(April 2006)

Explanatory Statement

ASA 540 Audit of Accounting Estimates

Issued by the Auditing and Assurance Standards Board

Explanatory Statement

Reasons for Issuing ASA 540 Audit of Accounting Estimates

The Auditing and Assurance Standards Board (AUASB) issues Auditing Standard ASA 540 Audit of Accounting Estimates due to the requirements of the legislative provisions explained below.

The Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 established the AUASB as an independent statutory body under section 227A of the Australian Securities and Investments Commission Act 2001, as from 1 July 2004. Under section 336 of the Corporations Act 2001, the AUASB may make Auditing Standards for the purposes of the corporations legislation. These Auditing Standards are legislative instruments under the Legislative Instruments Act 2003.

Process of making Auditing Standards

Section 1455 of the Corporations Act 2001 and Corporations Regulation 10.5.01 gave interim legal endorsement from 1 July 2004 to the majority of Auditing Standards made by the former Auditing & Assurance Standards Board of the Australian Accounting Research Foundation. The AUASB has reviewed the Auditing Standards and has proceeded to make them as legally enforceable Auditing Standards under the Corporations Act 2001.

The Auditing Standards have been made also in accordance with the Financial Reporting Council’s Strategic Direction to the AUASB dated 6 April 2005, pursuant to section 225 of the ASIC Act.

The Strategic Direction, inter alia, provides that the AUASB develops Auditing Standards that:

• have a clear public interest focus and are of the highest quality;
• use the International Standards on Auditing (ISAs) of the International Auditing and Assurance Standards Board (IAASB) as a base;
• conform with the Australian regulatory environment; and
• are capable of enforcement.

In implementing the Strategic Direction, the AUASB has undertaken a process of thorough review and revision that has:

• addressed the enforceability of mandatory requirements;
• clarified auditors’ obligations under the Auditing Standards;
• provided for sector neutrality in the Auditing Standards; and
• included other amendments as necessary.

Purpose of Auditing Standard ASA 540 Audit of Accounting Estimates

The purpose of Auditing Standard ASA 540 is to establish mandatory requirements and to provide explanatory guidance on the audit of accounting estimates contained in a financial report.

Auditing Standard ASA 540 is to be read in conjunction with the Preamble to AUASB Standards, which sets out the intentions of the AUASB on how the Auditing Standards are to be understood, interpreted and applied.

Operative Date

This Auditing Standard is operative for financial reporting periods commencing on or after 1 July 2006.

Main changes from Auditing Standard AUS 516 (October 1995) Audit of Accounting Estimates

The main differences between ASA 540 and AUS 516 are that in ASA 540:

1. The word ‘shall’, in the bold-type paragraphs, is the terminology used to describe an auditor’s mandatory requirements, whereas an auditor’s degree of responsibility is described in AUS 516 by the word ‘should’.
2. The explanatory paragraphs provide guidance and illustrative examples to assist the auditor in fulfilling the mandatory requirements, whereas in AUS 516 some obligations are implied within certain explanatory paragraphs. Accordingly, such paragraphs have been redrafted to clarify that the matter forms part of the explanatory guidance.
3. The following specific mandatory requirement, not in AUS 516, has been included:

(a)                the auditor shall endeavour to obtain written representations from management regarding the reasonableness of significant assumptions used by them in making accounting estimates (paragraph 32).

4.                   Explanatory guidance on management representations has been included at paragraphs 33 and 34.

5.                   Appendix 1 of AUS 516 has been removed and additional examples of accounting estimates have been included at paragraph 6.

Consultation prior to issuing this Auditing Standard

The AUASB has consulted publicly as part of its due process in developing this Auditing Standard. Exposure Draft ED 29/05 Proposed Auditing Standard: Audit of Accounting Estimates (Re-issuance of AUS 516) was issued on 9 December 2005 with a 45 day comment period. Submissions were received by the AUASB and it has considered these submissions as part of the development and finalisation of this Auditing Standard.