top stories

Share

Proposed revised and redrafted International Standard on Auditing issued for comment by the International Auditing and Assurance Standards Board of the International Federation of Accountants

Comments from ACCA
April 2007

Executive Summary

ACCA welcomes the opportunity to comment on the proposed International Standard on Auditing ISA 540 (Revised and Redrafted) Auditing Accounting

Estimates, Including Fair Value Accounting Estimates, and Related

Disclosures (proposed ISA 540), issued for comment by the International Auditing and Assurance Standards Board (IAASB) of the International Federation of Accountants and the proposed withdrawal of ISA 545, Auditing Fair Value Measurements and Disclosures .

We support combining ISA 545 with ISA 540 and have called for this since 2002. We suggest, however, that more could be done to minimise the resulting duplications.

As explained in the Explanatory Memorandum forming part of the exposure draft, the IAASB is not seeking comments on matters that have been debated and resolved in arriving at the 'close-off' document concerning the audit of accounting estimates and related disclosures. Accordingly we confine our comments to the matters on which specific questions are asked in the Explanatory Memorandum.

Our main concern with proposed ISA 540 is that several of the proposed requirements do not properly reflect the intentions of the close-off document on which it is based. The practical effect of this could be the addition of significant extra cost to audits which will fall disproportionately on smaller audited entities.

The Appendix to this response provides further information on the deficiencies that we identify in the requirements of this and other proposed ISAs resulting from the Clarity project.

Matters on which Specific Questions are Asked

In this section of our response we address the issues identified for specific comment in the Explanatory Memorandum forming part of the Exposure Draft.

Objective

We consider that the objective is appropriate.

Requirements

The Appendix to this response provides further information on the deficiencies that we identify in the requirements of this and other proposed ISAs resulting from the Clarity project. It should be read in conjunction with each comment below as such deficiencies are particularly evident in these paragraphs.

8(b)

The second sentence of this subparagraph has been elevated from guidance in the close-off document. The introductory words 'in obtaining this understanding' identify this as duplication. It is inherent in the requirement in the first sentence of the subparagraph. Change in circumstances is clearly one of the most obvious ways in which management is alerted to the need to make or revise accounting estimates. The fact that some auditors may benefit from guidance to that effect is not in itself sufficient justification to introduce duplication of a requirement. We recommend transferring this material to the Application and Other Explanatory Material (A&OEM) section.

9

There is considerable overlap between this paragraph and requirement 8(c)(iv). Paragraph A29 (referenced from requirement 8(c)(iv)) deals with changes in methods whereas paragraphs A31 to A36 (referenced from paragraph 9) deal extensively with many aspects of retrospective review; including the fact that ISA 240 (Redrafted) requires this to be done to identify management bias. The requirement in paragraph 9 is written so that, in effect, the auditor is only required to do what the auditor decides to do.

We recommend that this duplication be eliminated by transferring the material from paragraph 9 to the A&OEM section. We further recommend reducing the emphasis on retrospective review in that section. While such procedures may be effective in some instances, proposed ISA 540 is biased towards them. If paragraph 9 is not amended, auditors will be deterred from carrying out appropriate procedures on current estimates because they have to spend a disproportionate time 'ticking boxes' dealing with prior period estimates.

10

As written, the requirements in paragraph 10 do not achieve their intended purpose. Unless changed, they will result in significant extra cost on all audits which will fall disproportionately on smaller audited entities.

Subparagraph 10(a) has been elevated from paragraph 33 of the close-off document. The reason given is that it is 'An essential amplification of the general requirement to assess risks in relation to estimates. Applicable in all cases.'

The statement that 'In assessing the risks of material misstatement,

the auditor considers the degree of estimation uncertainty and susceptibility to bias...' is clearly guidance. It reminds auditors of two aspects of risk. As a requirement we categorise it as one embodying a basic principle. As set out in detail in the Appendix to this response, under the heading 'Basic principles and essential procedures', it is easy for auditors to confuse this with a required procedure. If treated as a required procedure, auditors will spend a considerable time for each accounting estimate, irrespective of its materiality, assessing and documenting two factors: its degree of estimation uncertainty and its susceptibility to bias.

Subparagraph 10(b) stems from a requirement in paragraph 35 of the close-off document. That requirement follows guidance on matters the auditor considers as part of the risk assessment required by ISA 315.

The wording of the requirement in the close-off document clearly indicates that it is a summation of what has gone before: 'Using information gathered from the risk assessment procedures, the auditor should determine which accounting estimates have high estimation uncertainty and may, therefore, give rise to significant risks.'

When presented in proposed ISA 540 this becomes a requirement that the auditor shall 'determine which accounting estimates, whether recognized or disclosed in the financial statements, have high estimation uncertainty and may, therefore, give rise to significant risks.'

This is a prime example of the danger of rewriting in the Clarity project. The result is a further requirement that auditors are likely to interpret as needing extensive work for every accounting estimate, irrespective of materiality, to assess and document a decision on the degree of estimation uncertainty.

We draw attention to the discussion of such issues in the Appendix to this response and we stress in the strongest possible terms the need to redraft paragraph 10.

11 to 13

Paragraphs 11 to 13 apply to all estimates, not just those where the auditor is responding to significant risks. We comment below on several of these paragraphs and suggest that overall the level of detail in these paragraphs is disproportionate to the importance of such work. The extra costs introduced in respect of estimates where the risk is not significant will fall disproportionately on the audit of smaller entities.

12

This is an example of a principle that has been rendered as a required procedure (see the Appendix to this response). The literal interpretation of this requirement is that for every accounting estimate, irrespective of materiality, the auditor will be required to carry out procedures designed to determine if an expert needs to be involved.

We recommend that this paragraph be redrafted to reflect the intention of the close-off document. In this instance, this may best be achieved by transferring the material to the A&OEM section.

Paragraph A16 (which is also referenced from paragraph 7) introduces the concept of a 'threshold amount'. We do not agree with the introduction of this new concept in proposed ISA 580. Auditors consider materiality and risk when deciding what representations to request and the introduction of this further concept is unnecessary and potentially misleading.

13(b)

Subparagraph 13(b) contains two further subparagraphs. The requirement in the subparagraphs 13(b)(i) and 13(b)(ii) are effectively duplicated by the requirement in the first sentence of subparagraph 13(b). It is inherent in testing how management made an accounting estimate and the data on which it is based that the auditor will consider the method of measurement and the assumptions used by management. If it is thought necessary that guidance be provided on this, then the appropriate place for such material is in the A&OEM section.

13(d)

Subparagraph 13(d) and deals with the development of a point estimate or range to evaluate management's point estimate. The subparagraphs 13(d)(i) and 13(d)(ii) deal with certain aspects of this that we do not believe necessitate such emphasis.

Subparagraph 13(d)(i) requires auditors to obtain an understanding of management's assumptions or methods, in support of their own work. This will not be appropriate in all cases. The decision to adopt the response covered by subparagraph 13(d) (as opposed to 13(a), (b) or (c)) is likely to be driven by auditors deciding either that their approach is more efficient or that management's approach (of which there have already developed an understanding) is deficient. If the former, complying with the further requirements is an unjustified cost; if the latter, there is no merit in investigating further management's methods that have caused auditors to reject the approach relevant to requirement 13(b). Subparagraph 13(d)(i) should either be eliminated or transferred to the A&OEM section.

Subparagraph (13)(d)(ii) deals with narrowing a range until all outcomes within it are considered reasonable. What is reasonable is not further defined. Some auditors may interpret this as meaning that all values have an equal chance of being correct, ie each could reasonably be the appropriate value.

The guidance at paragraphs A82 to A85 is extensive and we believe that, taken together with the requirement, it will result in auditors spending excessive time deciding on the precise extent of ranges rather than concentrating on the more important relationship between the values that they feel are appropriate and management's estimate.

Given that there are many ways in which ranges may be developed, we do not believe that the requirement in subparagraph 13 (d)(ii) is justified. It should be either be eliminated or transferred to the A&OEM section.

14

We do not believe that the drafting of paragraph 14 correctly interprets the intention of the requirements in paragraph 76 of the close-off document.

Paragraph 76(a) requires the auditor to evaluate: 'How management has considered alternative assumptions or outcomes, and why it has rejected them, or otherwise has addressed the effects of estimation uncertainty on the accounting estimates;'. This makes it clear that the evaluation is directed at the effects of estimation uncertainty .

Paragraph 14(a) has included guidance material from paragraph 79 rewritten as a requirement. This results in a separation of the evaluation of ' How management has considered alternative assumptions or outcomes, and why it has rejected them' from the purpose of that evaluation and turns it into a stand-alone requirement having no bearing on estimation uncertainty. Such a requirement will drive auditors to carry out procedures of little relevance, instead of addressing the issue of estimation uncertainty directly.

We consider the wording of paragraph 76 superior to that of paragraph 14 and recommend rewriting paragraph 14 to agree directly with the intent of paragraph 76. The material in paragraph 79 should remain as guidance.

A32 and A66

Although not themselves requirements, we are aware that some may interpret aspects of these paragraphs as limiting the auditor's responsibilities set out in paragraphs 9 and 13 respectively. We do not share that view and agree with the treatment in proposed ISA 540. These statements are no more than guidance.

The proposed combination of ISAs 540 and 545, its effect on the content of the ISA, and the proposed withdrawal of ISA 545.

In April 2005 we commented on proposed ISA 540 (Revised) Auditing Accounting Estimates and Related Disclosures (Other Than Those Involving Fair Value Measurements and Disclosures). In that response, we referred to our long-standing concerns first voiced in 2002, when extant ISA 545 Auditing Fair Value Measurements and Disclosures was exposed for comment, that it is more appropriate to deal with accounting estimates and fair value measurements together. We are fully supportive, therefore, of the current proposed combination and the related withdrawal of ISA 545.

We are concerned that the A&OEM section contains several paragraphs where similar material is presented. This may arise because of overlap in the requirements (as we have commented on elsewhere in this response) or because of the combination of material from two ISAs. We suggest that further consideration be given to eliminating such duplication. The response of the European Federation of Accountants (in which ACCA is an active participant) provides a list of matters for consideration.

Small entities

We have commented in relation to several proposed requirements that they will add costs to audits that will fall disproportionately on smaller audited entities.

Public sector entities

Although the guidance in paragraph A10 could equally apply to not-for-profit entities, we question whether the circumstances are sufficiently common to merit the inclusion of this material at all.

Documentation

While the documentation requirements refer to appropriate matters to record, these would be documented under the requirements of other ISAs and we do not consider it necessary to include them in proposed ISA 540. In particular, indicators of management bias would be documented in relation to ISA 240 and the inclusion of a separate requirement in proposed ISA 540 gives such matters undue prominence in relation to accounting estimates.

Translation

We suggest that translation could be made more easy if the use of long sentences was kept to a minimum and more effort was put into eliminating superfluous words.

Appendix: Common Deficiencies in Requirements

This Appendix provides further information on the deficiencies that we identify in the requirements of this and other proposed ISAs issued as part of the Clarity project.

Growth in number of requirementS

There seems to be no external economic or social justification, suddenly to increase the degree of specificity of ISAs; nevertheless, many proposed ISAs exhibit a substantial growth in the number and detail of specific requirements. We are not convinced that the guidelines adopted for deciding on the requirements to be included in an ISA are correct.

We are concerned that the proliferation of requirements will promote a 'tick-box' mentality. Each extra requirement introduced is another box to tick, another factor that can reduce the quality of an audit, and another cost that bears disproportionately on smaller audits and deters the more widespread application of ISAs.

Our detailed analysis concludes that hardly any of the changes from a present-tense statement to a requirement are justified. We recommend that the proposed requirements be reconsidered on an individual basis and that each remains as a requirement only if a strong case can be made for that.

The 'requirement' is really guidance on another requirement

Many new requirements deal with the same subject as another but in greater detail: the auditor is required both to do something and also to carry out the steps in that process. This is a simple duplication, which should be eliminated.

In some instances, the secondary requirements illustrate how the primary requirement is met in circumstances that will be relatively rare, giving rise to complex prose.

Such secondary requirements are best treated as explanatory material that auditors can refer to in relation to the primary requirement.

Drafting of Requirements

We do not find the requirements sections of proposed ISAs easy to understand. There are three main reasons for this:

• explanatory material is interspersed with the requirements,
• the wording of requirements makes no distinction between basic principles and essential procedures, and
• the requirements are not constructed in a simple fashion.

Explanatory material

We do not support splitting the supplementary material providing explanation and guidance between the A&OEM section and the requirements section. Such an approach forces users to carry out a detailed analysis of the text of the requirements section to identify the 'essential explanatory material' and discover which parts of the text are actual requirements. Rather than improving clarity, explanatory material adds unnecessary length and detracts from the reader's understanding. Instead, we strongly suggest that the 'essential explanatory material' and the 'supplementary material providing further explanation and guidance' both be presented only in the A&OEM section (or its appendices).

Basic principles and essential procedures

The bold type in extant ISAs identifies basic principles and essential procedures. These are substantially different in nature, but the Clarity project has combined the two as 'requirements'. We do not agree with this approach, which leads to confusion, as auditors may attempt to treat a principle as an action.

The corresponding and perhaps greater danger is that auditors who correctly interpret some of the 'shall' statements as principles will treat as principles some that are intended as active requirements. We recommend separating the principles with which the auditor is required to comply from the required procedures and other actions.

Simple construction

We do not find the requirements easy to understand because they are not always drafted in a simple fashion. Requirements with multiple conditions precedent are particularly difficult to understand when written in prose. The complexity of the material also makes translation difficult.

Auditors who need to know when a requirement applies, and when it does not, have to be very diligent and analytic readers. We recommend rewording all requirements so that there is no doubt about the meaning of the various 'shall' statements. This should be done using a structure that clearly shows:

• any conditions precedent
• on whom the requirement is placed
• the action required, and
• the object of that action.

An example of such an structure was include as an Appendix to our February 2006 response to the redrafting proposals 'Improving the Clarity of IAASB Standards'.

Back to top