PCAOB Adopts New Standard on Auditing Accounting Estimates

The Public Company Accounting Oversight Board (PCAOB) adopted a new standard on auditing accounting estimates.  The standard is in response to the increasing use and significance of accounting estimates in the preparation of financial statements.  The new changes enhance existing audit approaches and are intended to promote consistency in practice in areas that have created challenges to auditors.

The new standard on auditing estimates replaces three existing standards:

  1. Auditing Standard (AS) 2501, Auditing Accounting Estimates
  2. AS 2502, Auditing Fair Value Measurements and Disclosures
  3. AS 2503, Auditing Derivative Instruments, Hedging Activities and Investments in Securities

The standard refines the definition of an accounting estimate to include a decision not to recognize a transaction or event based on a calculation or other analysis.  It also emphasizes the need for professional skepticism when auditing accounting estimates due to the subjective nature of assumptions used and measurement uncertainty that make estimates susceptible to management bias.  The new standard is intended to promote a risk-based audit approach.  The consolidation and changes of previous standards are anticipated to clarify and enhance existing auditing standards to improve overall audit quality.  Additionally, more work is expected to be required in evaluating information provided related to certain estimates.

Key Changes

The new standard creates/changes the requirements to gather audit evidence and evaluate estimates as follows:

  1. Testing a company’s process for developing the estimate;
  2. Developing an independent expectation of the estimate for comparison to the company’s estimate;
  3. Evaluating events or transactions that occur after the measurement date,
  4. Requiring the auditor to obtain an understanding of management’s analysis of critical accounting estimates and take that understanding into account when evaluating the reasonableness of significant assumptions and management bias;
  5. Explicitly requiring the auditor to assess certain factors to identify significant assumptions that are susceptible to bias or depend on the company’s intent and ability to carry out specific courses of action;
  6. Strengthening requirements for testing whether data produced by the company is complete and accurate and evaluating whether data is appropriately used by a company, including a new requirement to evaluate whether a company’s change in the source of data is appropriate;
  7. Requiring an integration for evaluating estimates with the risk assessment standards to focus auditors’ attention on estimates with greater risk of material misstatement which includes enhancing requirements for obtaining an understanding of the company’s process for determining accounting estimates; and
  8. Establishing requirements for the auditor to determine whether pricing information obtained from third parties provides sufficient, appropriate audit evidence.

The new standard applies to all audits conducted under PCAOB Standards, and the changes are subject to approval by the Securities and Exchange Commission (SEC).  The standard would be effective for audits of periods ending on or after December 15, 2020.

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