(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:
- 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’.
- 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.
- 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.
Overview
The Auditing and Assurance Standards Board (AUASB) issued Auditing Standard ASA 540 Audit of Accounting Estimates in 2006, pursuant to the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004. This Act established the AUASB as an independent statutory body, with the ability to create Auditing Standards under the Corporations Act 2001. ASA 540 was developed in line with the Financial Reporting Council’s Strategic Direction to the AUASB, focusing on ensuring the highest quality standards with a clear public interest focus, using International Standards on Auditing as a base and being adaptable to the Australian regulatory environment. The purpose of ASA 540 is to provide mandatory requirements and explanatory guidance on auditing accounting estimates within financial reports, thereby enhancing the quality and reliability of financial disclosures. This Auditing Standard became operative for financial reporting periods commencing on or after 1 July 2006.
Scope and Application
Auditing Standard ASA 540, issued by the Auditing and Assurance Standards Board (AUASB), applies to auditors and entities that prepare financial reports in Australia. The standard mandates specific requirements and provides guidance on auditing accounting estimates within financial reports, aiming to ensure the reliability of these estimates. The AUASB, established by the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004, has the authority to issue such auditing standards under the Corporations Act 2001. ASA 540 is operative for financial reporting periods commencing on or after 1 July 2006, and it revises and replaces the previous Auditing Standard AUS 516. It introduces more stringent mandatory requirements, using the term "shall" to denote obligations that auditors must adhere to, and clarifies certain obligations through explanatory guidance and illustrative examples. The standard is designed to enhance the quality and enforceability of auditing practices in Australia, ensuring that auditors perform their duties with a clear public interest focus, aligning with the strategic direction set by the Financial Reporting Council.
Key Provisions
Auditing Standard ASA 540 Audit of Accounting Estimates, issued by the Auditing and Assurance Standards Board (AUASB), sets out the mandatory requirements for auditors when auditing accounting estimates in a financial report. The standard applies to financial reporting periods commencing on or after 1 July 2006. The key provisions of ASA 540 revolve around ensuring that the auditor obtains sufficient appropriate audit evidence to evaluate the reasonableness of accounting estimates and related disclosures. For instance, under section 32 of the standard, the auditor shall obtain an understanding of how management makes the accounting estimates, including the methods and significant assumptions used. Additionally, section 33 requires the auditor to evaluate the reasonableness of significant assumptions and the rationality of any significant changes in estimation methods.
The Auditing Standard imposes several obligations on auditors. Firstly, under section 25, the auditor must assess the adequacy of the accounting policies and the appropriateness of the accounting estimates. This involves evaluating whether the estimates are in accordance with the applicable accounting standards and are applied consistently. Furthermore, under section 32, the auditor is required to determine whether management has identified and accounted for all significant classes of transactions, account balances, and disclosures. The auditor must also evaluate the appropriateness of the methods used by management in making the accounting estimates, and if necessary, make appropriate adjustments.
Breaching the requirements of ASA 540 may lead to various consequences. Firstly, auditors who fail to comply with the mandatory requirements of the standard may be subject to disciplinary action by the AUASB. This could include reprimands, fines, or in severe cases, suspension or revocation of the auditor's registration. Additionally, if the audit of accounting estimates is not conducted in accordance with the standard, it may result in an improper audit opinion being issued. This, in turn, could lead to legal action against the auditor by the company's shareholders or other stakeholders. The potential consequences underscore the importance of adherence to the Auditing Standard for maintaining the integrity of financial reporting and ensuring that users of financial reports can have confidence in the reliability of the information presented.