Learning ObjectivesLO1 Understand the traditional approach to dealing with accounting uncertainty and going concern.LO2 Describe the main concepts of CAS 540 and its relevance for financial reporting. LO3 Demonstrate an ability to apply CAS 540 in a qualitative way.LO4 Explain the problems with existing standards.

1

Review of CAS 540Key definitions:Accounting estimateAuditor’s point estimate or auditor’s rangeEstimation uncertaintyManagement biasManagement’s point estimateOutcome of an accounting estimate

LO2

2

Review of CAS 540 CAS 540.11: The auditor shall determine

whether in the auditor’s judgment, any of those accounting estimates that have been identified as having high estimation uncertainty give rise to significant risks.

A43–A44: Not all differences between outcomes and estimates are due to misstatements but this seems to depend on the financial reporting framework.

LO2

3

Review of CAS 540A47–51: The amount of the estimate is not always an indicator of the estimation uncertainty. High estimation uncertainty situations include those in which the estimates are highly dependent on judgment such as pending litigation and highly specialized, entity developed models. Estimation uncertainty may be so high that a reasonable accounting estimate cannot be made The applicable financial reporting framework may not allow recognition or measurement of the item, or may require disclosure of the high estimation uncertainty.

LO2

4

Review of CAS 540A87–91: Auditors can develop either a point estimate or a range.A91 describes a number of ways to make a range or point estimate.A92: A difference (in estimate) may arise because the auditor used different, but equally valid, assumptions as compared with those used by management.

LO2

5

Review of CAS 540A93–95: When the auditor concludes that it is appropriate to use a range to evaluate the reasonableness of management’s point estimate the auditor’s range must encompass all “reasonable outcomes” rather than all possible outcomes.

LO2

6

Review of CAS 540A116: Evaluating the reasonableness of the accounting estimates and determining misstatements.The difference between either the auditor’s point estimate and management’s estimate, or the nearest point of the auditor’s range and management’s point estimate is at least the minimum of the misstatement

LO2

7

Review of CAS 540A118: There are three types of misstatements:

1. factual —misstatements about which there is no doubt

2. judgmental —management’s judgments that the auditor considers unreasonable (i.e. forecast errors. This type also includes auditors’ nonsampling errors.)

3. projected misstatements —projection of misstatements from samples to the entire population

LO2

8

Discussion of CAS 540Estimation uncertainties incorporate all three types of misstatements of paragraph A118.Factual and projected misstatements relate to sampling theory.

Sampling risk and confidence intervals can be reduced by increasing the sample size; that is, gathering more evidence.

Judgmental misstatements are “differences arising from management’s judgments and the auditors concerning accounting estimates.

LO2

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