Accounting Estimates: How Do Auditors Evaluate Them?

When audit companies in Dubai report their financial results, they are usually based on estimates prepared by management. Examples include provisions for bad debts, guarantee obligations, pending litigation costs, impairment of goodwill, and fair value of acquired intangible assets. How do auditors in Dubai assess whether the amounts for these items in the financial statements are reasonable?

The measurement of accounting estimates involves a certain degree of uncertainty. Therefore, accounting estimates such as provision for doubtful debts, impairment of long-lived assets, and valuation of financial and non-financial assets require additional attention from auditors. The current audit rating standards and examples of professionals who may be hired to provide independent ratings are detailed below.

Consulting and Testing

Accounting estimates may be based on subjective or objective information (or both) and involve a degree of measurement uncertainty. The external auditors will evaluate accounting estimates as part of their standard audit procedures.

For example, they might ask about the underlying assumptions (or inputs) used to estimate whether the inputs are complete, accurate, and relevant. Estimates based on objective data, such as published interest rates or percentages observed in prior reporting periods, are generally less prone to bias than estimates based on unobservable speculative data. This is especially true if management needs to gain experience in making similar estimates.

Auditors attempt to restate management’s estimates using the same (or their own) assumptions whenever possible. If the auditor’s estimates differ materially from those presented in the financial statements, the auditor will require management to explain the difference. In some cases, independent professionals such as appraisers or engineers may be necessary to evaluate complex projects.

Auditors can also compare past estimates to what happened after the financial statement date. Estimated results often differ from original management estimates. Possible explanations include errors, unexpected follow-up events, and administrative bias. If management’s estimates are consistent with what happens next, it adds credibility to previous management estimates. However, if material discrepancies are found, auditors may become more skeptical of management’s current estimates and need to use additional audit procedures.

Application of Auditing Standards

Some estimates can be determined easily, but many are subjective or complex. Auditing standards typically provide three approaches to the substantive testing of fair value measurements and other accounting estimates:

Test management process.

 Auditors assess the reasonableness and consistency of management’s assumptions and test that underlying data is complete, accurate, and relevant.

Develop an independent estimate.

 Using management’s assumptions (or alternative assumptions), auditors make estimates for comparison with what is reported in internally prepared financial statements.

View subsequent events or transactions. 

The reasonableness of the estimate can be measured by considering events or transactions that occurred after the balance sheet date but before the audit report date.

Independence guidelines generally prohibit auditors from providing certain services to public audit clients. To obtain independent accounting estimates, companies often turn to outside professionals.

Rely on experts

Examples of professionals used to prepare accounting estimates include:

  • Actuaries determine employee benefit obligations
  • Engineers determine obligations related to environmental remediation
  • Appraisers determine the value of intangible assets or real property
  • Geologists estimate mineral deposits or oil reserves for mining and energy companies
  • Lawyers predict potential losses from legal action.

Auditors often help guide these professionals to reduce the risk of misstatement, especially when the experts are not bound by the company’s training, resources, and quality control systems.

Receive help

Business transactions have grown more complex in recent years, leading companies to exercise a great deal of self-judgment and rely more on the expertise of third parties. Our audit and assurance team knows how to apply auditing standards to accounting estimates made internally and/or using external professionals. Contact us today for any auditing help to find out how we can help you.

Final thoughts 

Making estimates is an inevitable part of preparing financial statements. Management must estimate various assets and liabilities to show them at a reliable value. These estimates involve routine matters such as the expected useful life of property, plant, and equipment, appropriate provisions for receivables, and more complex issues such as estimating retirement liabilities for newly acquired subsidiaries. Estimates have one most important characteristic: they attempt to look into the future and are, therefore, subject to a high degree of uncertainty and thus have an inherent risk of misstatement. Hire audit firms in Dubai if you need help handling the financing.

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