Auditing accounting estimates
How an audit team can test allowances, provisions and useful lives under ISA 540 (Revised), watch for management bias and document the judgement.
By Achekam · · 5 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
The receivables balance agrees to the age analysis, the invoices exist and the customers confirm what they owe. Then comes the line that cannot be vouched to a document: the allowance for expected credit losses. Management says it is adequate. The audit senior has a spreadsheet, a few prior-year figures and a nagging sense that the allowance is the same as last year even though two large customers are paying late.
Accounting estimates are where audits go wrong most quietly. There is no invoice to inspect and no confirmation to send. The figure depends on judgement about the future, made by people who have a view on what the answer should be. That is why the auditing standard on estimates asks for more than a recalculation.
This article sets out a practical approach to auditing estimates under ISA 540 (Revised), and how the work is recorded in Achekam.
Why estimates carry higher risk
An estimate is a figure that cannot be measured precisely, only approximated: an allowance for doubtful debts or expected credit losses, a warranty or legal provision, the useful life and residual value of equipment, an inventory write-down, a fair value.
ISA 540 (Revised) directs the auditor's attention to what makes a particular estimate risky:
- Estimation uncertainty: how far the outcome could differ from the estimate.
- Complexity: how hard the method, model or data are to get right.
- Subjectivity: how much depends on management's choices of assumptions.
A useful-life estimate for office furniture scores low on all three. A provision for a disputed contract claim may score high on every one. The work should scale accordingly. The IAASB's page on ISA 540 (Revised) describes the standard on auditing accounting estimates and related disclosures, and the full text is the reference for the requirements.
Three ways to obtain evidence
The standard offers three broad approaches, which can be combined.
Test how management made the estimate
Understand the method, test the data going in, and challenge the assumptions. For an expected credit loss allowance, that means checking that the ageing is accurate, that the loss rates come from the client's actual history, and that management has adjusted them for current conditions it knows about, such as those two late-paying customers.
Develop your own estimate or range
Build an independent point estimate or range and compare it with management's. This is often the strongest evidence where management's process is weak, and it forces the team to understand the drivers rather than accept a method on trust.
Use events after the period end
Look at what has happened since the reporting date. Cash received from customers after year end is direct evidence about the collectability of receivables at year end. The settlement of a legal claim tells you a great deal about the provision. Later events are not always available in time, but where they are, they can be the most persuasive evidence of all.
Indicators of management bias
The standard asks the auditor to look for possible management bias, not just error. Warning signs include:
- a change in method or assumptions that has no clear reason and moves the result in management's favour;
- estimates that land consistently at the optimistic end of reasonable ranges;
- assumptions that conflict with what management says elsewhere, for example in budgets or board minutes;
- an allowance that stays flat while the underlying risk has plainly changed;
- last year's estimates that turned out materially wrong in the same direction.
Looking back at how last year's estimates actually turned out is one of the most revealing procedures available. It tells you how reliable management's estimating process is.
Specialists where needed
Some estimates need expertise the team does not have: actuarial valuations, property valuations, complex financial instruments, environmental provisions. ISA 540 (Revised) expects the auditor to consider whether specialised skills are needed.
In Achekam, specialists can be recorded on an audit through the Specialists & Experts screen. Note that the Audit Resource Pools and Delivery Centres screens stay empty, because no route or screen adds a pool or a centre; record specialists through the Specialists & Experts screen instead. Using the work of an auditor's or management's expert brings its own requirements; using an expert's work covers them.
Documenting the judgement
Estimates are judgement-heavy, and judgement must be visible in the file.
Each work item in Achekam lists the procedures to perform and the documents required. A step is marked done only with a written response and its documents, or set aside with a reason, and steps are never deleted. For an estimate, the written response should show what the team did, what it found and why it reached its conclusion, not just "agreed, no exceptions".
A working paper can have a spreadsheet workbook whose figures are refreshed from the engagement's trial balance, with any figure it could not read listed. That keeps the team's recalculation or independent range tied to the current balances, rather than to a copy that went stale after the last adjustment.
Staff can ask AI to draft a conclusion or a procedure's response on a working paper, but a draft goes into the file only when a person saves it, and the paper still moves through manager and partner review; the preparer cannot also review it, and Achekam refuses any sign-off made by an AI. For estimates in particular, the conclusion is the team's judgement, and the reviewer should be able to see that.
When the team and management disagree, or the team disagrees internally, use a technical consultation. Staff can take one from question to conclusion and closure, and record a difference of opinion with each party's position, escalation and resolution. That record is the best answer to an inspector's question about how a difficult estimate was resolved.
Provisions are among the estimates with the widest range of outcomes; provisions and contingent liabilities covers the accounting the audit is testing.
On your next audit, choose the estimate with the most subjectivity and ask the team to show, in one page, which of the three approaches they used and what bias indicators they looked for.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
