Revised standard on auditing accounting estimates and related disclosures – ISA 540 (Revised)

During March 2016, the International Auditing and Assurance Standards Board (IAASB) released a project proposal with the intention to revise ISA 540, Auditing Accounting Estimates, Including Fair value Accounting Estimates and Related Disclosures. During April 2017, the IAASB released the proposed Exposure Draft. During October 2018, the IAASB released the revised ISA 540 standard and indicated that the effective implementation date is set for financial statement audits for periods beginning on or after December 15, 2019. The revision mainly ensures that the standard continues to keep pace with the changing market and fosters a more independent and challenging sceptical mindset in auditors.

 

The International Regulatory Board for Auditors (IRBA), acknowledged through their 2018 Public Inspections Report that the theme of estimates and judgements attracted the most inspection findings both locally and globally over the past few years and that it will continue to be a key focus area during inspections due to the inherent subjective nature of estimates.

 

The following key enhancements have been made to ISA 540 by the IAASB[1]:

 

  • Explicitly recognised spectrum of inherent risk;
  • With respect to external information sources, conforming and consequential amendments;
  • New and enhanced application material;
  • Expanded documentation requirement;
  • Emphasised requirement when communicating with those charged with governance;
  • Enhanced requirements addressing disclosures;
  • Introduced concept of inherent risk factors;
  • Enhanced risk assessment procedures;
  • Required separate assessment of inherent risk and control risk;
  • Emphasised the importance of the auditor’s decisions about controls; and
  • Introduced objectives-based work effort requirements.

 

Professional scepticism plays a significant role in the auditing of estimates. The auditor’s application of professional scepticism is therefore enhanced by the revised ISA 540. The following has been implemented in order to enhance the auditor’s professional scepticism[2]:

 

  • Requirement to design and perform further audit procedures in a manner that is not biased towards obtaining audit       evidence that may be corroborated or towards excluding audit evidence that may be contradictory;
  • Requirement to stand back and evaluate the audit evidence obtained regarding the estimates;
  • Use of stronger language (“challenging”, “question” and “reconsider”) in application material to reinforce the      importance of exercising professional scepticism; and
  • Focus on management bias in risk assessment and work effort.

 

From the above, it is evident that estimates will remain a “hot topic” in the audit industry for an undetermined period due to the nature thereof. It is therefore crucial for auditors to upskill themselves in obtaining the proper knowledge required in order to implement the revised ISA 540 in the audits of financial statements.

 

The above article only highlights certain aspects of the revised standard and should not be deemed as a replacement of the revised standard.

 

[1] As per the IAASBs ISA 540 presentation.

 

[2] As per the IAASBs ISA 540 presentation.

 

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

The audit process

To get a better understanding of the audit process, we can take a look at the definition of an audit. Audit – “an official inspection of an organisation’s accounts, typically by an independent body”. An efficient audit is one that reduces the audit risk to the targeted level, ensures that there are no material errors contained in the financial statements and gives the stakeholders an independent reassurance that their interests are taken care of. 

The audit process can be split up into what auditors do and why they do it.

 

What auditors do Why they do it
Compile the engagement letter The engagement letter sets out the terms and responsibilities of both the client and the auditor to give a clear understanding of what is required of both parties.
Audit planning To get a better understanding of the company being audited, the environment they operate in, the internal control systems in place and inherent risks of the company.
Risk assessment procedures After a better understanding of the inherent and control risks are established, the auditor will be able to determine the number and type of procedures to perform.
Perform the risk response procedures The auditor performs the procedures as determined during the planning stage to give reassurance that the accounting work is free from material misstatements and that other legislation has been complied with.
Compile a management report Give management feedback on findings from the procedures performed and make recommendations where required.
Give an independent and objective opinion (the audit report) Give stakeholders, for example, shareholders, the bank, etc. an objective opinion that the financial information as presented by management is free from material misstatement and can be trusted.
Going concern conclusion, Reassurance that the business is a going concern, in other words, the business is in a financial position to continue operating in the near future.

 

Due to the nature of testing (samples tested) and inherent limitations, an audit is not a 100% confirmation that the financial statements are free from all misstatements and that there is no fraud involved in the company. The objective of an audit is to give reassurance that the information provided to stakeholders by management are free from material misstatements. Due to the focus on specific areas of key legislation, the audit also does not guarantee that all legislation has been complied with even though during the audit fraud may be identified.

 

The goal for management is to get an unqualified audit report, meaning that the financial statements are free from material misstatements. There are no findings made by the auditor on the management report and the auditor identifies no material findings on non-compliance with legislation. To ensure an unqualified audit report, management is required to uphold high-quality governance, ethical leadership with appropriate policies and procedures in place and ensure financial and performance management of a high stand is maintained.

 

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

When should financial statements be audited, reviewed or compiled?

The Companies Act of South Africa (the Act) requires all companies to prepare financial statements within 6 months after the end of its financial year. A very popular question among business owners with regards to financial statements is whether the statements should be independently audited, reviewed or compiled. In determining the engagement type, the Act prescribes the following criteria to be applied:

 

Audited financial statements

 

  1. Any profit or non-profit company that, in the ordinary course of its primary activities, holds assets in a fiduciary capacity for persons who are not related to the company, and the aggregate value of such assets held at any time during the financial year exceeds R5 million;
  2. Any non-profit company, if it was incorporated:
    • directly or indirectly by the state, a state-owned company, an international entity or a company; or
    • primarily to perform a statutory or regulatory function in terms of any legislation, a state-owned company, an international entity, or a foreign state entity, or for a purpose ancillary to any such function;
  3. Any other company whose public interest score in that financial year is:
    • 350 or more; or
    • at least 100, but less than 350, if its annual financial statements for that year were internally compiled.

 

How to calculate your public interest score, to determine if you exceed 350 points or not:

  1. a number of points equal to the average number of employees of the company during the financial year;
  2. one point for every R1 million (or portion thereof) in third-party liabilities of the company, at the financial year end;
  3. one point for every R1 million (or portion thereof) in turnover during the financial year; and
  4. one point for every individual who, at the end of the financial year, is a member of the company, or a member of an association that is a member of the company.

 

Independent review of financial statements

 

The Act prescribes that an independent review of a company’s annual financial statements must be performed if the following apply and the company does not select to be voluntarily audited:

 

If, with respect to a company, every person who is a holder of, or has a beneficial interest in, any securities issued by that company is not a director of the company, that financial statements should be independently reviewed.

 

A company and its directors may choose to be voluntarily audited or reviewed if they wish to engage in an assurance engagement, although it has not been prescribed by the Act.

 

Compiled financial statements:

 

If none of the above-mentioned requirements has been met, the financial statements may be compiled.

 

With compilations, or compiled financial statements, the outside accountant converts the data provided by the client into financial statements without providing any assurances or auditing services.

 

If you need any assistance with your engagement in financial statements, do not hesitate to contact our friendly staff.

 

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)