Question

Why do estimates pose challenges for auditors? Reference the appropriate authoritative standards and describe how auditors should evaluate the reasonableness of estimates.

Answer 1

^{AS 2501: Auditing Accounting Estimates: - These Audit Standard deals with Estimates. An estimate has to be made of expense of the next month/year etc to book in books of accounts as we need to close the books for audit purpose or submitting to bank etc. The challenge is whether the estimate made by management is reasonable or not.}

In evaluating the reasonableness of an estimate, the auditor normally concentrates on key factors and assumptions that are—

• Significant to the accounting estimate
• Sensitive to variations.
• Deviations from historical patterns.
• Subjective and susceptible to misstatement and bias.

The auditor normally should consider the historical experience of the entity in making past estimates as well as the auditor's experience in the industry. However, changes in facts, circumstances, or entity's procedures may cause factors different from those considered in the past to become significant to the accounting estimate.

In evaluating reasonableness, the auditor should obtain an understanding of how management developed the estimate. Based on that understanding, the auditor should use one or a combination of the following approaches: -

i) Review and test the process used by the management to develop the estimate.

ii) Develop an independent expectation of the estimate to corroborate the reasonableness of management's estimate.

iii) Review subsequent events or transactions occurring prior to the date of the auditor's report.