Auditors’ responsibility for accounting estimates may increase with proposed standard

The PCAOB on June 1, 2017, published Release No. 2017-002, Proposed Auditing Standard—Auditing Accounting Estimates, Including Fair Value Measurements and Proposed Amendments to PCAOB Auditing Standards, shortly after the board members unanimously approved proposing an increase in auditors’ responsibilities for examining the estimated financial information employed by clients.

Comments are due by Aug. 30.

In the past several years, companies have been increasingly using estimates to account for certain assets and liabilities that cannot be directly measured, such as impairments of long-lived assets, allowances for loan losses, and the anticipated liabilities from lawsuits and other risks.

Estimates have a significant effect on a company’s financial results. But checking estimates has been challenging for auditors because companies often use complex processes and methods that involve subjective assumptions and measurement uncertainty, which are susceptible to management bias.

“Consequently, accounting estimates often are some of the areas of greatest risk in an audit, requiring additional audit attention and appropriate application of professional skepticism,” the PCAOB said in Release No. 2017-002.

PCAOB inspectors have found recurring problems in auditors’ reviews of clients’ accounting estimates, and the board said it needs to update its standards to better guide auditors.

“While we cannot reduce the challenges inherent in auditing estimates, we can present clear standards that emphasize the importance of risk assessment, awareness of the possibility of management bias, and the need for professional skepticism to support the performance of high quality audits,” PCAOB member Lewis Ferguson said.

The proposal calls on the auditors to apply greater professional skepticism and pay more attention to potential management bias when auditing accounting estimates, including fair value measurements.

If the proposal in Release No. 2017-002 becomes a final standard, it will replace three existing standards. The proposal offers to update Auditing Standard (AS) 2501, Auditing Accounting Estimates, formerly AU Section 342, and retitle it as AS 2501, Auditing Accounting Estimates, Including Fair Value Measurements. AS 2502, Auditing Fair Value Measurements and Disclosures, formerly AU-C Section 540, and AS 2503, Auditing Derivative Instruments, Hedging Activities, Investments in Securities, formerly AU-C Section 500, are slated to be superseded by the new AS 2501.

“Although the risk assessment standards and certain other PCAOB standards address professional skepticism and management bias, the existing estimates standards are largely silent on how to address those topics in the context of auditing accounting estimates,” the PCAOB said in Release No. 2017-002. “The differences in requirements among the three existing estimates standards suggest that revising PCAOB standards to set forth a more uniform, risk-based approach to auditing estimates could lead to improvements in auditing practices for responding to the risks of material misstatement in accounting estimates, whether due to error or fraud.”

The proposed standard has specific requirements to address certain aspects unique to auditing fair values of financial instruments, including the use of information from third-party pricing sources.

It also focuses auditors on estimates with greater risk of material misstatements.

The proposal builds upon the August 2014 Staff Consultation Paper: Auditing Accounting Estimates and Fair Value Measurements.

The PCAOB also approved issuing a companion proposal on the auditor’s use of the work of specialists in Release No. 2017-003, Proposed Amendments to Auditing Standards for Auditor’s Use of the Work of Specialists. (See Proposal Addresses Auditor’s Use of Specialists in the June 5, 2017, edition of Accounting & Compliance Alert.)

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