Change in Estimates

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Change in Estimates Audit Case Example: ABC Manufacturing Company

Context

If ABC Manufacturing Company has made significant changes in accounting estimates during the period, such as adjusting the depreciation method or period for its machinery, estimating the recoverable amount of an asset, or revising estimated warranty liabilities, these changes could significantly impact the company’s financial results and position. Understanding and verifying the basis for these changes is crucial for auditors.

Audit Objective

To obtain reasonable assurance that changes in accounting estimates made by ABC Manufacturing Company are justified, accurately calculated, appropriately recognized, and disclosed in accordance with the applicable financial reporting framework.

Types of Audit Evidence and Documentation for Changes in Estimates Assertions

1. Accuracy

• Case: Assess the accuracy of the calculations underlying the change in accounting estimates.

• Documentation: Document the review of calculations and methodologies used by management to determine the new estimates, including any external data or inputs used in the estimation process.

2. Occurrence

• Case: Verify that the change in estimate is the result of new information and not a correction of an error.

• Documentation: Summarize the assessment of the reasons for the change in estimates, distinguishing between changes due to new information and corrections of errors.

3. Completeness

• Case: Ensure that all required disclosures related to changes in accounting estimates are complete and included in the financial statements.

• Documentation: Outline the procedures for verifying the completeness of disclosures related to changes in estimates, such as the nature of the change, the reason for the change, and the effect on the current and future periods, if material.

4. Presentation and Disclosure

• Case: Review the financial statements to ensure that changes in accounting estimates are appropriately disclosed and presented in accordance with the applicable financial reporting framework.

• Documentation: Note the evaluation of the presentation and disclosure of changes in accounting estimates, verifying that disclosures provide sufficient detail for users to understand the nature and impact of the changes.

Additional Considerations

• Assessment of Judgment and Assumptions: Given that changes in accounting estimates often involve significant judgment and assumptions, document the inquiries made to management regarding the basis for the changes and any external factors or trends considered.

• Comparative Information: If the change in estimate affects comparative figures, document the review of adjustments made to prior period comparatives, where applicable, and the adequacy of the related disclosures.

• Communication with Those Charged with Governance: Discuss significant findings related to changes in accounting estimates with management and those charged with governance, especially where there are significant judgments or assumptions that could affect future periods.

Conclusion

The audit of changes in accounting estimates is integral to ensuring the financial statements accurately reflect the current expectations for the company’s assets, liabilities, income, and expenses. Documenting the audit procedures and findings related to each relevant assertion for changes in estimates provides a basis for the auditor’s opinion on the financial statements, enhancing the reliability of the reported information. This approach helps stakeholders understand the impact of changes in estimates on the company’s financial position and performance.