

basis for designing and performing further audit procedures to respond to the assessed risks

of material misstatement, including significant risks, for accounting estimates at the

relevant assertion level in accordance with section 330, Performing Audit Procedures in

Response to Assessed Risks and Evaluating the Audit Evidence Obtained.

In identifying

and assessing risks of material misstatement for significant classes of transactions, account

balances, or disclosures other than accounting estimates, the auditor may make separate or

combined assessments of inherent and control risk depending on preferred audit techniques or

methodologies and practical considerations. The assessment of the risks of material

misstatement may be expressed in quantitative terms, such as in percentages or in

nonquantitative terms. In any case, the need for the auditor to make appropriate risk

assessments is more important than the different approaches by which they may be made.

Paragraph .15 of section 540, Auditing Accounting Estimates and Related Disclosures.

Paragraph .07b of section 330.

[Subsequent footnotes renumbered.]

[No further amendment to AU-C section 200.]

AU-C Section 230, Audit Documentation

[No amendment to paragraphs .01–.A7. Paragraph .A8 included for contextual purposes

only.]

Documentation of Compliance With GAAS (Ref: par. .08a)

.A8 In principle, compliance with the requirements of this section will result in the audit

documentation being sufficient and appropriate in the circumstances. Other AU-C sections

contain specific documentation requirements that are intended to clarify the application of this

section in the particular circumstances of those other AU-C sections. The specific

documentation requirements of other AU-C sections do not limit the application of this section.

Furthermore, the absence of a documentation requirement in any particular AU-C section is

not intended to suggest that there is no documentation that will be prepared as a result of

complying with that AU-C section.

.A9 Audit documentation provides evidence that the audit complies with GAAS.

However, it is neither necessary nor practicable for the auditor to document every matter

considered, or professional judgment made, in an audit. Further, it is unnecessary for the

auditor to document separately (as in a checklist, for example) compliance with matters for

which compliance is demonstrated by documents included within the audit file. For example:

• The existence of an adequately documented audit plan demonstrates that the auditor

has planned the audit.

• The existence of a signed engagement letter in the audit file demonstrates that the

auditor has agreed to the terms of the audit engagement with management or, when

appropriate, those charged with governance.

• An auditor’s report containing an appropriately qualified opinion on the financial

statements demonstrates that the auditor has complied with the requirement to express

a qualified opinion under the circumstances in accordance with GAAS.

• Regarding requirements that apply generally throughout the audit, there may be a

number of ways in which compliance with them may be demonstrated within the audit

file:

— For example, there may be no single way in which the auditor’s professional

skepticism is documented. But the audit documentation may nevertheless provide

evidence of the auditor’s exercise of professional skepticism in accordance with

GAAS, for example, in relation to accounting estimates, when the audit

evidence obtained includes evidence that both corroborates and contradicts

management’s assertions, documenting how the auditor evaluated that

evidence, including the professional judgments made in forming a conclusion

about the sufficiency and appropriateness of the audit evidence obtained. Such

evidence may include specific procedures performed to corroborate

management’s responses to the auditor’s inquiries.

— Similarly, that the engagement partner has taken responsibility for the direction,

supervision, and performance of the audit in compliance with GAAS may be

evidenced in a number of ways within the audit documentation. This may include

documentation of the engagement partner’s timely involvement in aspects of the

audit, such as participation in the team discussions required by section 315,

Understanding the Entity and Its Environment and Assessing the Risks of Material

Misstatement.

fn 6

[Footnote omitted for purposes of this SAS.]

Documentation of Significant Findings or Issues and Related Significant Professional

Judgments (Ref: par. .08c)

[No amendment to paragraphs .A10–.A11.]

.A12 Some examples of circumstances in which, in accordance with paragraph .08, it is

appropriate to prepare audit documentation relating to the exercise of professional judgment

include, when the findings, issues, and judgments are significant

• the rationale for the auditor’s conclusion when a requirement provides that the

auditor should consider certain information or factors, and that consideration is

significant in the context of the particular engagement.

• the basis for the auditor’s conclusion on the reasonableness of areas of subjective

judgments made by management (for example, the reasonableness of significant

accounting estimates).

• The basis for the auditor’s evaluation of whether an accounting estimate and

related disclosures are reasonable in the context of the applicable financial

reporting framework or are misstated.

• the basis for the auditor’s conclusions about the authenticity of a document when

further investigation (such as making appropriate use of a specialist or of

confirmation procedures) is undertaken in response to conditions identified during

the audit that caused the auditor to believe that the document may not be authentic.

• when section 701, Communicating Key Audit Matters in the Independent Auditor’s

Report, applies, the auditor’s determination of the key audit matters or the

determination that there are no key audit matters to be communicated, including in

the extremely rare circumstances in which the auditor determines that the matter

should not be communicated in the auditor’s report because the adverse

consequences of doing so would reasonably be expected to outweigh the public

interest benefits of such communication.

[No amendment to paragraphs .A13–.A29.]

Exhibit — Audit Documentation Requirements in Other AU-C Sections

.A30 The following lists the main paragraphs in other AU-C sections that contain specific

documentation requirements. This list is not a substitute for knowledge of the AU-C sections:

a. Paragraphs .10, .13, and .16 of section 210, Terms of Engagement

b. Paragraphs .25–.26 of section 220, Quality Control for an Engagement Conducted

in Accordance With Generally Accepted Auditing Standards

c. Paragraphs .43–.46 of section 240, Consideration of Fraud in a Financial Statement

Audit

d. Paragraph .28 of section 250, Consideration of Laws and Regulations in an Audit of

Financial Statements

e. Paragraph .20 of section 260, The Auditor’s Communication With Those Charged

With Governance

f. Paragraph .12 of section 265, Communicating Internal Control Related Matters

Identified in an Audit

g. Paragraph .14 of section 300, Planning an Audit

h. Paragraph .33 of section 315, Understanding the Entity and Its Environment and

Assessing the Risks of Material Misstatement

i. Paragraph .14 of section 320, Materiality in Planning and Performing an Audit

j. Paragraphs .30–.33 of section 330, Performing Audit Procedures in Response to

Assessed Risks and Evaluating the Audit Evidence Obtained

k. Paragraph .12 of section 450, Evaluation of Misstatements Identified During the

Audit

l. Paragraph .20 of section 501, Audit Evidence — Specific Considerations for Selected

Items

m. Paragraph .08 of section 520, Analytical Procedures

n. Paragraph .22.38 of section 540, Auditing Accounting Estimates, Including Fair

Value Accounting Estimates, and Related Disclosures

o. Paragraph .28 of section 550, Related Parties

p. Paragraph .22 of section 570, The Auditor’s Consideration of an Entity’s Ability to

Continue as a Going Concern

q. Paragraphs .49 and .64 of section 600, Special Considerations — Audits of Group

Financial Statements (Including the Work of Component Auditors)

r. Paragraphs .33–.35 of section 610, Using the Work of Internal Auditors

s. Paragraph .17 of section 701, Communicating Key Audit Matters in the Independent

Auditor’s Report

tr. Paragraph .13 of section 915, Reports on Application of Requirements of an

Applicable Financial Reporting Framework

us. Paragraphs .42–.43 of section 930, Interim Financial Information

vt. Paragraphs .39–.42 of section 935, Compliance Audits

[No further amendment to AU-C section 230.]

AU-C Section 240, Consideration of Fraud in a Financial Statement Audit

[No amendment to paragraphs .01–.A50. Paragraphs .A51–.A52 included for contextual

purposes only.]

Accounting Estimates (Ref: par. .32b)

.A51 The preparation and fair presentation of the financial statements requires

management to make a number of judgments or assumptions that affect significant accounting

estimates and monitor the reasonableness of such estimates on an ongoing basis. Fraudulent

financial reporting is often accomplished through intentional misstatement of accounting

estimates. This may be achieved by, for example, understating or overstating all provisions or

reserves in the same fashion so as to be designed either to smooth earnings over two or more

accounting periods, or to achieve a designated earnings level in order to deceive financial

statement users by influencing their perceptions about the entity’s performance and

profitability.

.A52 The purpose of performing a retrospective review of management judgments and

assumptions related to significant accounting estimates reflected in the financial statements of

the prior year is to determine whether an indication exists of a possible bias on the part of

management. This review is not intended to call into question the auditor’s professional

judgments made in the prior year that were based on information available at the time.

.A53 A retrospective review is also required by section 540, Auditing Accounting

Estimates, Including Fair Value Accounting Estimates, and Related Disclosures.

That

review is conducted as a risk assessment procedure to obtain information regarding the

effectiveness of management’s previous accounting estimates prior period estimation process,

audit evidence about the outcome, or when applicable, the subsequent reestimation to assist of

prior period accounting estimates that is pertinent to making in identifying and assessing the

risks of material misstatement in the current period accounting estimates, and audit evidence

of matters, such as estimation uncertainty, that may be required to be disclosed in the financial

statements. As a practical matter, the auditor’s review of management judgments and

assumptions for biases that could represent a risk of material misstatement due to fraud in

accordance with this section may be carried out in conjunction with the review required by

section 540.

Paragraph .1309 of section 540, Auditing Accounting Estimates, Including Fair Value

Accounting Estimates, and Related Disclosures

[No further amendment to AU-C section 240.]

AU-C Section 260, The Auditor’s Communication With Those Charged With Governance

[No amendment to paragraphs .01–.09. Paragraphs .10–.12 included for contextual purposes

only.]

Matters to Be Communicated

The Auditor’s Responsibilities With Regard to the Financial Statement Audit

.10 The auditor should communicate with those charged with governance the auditor’s

responsibilities with regard to the financial statement audit, including that (Ref: par. .A13–

.A18)

a. the auditor is responsible for forming and expressing an opinion about whether the

financial statements that have been prepared by management, with the oversight of those

charged with governance, are prepared, in all material respects, in accordance with the

applicable financial reporting framework.

b. the audit of the financial statements does not relieve management or those charged

with governance of their responsibilities.

Planned Scope and Timing of the Audit

.11 The auditor should communicate with those charged with governance an overview

of the planned scope and timing of the audit, which includes communicating about the

significant risks identified by the auditor. (Ref: par. .A19–.A24)

Significant Findings or Issues From the Audit

.12 The auditor should communicate with those charged with governance (Ref: par.

.A25–.A26)

a. the auditor’s views about qualitative aspects of the entity’s significant

accounting practices, including accounting policies, accounting estimates, and

financial statement disclosures. When applicable, the auditor should (Ref: par.

.A27–.A29)

i. explain to those charged with governance why the auditor considers a

significant accounting practice that is acceptable under the applicable

financial reporting framework not to be most appropriate to the particular

circumstances of the entity and

ii. determine that those charged with governance are informed about the

process used by management in formulating particularly sensitive

accounting estimates, including fair value estimates, and about the basis for

the auditor’s conclusions regarding the reasonableness of those estimates.

b. significant unusual transactions, if any (Ref: par. .A30)

c. significant difficulties, if any, encountered during the audit. (Ref: par. .A31)

d. disagreements with management, if any. (Ref: par. .A32)

e. circumstances that affect the form and content of the auditor’s report, if any.

(Ref: par. .A33–.A34)

f. matters that are difficult or contentious for which the auditor consulted

outside the engagement team and that are, in the auditor’s professional

judgment, significant and relevant to those charged with governance

regarding their responsibility to oversee the financial reporting process.

g. other findings or issues, if any, arising during the audit that are, in the

auditor’s professional judgment, significant and relevant to those charged

with governance regarding their responsibility to oversee the financial

reporting process. (Ref: par. .A35–.A37)

[No amendment to paragraphs .13–.A26. Paragraph .A29 included for contextual purposes

only.]

Qualitative Aspects of the Entity’s Significant Accounting Practices (Ref: par. .12a)

.A27 Financial reporting frameworks ordinarily allow for the entity to make accounting

estimates and judgments about accounting policies and financial statement disclosures, for

example, the use of key assumptions in the development of accounting estimates for which

there is significant measurement uncertainty. In addition, law, regulation, or financial reporting

frameworks may require disclosure of a summary of significant accounting policies or make

reference to “critical accounting estimates” or “critical accounting policies and practices” to

identify and provide additional information to users about the most difficult, subjective, or

complex judgments made by management in preparing the financial statements.

.A28 As a result, the auditor’s views on the subjective aspects of the financial statements may

be particularly relevant to those charged with governance in discharging their responsibilities

for oversight of the financial reporting process. For example, in relation to the matters

described in paragraph .A27, those charged with governance may be interested in the auditor’s

evaluation of the adequacy of disclosures of the estimation uncertainty relating to accounting

estimates that give rise to significant risks and the quality of the disclosures views on the degree

to which complexity, subjectivity, or other inherent risk factors affect the selection or

application of the methods, assumptions, and data used in making a significant accounting

estimate, as well as the auditor’s evaluation of whether management’s point estimate and

related disclosures in the financial statements are reasonable in the context of the applicable

financial reporting framework. Open and constructive communication about qualitative

aspects of the entity’s significant accounting practices may also include comment on the

acceptability of significant accounting practices and the quality of the disclosures. When

applicable, this may include whether a significant accounting practice of the entity relating

to accounting estimates is considered by the auditor to not be the most appropriate to the

particular circumstances of the entity, for example, when an alternative acceptable method

for making an accounting estimate would, in the auditor’s judgment, be more appropriate.

The appendix, “Qualitative Aspects of Accounting Practices,” identifies matters that may be

included in this communication.

.A29 Certain accounting estimates have higher estimation uncertainty because of their

significance to the financial statements and because of the possibility that future events

affecting them may differ markedly from management’s current judgments. In communicating

with those charged with governance about the process used by management in formulating

particularly sensitive accounting estimates, including fair value estimates, and about the basis

for the auditor's conclusions regarding the reasonableness of those estimates, the auditor may

consider communicating

• the nature of significant assumptions,

• the degree of subjectivity involved in the development of the assumptions, and

• the relative materiality of the items being measured to the financial statements as a

whole.

[No amendment to paragraphs .A30–.A55.]

Appendix — Qualitative Aspects of Accounting Practices

.A56 The communication required by paragraph .12a and discussed in paragraphs

.A24–.A25 may include such matters as the following:

Accounting Policies

• The appropriateness of the accounting policies to the particular circumstances of

the entity, considering the need to balance the cost of providing information with

the likely benefit to users of the entity's financial statements (when acceptable

alternative accounting policies exist, the communication may include identification

of the financial statement items that are affected by the choice of significant policies

as well as information on accounting policies used by similar entities)

• The initial selection of, and changes in, significant accounting policies, including

the application of new accounting pronouncements (the communication may

include the effect of the timing and method of adoption of a change in accounting

policy on the current and future earnings of the entity, and the timing of a change

in accounting policies with regard to expected new accounting pronouncements)

• The effect of significant accounting policies in controversial or emerging areas (or

those unique to an industry, particularly when there is a lack of authoritative

material or consensus)

• The effect of the timing of transactions in relation to the period in which they are

recorded

Accounting Estimates and Related Disclosures

• For items for which estimates are significant, issues discussed in section Appendix

B of section 540 540, Auditing Accounting Estimates, Including Fair Value

Accounting Estimates, and Related Disclosures, includes matters that the auditor

may consider communicating with respect to significant qualitative aspects of the

entity’s accounting practices related to accounting estimates and related

disclosures. including the following examples:

o Management’s identification of accounting estimates

o Management’s process for making accounting estimates

o Risks of material misstatement

o Indicators of possible management bias

o Disclosure of estimation uncertainty in the financial statements

Financial Statement Disclosures

• The issues involved, and related judgments made, in formulating particularly

sensitive financial statement disclosures (for example, disclosures related to

revenue recognition, going concern, subsequent events, and contingency issues)

• The overall neutrality, consistency, and clarity of the disclosures in the financial

statements

Related Matters

• The potential effect on the financial statements of significant risks and exposures

and uncertainties, such as pending litigation, that are disclosed in the financial

statements

• The extent to which the financial statements are affected by unusual transactions,

including nonrecurring amounts recognized during the period, and the extent to

which such transactions are separately disclosed in the financial statements

• The factors affecting asset and liability carrying values, including the entity's

bases for determining useful lives assigned to tangible and intangible assets (the

communication may explain how factors affecting carrying values were selected

and how alternative selections would have affected the financial statements

• The selective correction of misstatements (for example, correcting misstatements

with the effect of increasing reported earnings, but not those that have the effect

of decreasing reported earnings)

Exhibit — Requirements to Communicate With Those Charged With Governance in

Other AU-C Sections

.A57 Requirements for the auditor to communicate with those charged with governance

are included in other AU-C sections. This section does not change the requirements in

a. paragraph .17 of section 210, Terms of Engagement

b. paragraphs .21, .38ci, and .39–.41 of section 240, Consideration of Fraud in a

Financial Statement Audit

c. paragraphs .14, .18, and .21–.23 of section 250, Consideration of Laws and

Regulations in an Audit of Financial Statements

d. paragraph .11 of section 265, Communicating Internal Control Related Matters

Identified in an Audit

e. paragraph .27 of section 550, Related Parties

f. paragraphs .10b–c, .12a, .15a, .17a, and .18 of section 560, Subsequent Events and

Subsequently Discovered Facts

g. paragraph .37 of section 540, Auditing Accounting Estimates and Related

Disclosures

gh. paragraph .28 of section 570, The Auditor’s Consideration of an Entity’s Ability

to Continue as a Going Concern

hi. paragraphs .45–.48 of section 600, Special Considerations — Audits of Group

Financial Statements (Including the Work of Component Auditors)

ji. paragraph .28 of section 610, Using the Work of Internal Auditors

kj. paragraph .16 of section 701, Communicating Key Audit Matters in the Independent

Auditor’s Report

lk. paragraphs .12, .14, .24, and .31 of section 705, Modifications to the Opinion in the

Independent Auditor’s Report

ml. paragraph .12 of section 706, Emphasis-of-Matter Paragraphs and Other-Matter

Paragraphs in the Independent Auditor’s Report

nm. paragraphs .15, 20b, and .21a of section 720, Other Information in Documents

Containing Audited Financial Statements

on. paragraph .06 of section 730, Required Supplementary Information

po. paragraphs .23–.28 of section 930, Interim Financial Information

qp. paragraphs .36–.37 of section 935, Compliance Audits

[No further amendment to AU-C section 260.]

AU-C Section 501, Audit Evidence — Specific Considerations for Selected Items

Scope of This Section

.01 This section addresses specific considerations by the auditor in obtaining sufficient

appropriate audit evidence, in accordance with section 330, Performing Audit Procedures in

Response to Assessed Risks and Evaluating the Audit Evidence Obtained; section 500, Audit

Evidence; section 540, Auditing Accounting Estimates and Related Disclosures; and other

relevant AU-C sections, regarding certain aspects of (a) investments in securities and

derivative instruments; (b) inventory; (c) litigation, claims, and assessments involving the

entity; and (d) segment information in an audit of financial statements.

[No amendment to paragraphs .02–.03.]

Investments in Securities When Valuations Are Based on the Investee’s Financial Results

(Excluding Investments Accounted for Using the Equity Method of Accounting)

.04 When investments in securities are valued based on an investee’s financial results,

excluding investments accounted for using the equity method of accounting, the auditor

should obtain sufficient appropriate audit evidence regarding in support of the investee’s

financial results, including as applicable in the circumstances, performing the as follows

following procedures: (Ref: par. .A4–.A8)

a. Obtain and read available financial statements of the investee and the accompanying

audit report, if any, including determining whether the report of the other auditor is

satisfactory for this purpose.

b. If the investee’s financial statements are not audited, or if the audit report on such

financial statements is not satisfactory to the auditor, apply, or request that the

investor entity arrange with the investee to have another auditor apply, appropriate

auditing procedures to such financial statements, considering the materiality of the

investment in relation to the financial statements of the investor entity.

c. If the carrying amount of the investment reflects factors that are not recognized in the

investee’s financial statements or fair values of assets that are materially different

from the investee’s carrying amounts, obtain sufficient appropriate audit evidence

regardingin support of such amounts.

d. If the difference between the financial statement period of the entity and the investee

has or could have a material effect on the entity’s financial statements, determine

whether the entity’s management has properly considered the lack of comparability

and determine the effect, if any, on the auditor’s report. (Ref: par. .A9)

If the auditor is not able to obtain sufficient appropriate audit evidence in support of the

investee’s financial results because of an inability to perform appropriate procedures, one

or more of these procedures, the auditor should determine the effect on the auditor’s opinion,

in accordance with section 705, Modifications to the Opinion in the Independent Auditor’s

Report.

[No amendment to paragraph .05.]

Investments in Derivative Instruments and Securities Measured or Disclosed at Fair Value

.06 With respect to investments in derivative instruments and securities measured or

disclosed at fair value, the auditor should

a. determine whether the applicable financial reporting framework specifies the method

to be used to determine the fair value of the entity’s derivative instruments and

investments in securities and

b. evaluate whether the determination of fair value is consistent with the specified

valuation method. (Ref: par. .A11–.A13)

.07 If estimates of fair value of derivative instruments or securities are obtained from

broker-dealers or other third-party sources based on valuation models, the auditor should

understand the method used by the broker-dealer or other third-party source in

developing the estimate and consider the applicability of section 500.

(Ref: par. .A14–

.A15)

Paragraph .08 of section 500, Audit Evidence, addresses management’s specialists.

.08 If derivative instruments or securities are valued by the entity using a valuation

model, the auditor should obtain sufficient appropriate audit evidence supporting

management’s assertions about fair value determined using the model. (Ref: par. .A16)

Impairment Losses

.09 The auditor should

a. evaluate management’s conclusion (including the relevance of the information

considered) about the need to recognize an impairment loss for a decline in a security’s

fair value below its cost or carrying amount and

b. obtain sufficient appropriate audit evidence supporting the amount of any impairment

adjustment recorded, including evaluating whether the requirements of the applicable

financial reporting framework have been complied with. (Ref: par. .A17–.A18)

Unrealized Appreciation or Depreciation

.10 The auditor should obtain sufficient appropriate audit evidence about the amount of

unrealized appreciation or depreciation in the fair value of a derivative that is recognized or

that is disclosed because of the ineffectiveness of a hedge, including evaluating whether the

requirements of the applicable financial reporting framework have been complied with. (Ref:

par. .A19)

[No amendment to paragraphs .11–.25, which are renumbered as paragraphs .06–.20.

Subsequent footnotes also renumbered.]

Application and Other Explanatory Material

Investments in Securities and Derivative Instruments (Ref: par. .04–.10)

.A1 Section 540, Auditing Accounting Estimates and Related Disclosures, addresses the

auditor’s responsibilities relating to accounting estimates, including fair value accounting

estimates and related disclosures, in an audit of financial statements. This section addresses

aspects relating to auditing valuation of investments in securities and derivative instruments

that are incremental to section 540.

.A1.A2. Evaluating audit evidence for assertions about investments in securities and

derivative instruments often involves may involve professional judgment because the

assertions, especially those about valuation, are based on highly subjective assumptions or are

particularly sensitive to changes in the underlying circumstances. Valuation assertions relating

to investments in securities and derivative instruments may be based on assumptions about

the occurrence of future events for which expectations are difficult to develop or on

assumptions about conditions expected to exist over a long period (for example, default rates

or prepayment rates). Accordingly, competent persons could reach different conclusions about

estimates of fair values or estimates of ranges of fair values. Professional judgment also may

be necessary when evaluating audit evidence for assertions based on features of the security or

derivative and the requirements of the applicable financial reporting framework, including

underlying criteria for hedge accounting, which may be are extremely complex. For example,

determining the fair value of a structured note may require consideration of a variety of features

of the note that react differently to changes in economic conditions. In addition, one or more

other derivatives may be designated to hedge changes in cash flows under the note. Evaluating

audit evidence about the fair value of the note, the determination of whether the hedge is highly

effective, and the allocation of changes in fair value to earnings and other comprehensive

income requires professional judgment.

.A2 This section addresses only certain specific aspects relating to auditing valuation of

investments in securities and derivative instruments. Section 540, Auditing Accounting

Estimates, Including Fair Value Accounting Estimates, and Related Disclosures, addresses the

auditor’s responsibilities relating to accounting estimates, including fair value accounting

estimates and related disclosures in an audit of financial statements. The Audit Guide Auditing

Derivative Instruments, Hedging Activities, and Investments in Securities provides additional

and more detailed guidance to auditors related to planning and performing auditing procedures

for assertions about derivative instruments, hedging activities, and investments in securities.

[No amendment to paragraph .A3. Paragraphs .A4 and .A7 included for contextual purposes

only.]

Investments in Securities When Valuations Are Based on the Investee’s Financial Results

(Excluding Investments Accounted for Using the Equity Method of Accounting) (Ref: par.

.04–.05)

.A4 Section 600, Special Considerations — Audits of Group Financial Statements (Including

the Work of Component Auditors), addresses auditing investments accounted for using the

equity method of accounting.

.A5 For valuations based on an investee’s financial results (excluding investments accounted

for using the equity method of accounting), obtaining and reading the financial statements of

the investee that have been audited by an auditor whose report is satisfactory may be sufficient

for the purpose of obtaining sufficient appropriate audit evidence of the amount used in the

estimate. In determining whether the report of another auditor is satisfactory, the auditor may

perform procedures such as making inquiries regarding the professional reputation and

standing of the other auditor, visiting the other auditor, discussing the audit procedures

followed and the results thereof, and reviewing the audit plan and audit documentation of the

other auditor.

.A6 After obtaining and reading the audited financial statements of an investee, the auditor

may conclude that additional audit procedures are necessary to obtain sufficient appropriate

audit evidence, for example, when the date of the audited financial statements is different

from the investor’s measurement date. Further examples for when For example, the auditor

may conclude that additional audit evidence is needed include because of significant

differences in fiscal year-ends, significant differences in accounting principles, changes in

ownership, or the significance of the investment to the investor’s financial position or results

of operations. Examples of procedures that the auditor may perform are reviewing information

in the investor’s files that relates to the investee, such as investee minutes and budgets, and

investee cash flow information and making inquiries of investor management about the

investee’s financial results.

.A7 The auditor may need to obtain evidence relating to transactions between the entity and

investee to evaluate

a. the propriety of the elimination of unrealized profits and losses on transactions

between the entity and investee, if applicable, and

b. the adequacy of disclosures about material related party transactions or relationships.

.A8 Section 540, Auditing Accounting Estimates and Related Disclosures, addresses

Section 540 and paragraphs .06–.08 of this section address auditing fair value accounting

estimates. The Audit Guide Auditing Derivative Instruments, Hedging Activities, and

Investments in Securities also provides guidance on audit evidence that may be relevant to the

fair value of derivative instruments and securities and on procedures that may be performed by

the auditor to evaluate management’s consideration of the need to recognize impairment losses.

[No amendment to paragraphs .A9–.A10.]

Investments in Derivative Instruments and Securities Measured or Disclosed at Fair Value

(Ref: par. .06–.08)

.A11 The method for determining fair value may be specified by the applicable financial

reporting framework and may vary depending on the industry in which the entity operates or

the nature of the entity. Such differences may relate to the consideration of price quotations

from inactive markets and significant liquidity discounts, control premiums, and commissions

and other costs that would be incurred to dispose of the derivative instrument or security.

.A12 If the determination of fair value requires the use of accounting estimates, see

section 540, which addresses auditing fair value accounting estimates, including requirements

and guidance relating to the auditor’s understanding of the applicable financial reporting

framework relevant to accounting estimates and the method used in making the estimate

and

the auditor’s determination of whether management has appropriately applied the requirements

of the applicable financial reporting framework relevant to the accounting estimate.

The Audit

Guide Special Considerations in Auditing Financial Instruments also provides guidance on

audit evidence that may be relevant to the fair value of derivative instruments and investments

in securities.

Paragraphs .08a, .08c, .A12–.A14, and .A23–.A25 of section 540, Auditing Accounting

Estimates, Including Fair Value Accounting Estimates, and Related Disclosures.

Paragraphs .12a and .A53–.A57 of section 540.

.A13 Quoted market prices for derivative instruments and securities listed on national

exchanges or over-the-counter markets are available from sources such as financial

publications, the exchanges, NASDAQ, or pricing services based on sources such as those.

Quoted market prices obtained from those sources generally provide sufficient evidence of the

fair value of the derivative instruments and securities.

.A14 For certain other derivative instruments and securities, quoted market prices may

be obtained from broker-dealers who are market makers in them or through the National

Quotation Bureau. However, using such a price quote to test valuation assertions may require

special knowledge to understand the circumstances in which the quote was developed. For

example, quotations published by the National Quotation Bureau may not be based on recent

trades and may be only an indication of interest and not an actual price for which a counterparty

will purchase or sell the underlying derivative instrument or security.

.A15 If quoted market prices are not available for the derivative instrument or security,

estimates of fair value frequently may be obtained from broker-dealers or other third-party

sources, based on proprietary valuation models, or from the entity, based on internally or

externally developed valuation models (for example, the Black-Scholes option pricing model).

Understanding the method used by the broker-dealer or other third-party source in developing

the estimate may include, for example, understanding whether a pricing model or cash flow

projection was used. The auditor also may determine that it is necessary to obtain estimates

from more than one pricing source. For example, this may be appropriate if either of the

following occurs:

• The pricing source has a relationship with an entity that might impair its objectivity,

such as an affiliate or a counterparty involved in selling or structuring the product.

• The valuation is based on assumptions that are highly subjective or particularly

sensitive to changes in the underlying circumstances.