Question

Explain the procedures an assurance provider should undertake in providing assurance on prospective financial information and the level of assurance that is usually provided on such information

Answer 1

“Prospective financial information” means financial information based on assumptions about events that may occur in the future and possible actions by an entity. It is highly subjective in nature and its preparation requires the exercise of considerable judgment.

It can be in the form of forecast and projections including financial statements and can be prepared:

I. As an internal management tool

II. For the distribution/submission to third parties

Prospective financial information is the management’s estimate of future results and is based on evidence which is generally future-oriented and speculative in nature. The auditor will not be able to express an opinion if those results will be achieved or if they are free from material misstatement. Therefore per SAE 3400, the auditor can provide only a moderate level of assurance on the reasonableness of management’s assumptions.

Procedure to be followed

Procedures by assurance firms on prospective financial information (PFI) are well established, and separate guidance is given by the IAASB in ISAE 3400, The Examination of Prospective Financial Information, which again is very practical in nature. The standard defines PFI as ‘financial information based about events that may occur in the future and possible actions by an entity’.

The standard recognises that, because PFI relates to events and actions that have not yet occurred and may not occur, PFI work is highly subjective in its nature, and its preparation requires the exercise of considerable judgment.

ISAE 3400 requires that before accepting a PFI engagement, the terms of the engagement should be agreed on and sufficient knowledge of the business should be obtained. The period of time covered by the PFI should be clarified, which could be a forecast (usually a period of up to 12 months) and/or a projection (usually up to five years).

ISAE 3400 also requires that written representations should be requested from management regarding the intended use of the PFI, the completeness of significant management assumptions, and also management’s acceptance of its responsibility for the PFI. The assurance report should make it clear that management is responsible for the PFI and also the assumptions on which it is based. Given the subjective and speculative nature of the PFI, an opinion cannot be given on whether the results shown in the report will be achieved, so only negative assurance can be given.

The auditor should consider the following before accepting an engagement to examine prospective financial information:

i. The intended use of the information

ii. If the information will be for general or limited distribution

iii. Nature of assumptions – best estimate or hypothetical

iv. Elements to be included in the information

v. Period covered by the information

The auditor should not accept an engagement if the assumptions are clearly unrealistic or the prospective financial information will be inappropriate for intended use. Auditor and the client should agree on the terms of engagement per SA 210.

It is important for the auditor to obtain sufficient knowledge of the business to evaluate the significant assumptions required for the preparation of prospective financial information and also know the following:

i. Internal controls over the system

ii. Nature of documentation supporting the management assumption

iii. Statistical, mathematical and computer-assisted techniques

iv. Methods used to develop and apply assumptions

v. Accuracy of prospective financial information prepared in prior periods and if there were any significant variances later

vi. The extent to which reliance on historical information is justified.

If the prior period historical information was other than a clear report, then the auditor should consider the relevant facts and effect on the current examination

The period of time covered by the prospective financial information should be determined by considering some of the factors mentioned below:

i. The operating cycle eg. The time required to complete the project may dictate the period covered

ii. The degree of reliability of assumptions eg. Entity owning a long-term lease, a relatively long prospective period might be reasonable

iii. The need of users eg. Information used by investors in connection with the issue of securities to illustrate the intended use of the proceeds in the subsequent period

A. In determining the nature, timing and extent of examination procedures, following to be considered by the auditor:

i. Knowledge obtained during the previous engagements

ii. Management’s competence regarding the preparation of prospective financial information

iii. Likelihood of misstatement

iv. Management’s judgment effect on prospective financial information

v. Stability of entity’s business

vi. Source of information and its adequacy, reliability etc

vii. Engagement team’s experience with the business and industry

B. Source and reliability of the evidence (internal or external) supporting the management’s best-estimate assumptions should be analysed. Internal sources include budgets, projects, royalty agreements etc whereas external sources include government and industry publications, economic forecast etc

C. All significant implications are considered when using hypothetical assumptions and they are not clearly unrealistic Eg. If sales are assumed to increase beyond entity’s current capacity if the prospective financial information provides for necessary investment to expand plant capacity etc

D. If management’s assumptions are appropriately considered in preparation of prospective financial information. Eg making checks such as re-computation and reviewing the internal consistency

E. Areas which are sensitive to variation and would materially affect the prospective financial information should be focused by the auditor for evaluating appropriate and adequate audit evidence

F. All the components of financial statements including the interrelationship between those components should be considered by the auditor

G. If the elapsed portion of the current period is included in the prospective financial information, procedures related to historical information should be applied

H. Auditor to obtain written representations from the management for:

i. The intended use of the prospective information

ii. Completeness of significant management assumption

iii. Management responsibility for the prospective financial information (including identification and disclosure of uncontrollable factors, litigations etc)

An auditor should consider the following while assessing the prospective financial information:

i. The presentation is informative and not misleading

ii. Disclosure of accounting policies in the notes

iii. Adequate disclosure of assumptions in the notes including nature

iv. The date as of which it was prepared and disclosed

v. Any changes in the accounting policies of the entity and reason for such change

vi. The basis of establishing points in a range is clearly indicated

The auditor should document the following:

i. Evidence to support the auditor’s report on examination of prospective financial information

ii. Evidence that examination was carried out as per SAE

iii. Working papers include sources of information, the basis of forecast etc

iv. Evidence supporting the assumptions, hypothetical assumptions

v. Management representation regarding intended use and distribution of information

vi. Management’s acceptance of its responsibilities for the information

vii. Audit plan, the nature, timing and extent of examination procedures

viii. If auditors express modified opinion or withdraw from engagement, the reason for the same

Auditor’s report should contain the following:

i. Title

ii. Addressee

iii. Identification of the prospective financial information

iv. Reference to the applicable standards on auditing

v. Statement from management for its responsibilities including underlying assumptions

vi. Reference to the purpose and/or restricted distribution of prospective financial information as applicable

vii. Examination procedures included the examination on the test basis, evidence supporting the assumptions, forecast or disclosure

viii. Statement of negative assurance if assumptions provide a reasonable basis

ix. Opinion if the prospective financial information is properly prepared on the basis of assumptions and presented per the financial reporting framework

x. Date of report

xi. Place of signature

xii. Signature