# Presentation: 164425

## Accounting Estimates and Accruals

- Payables/Receivables – Methodology for Estimating

## Accounting Estimates and Accruals

- An “accounting estimate” is an approximation of a financial statement element, item or account used because:
- The measurement or valuation of some amount or account is uncertain, pending the outcome of future events, or
- Relevant data concerning events that have already occurred cannot be accumulated on a timely, cost-effective basis

## Accounting Estimates and Accruals

- Examples of an “accounting estimate” include:
- Property and casualty insurance loss reserves
- Taxes on real and personal property
- Revenues and costs to be incurred from percent-of-completion contracts
- Initial direct costs, executory costs, and residual values of leases
- Actuarial assumptions in pension costs and warranty claims

## Accounting Estimates and Accruals

- Management is responsible for establishing a process for preparing accounting estimates consisting of:
- Identifying situations requiring estimates and relevant factors that may affect the accounting estimates
- Accumulating relevant, sufficient and reliable data on which to base the estimates
- Developing relevant assumptions of the most likely circumstances and events, using judgment & experience
- Calculating the estimated amounts based on the assumptions and other relevant factors
- Presenting the estimates in conformity with GAAP and determining that disclosures are adequate

## Accounting Estimates and Accruals

- The risk of material misstatement of an accounting estimate normally varies with the:
- Complexity and subjectivity associated with the process
- Availability and reliability of relevant data
- Number and significance of assumptions that are made
- Degree of uncertainty associated with the assumptions

## Accounting Estimates and Accruals

- Management Controls that reduce the likelihood of material misstatements of estimates include:
- Communication of the need for proper estimates and the importance of accumulating relevant, sufficient and reliable data for preparing the estimates
- Preparation of estimates by qualified personnel
- Supervision, review and approval over the process for developing estimates by appropriate levels of authority
- Comparison of prior estimates with subsequent results to assess reliability of the process and needed changes
- Consideration of the need to use specialists

## Accounting Estimates and Accruals

- The auditor’s objective is to obtain sufficient competent evidential matter to provide reasonable assurance that:
- All accounting estimates that could be material to the financial statements have been developed
- Accounting estimates are reasonable in relation to the circumstances
- Accounting estimates are presented in conformity with applicable accounting principles and are properly disclosed

## Accounting Estimates and Accruals

- In evaluating reasonableness of an estimate, the auditor normally concentrates on key factors and assumptions that are:
- Significant to the accounting estimate
- Sensitive to variations
- Deviations from historical patterns
- Subjective and susceptible to misstatement and bias

## Accounting Estimates and Accruals

- To assess reasonableness of an estimate, the auditor develops an understanding and tests management’s process by performing procedures to determine if:
- Controls over the preparation of the estimate and supporting data are in place and effective
- Sources of data and factors used in forming the assumptions are relevant, reliable and sufficient
- No additional key factors or alternative assumptions exist that should have been considered
- Historical data is comparable and consistent with the current period data used in the estimate
- The calculation is accurate and well documented

## Accounting Estimates and Accruals

- The auditor must also evaluate the reasonableness of accounting estimates in relation to the financial statements as a whole:
- If the auditor believes the estimated amount is unreasonable, the difference between the estimate and the closest reasonable estimate should be treated as a likely misstatement and aggregated with other likely misstatements when forming the overall opinion on the financial statements