Auditors’ work on financial instruments to be enhanced

Business meeting professionals
By Anne Adrain, Head of Sustainability and Assurance

30 June 2017

The International Auditing and Assurance Standards Board (IAASB) is consulting on revisions to its standard on the audit of accounting estimates and related disclosures (ED-540).

The updated standard will apply to the audit of all accounting estimates and has been developed to support auditors following the introduction of IFRS 9, Financial Instruments, mandatory for accounting periods commencing on or after 1 January 2018.

Auditors will need to fulfil more stringent requirements when concluding upon ‘accounting estimates’ in company accounts. These accounting estimates, which will shortly include expected credit losses in banks, frequently feature in the financial statements of some of the largest UK and global entities, and can be one of the most difficult, complex and challenging areas to audit.


The audit approach under the revised International Standard on Auditing (ISA) 540, will require a more robust risk assessment and additional work effort to determine how uncertainty, complexity and judgements taken by management affect an estimate. It will also require the auditor to apply greater professional scepticism and to carry out a further final review of the audit work on the estimate before the audit is completed.

Reduced procedures will apply when the risk of material misstatement in the accounting estimate is low.

Some of the main points from the proposed changes are summarised below:

Work effort

The IAASB has chosen to develop an approach to accounting estimates that:

  • Produces requirements that are capable of being applied to specific circumstances;
  • Where inherent risk is not low, the auditor can identify and focus on those matters that may result from a specific risk of material misstatement;
  • Supports scalable application of the standard by introducing the need to design and perform further audit procedures only when inherent risk is not low;
  • Reinforces the need to test perform controls testing when the auditor intends to rely on those controls or when substantive procedures alone cannot provide sufficient appropriate audit evidence.

Key concepts in the revised standard

ED-540 highlights that the auditor’s identification and assessment of the risks of material misstatement for accounting estimates, and the auditor’s responses to those assessed risks, are affected by three concepts:

  • Complexity – Complexity in accounting estimates can arise from the estimation method used, and the data on which the accounting estimate is based;
  • The need for the use of judgment by management - Accounting estimates that rely upon significant judgment by management increase the risk of intentional or unintentional management bias; and
  • Estimation uncertainty – ED-540 highlights the need for management to understand and address estimation uncertainty and how this impacts the auditor’s evaluation of the reasonableness of management’s estimate and related disclosures.

Professional scepticism

Professional scepticism plays a central role in the audit of accounting estimates. ED-540 contains key provisions designed to enhance the auditor’s application of professional scepticism and consideration of the potential for management bias, including:

  • Enhanced risk assessment requirements to provide a better basis for identifying and assessing the risks of material misstatement related to accounting estimates;
  • More granular requirements on obtaining audit evidence when inherent risk is not low; and
  • Requirements to “stand back” and evaluate the audit evidence obtained to support the accounting estimates.


The IAASB has also sought to make ED-540 scalable and requires the auditor, when dealing with accounting estimates with low inherent risk, to determine whether one or more specific further audit procedures may provide sufficient appropriate audit evidence.

Specialised skills or expertise

Given the increasingly complex nature of certain accounting estimates, the IAASB has included an additional requirement to consider earlier in the process whether specialised skills and knowledge are required in the audit of accounting estimates.

Auditor’s point estimate or range

When inherent risk is not low, ED-540 requires the auditor to obtain sufficient appropriate audit evidence about whether management has taken appropriate steps to understand and address estimation uncertainty and to develop a point estimate and related disclosures that are reasonable.  The current ISA 540 includes a requirement to ‘narrow the range’ which raised some concern that it could result in an inappropriately wide range. This has been removed in the revised ED-540.

The consultation can be reviewed in full online, and responses to the consultation have been requested by the IAASB by the deadline of 1 August 2017.


  • Financial Services

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