A basic postulate of financial accounting is that timely financial reporting requires the use of estimates. And it is a fact that all accounting estimates, more or less, inherently involve a degree of subjectivity, complexity, and uncertainty—some considerably more than others. Therefore, estimates are not expected to be right; rather, it is the auditor’s job to be comfortably assured that, when made, they were based on the best information available, reasonably supportable assumptions, and sound methodology. The estimates should be revisited and revised as necessary in future reporting periods based on new information. Auditors are always supposed to bring to the table an appropriate level of knowledge of the business and the industry when assessing estimates.
Although auditors or specialists may provide advice and guidance, like to the financial statements in general, accounting estimates are ultimately the responsibility of management. To meet this responsibility, management should take all steps reasonably possible to make the estimation process appropriately robust and the estimates sufficiently reliable, based on all information available.
Significant accounting estimates—such as allowances for doubtful accounts, useful lives and possible impairments of long-lived assets, and fair values of financial and sometimes nonfinancial assets—typically require special attention from auditors.
Some estimates may be relatively simple to make, but the more subjective or complex they are, and the more quantitatively significant or material they are to the financial statements, the more judgment and expertise are required to arrive at reliable and supportable results. Sometimes, to provide the necessary expertise to assist management in making and supporting important estimates or to assist auditors in evaluating them, it will be necessary to engage outside specialists, such as appraisers, actuaries, lawyers, engineers, or geologists.
As of this writing, the AICPA’s Accounting Standards Board (ASB) and the PCAOB are both engaged in projects intended to strengthen their respective standards controlling the nature and extent of the audit procedures required to support management’s estimates, including procedures to apply when outside specialists are engaged by either the client or the auditor. Future developments in this area should be monitored closely; for now, below is a very brief summary of the extensive guidance provided in the auditing standards [AU-C 240.32(b), 540, and 620; AS 1210, 2401, and 2501]. This guidance generally requires that auditors assess the quality of fair value measurements and other accounting estimates made by management, including when supported by the work of outside specialists, in one or more of the following ways:
