Question

What responsibility do auditors have regarding accounting reserves established by company management. How should auditors test the reasonableness of accounting reserves established by company management?

Answer 1

Reserves are in simple words some amount segregated from the retained earnings or shareholders contribution to help the company in provisioning for uncertain, sudden and huge expenditures. There are different type of reserves generally created based upon the requirement of the company. Each reserve has its own purpose. Reserves are created for future expenses to be incurred based upon past experiences or the decisons made.

Management is responsible for establishing accounting reserves such as casualty insurance loss reserves, pension reserves, warranty reserves, capital reserves. Reserves are created based upon the knowledge and experience of the management. Many subjective and objective factors are considered at the time of the creation of reseve.

The responsibilty of auditor regarding accounting reserves established by company management is to check that all the appropriate reserves are created, any unwanted reserves are eleminated, provision amount in reserve is appropriate and as per guidelines.

Following tests can be conducted to check the above:

- What controls are in place by management to check the reasonablenss of the controls

- There is no biasness involved in reserves created

- Proper documentation exist pf the reasoning for the reserves created.

- Consider whether there are additional key factors or alternative assumptions about the factors.