Challenges in Auditing Accounting Estimates
Making accounting estimates involves approximating amounts of business transactions where precise measurement is not possible. Such estimates impact financial statements and future periods. Challenges include lack of precision, forecasting future outcomes, and estimation uncertainty. Significant estimation uncertainty can lead to misstatements, especially in fair valuation and government resource measurement. Estimation differences need to be adjusted in cost and revenue for construction contracts. Other major areas of accounting estimations include impairment of assets, biological assets, defined benefit plans, fair valuation of assets in business combinations, and financial instruments.
Uploaded on Mar 16, 2025 | 0 Views
Download Presentation
Please find below an Image/Link to download the presentation.
The content on the website is provided AS IS for your information and personal use only. It may not be sold, licensed, or shared on other websites without obtaining consent from the author.If you encounter any issues during the download, it is possible that the publisher has removed the file from their server.
You are allowed to download the files provided on this website for personal or commercial use, subject to the condition that they are used lawfully. All files are the property of their respective owners.
The content on the website is provided AS IS for your information and personal use only. It may not be sold, licensed, or shared on other websites without obtaining consent from the author.
E N D
Presentation Transcript
SEMINAR ON ACCOUNTING STANDARD SEMINAR ON ACCOUNTING STANDARD Challenges in Auditing Accounting Estimates Sunit Kumar Basu 14 June, 2023
What is an Accounting Estimate Approximation of amount of a business transaction Used where there is no precise means of measurement Usually anticipates probable future events yet to occur Makes Financial Statements complete in accrual accounting May be revised subsequently based on available information Changes in estimates impact current and future periods. No impact on prior periods Involves making assumptions and use of judgements 14 June, 2023 Sunit Kumar Basu
Challenges in making an Accounting Estimate Estimates ranges from simple to complex Lacks precision Often involves forecasting the future Actual outcomes are likely to be different Leads to estimation uncertainty 14 June, 2023 Sunit Kumar Basu
Challenges in making an Accounting Estimate Significant estimation uncertainty may lead to misstatements Lack of prescriptive guidelines Includes fair valuation Measurement impacted by Financial Reporting Framework Fair Valuation of Government Resources 14 June, 2023 Sunit Kumar Basu
Accounting for Construction Contracts Estimation of Revenue Estimation of cost to complete and recognition of margin Estimation of percentage of completion Claim estimation Estimation of expected losses on onerous contracts Estimation differences adjusted in cost and revenue 14 June, 2023 Sunit Kumar Basu
Other major areas of Accounting Estimations Impairment of Assets (Including DTA and going concern where applicable) Biological Assets Defined Benefit Plans Fair Valuation of assets in Business Combinations Fair Valuation of Financial Instruments 14 June, 2023 Sunit Kumar Basu
Challenges in Auditing an Accounting Estimate May involve management bias Availability and quality of underlying data Management not sharing all the information Often involves determining the fair value Risk of material misstatements Risk of Fraud 14 June, 2023 Sunit Kumar Basu
Indicators of Possible Management Bias Management Bias may not themselves constitute misstatements May be intentional or unintentional Susceptibility increases with subjectivity 14 June, 2023 Sunit Kumar Basu
Complex Accounting Estimates Outcome of litigations Prediction of future Fair valuation of derivative financial instruments Specialised entity developed models Absence of published price quotations Considering qualitative factors such as control Acquisition or swap transactions 14 June, 2023 Sunit Kumar Basu
Need for Reestimates New transactions/ Events Change in terms of transactions Change in Accounting Policy Regulatory Changes 14 June, 2023 Sunit Kumar Basu
Reasonability of Assumptions Significant Assumptions Relevance and Completeness Internal Consistency Whether Assumptions under management control maintenance Nature and extent of documentation supporting Assumption Fair Value Income vs. Market Approach Sunit Kumar Basu 14 June, 2023
What Auditor needs to do Evaluate Risk Assessment Procedure and related activities Management assessment of estimation uncertainty Whether high estimation uncertainty leads to significant risks Relevant Controls Test operating effectiveness of controls Whether Management used an expert Change from prior period in making the estimate Management decision to recognise/ not recognise estimates 14 June, 2023 Sunit Kumar Basu
What Auditor needs to do Compliance with applicable financial reporting framework Appropriateness of valuation method market vs. income approach Assumptions used are reasonable Test underlying data for accuracy, completeness and relevance Use of alternate assumption and sensitivity analysis Need to review prior period accounting estimates Need to use an Auditor s Expert Point estimate vs. range of estimates to address uncertainty Additional procedure like physical inspection 14 June, 2023 Sunit Kumar Basu
What Auditor needs to do Assess risk of material misstatement Materiality of accounting estimate needs to be qualitatively assessed Evaluate adequacy of disclosure Assess Going Concern where needed Obtain Representation May require KAM or EOM in audit report Sunit Kumar Basu 14 June, 2023
KAM - Zomato Ltd March 22 (Deloitte) Fair valuation of investment in other entities (Refer note 38 (b) of the Consolidated financial statement) The Group has made investments in Blink Commerce Private Limited (formerly known as Grofers India Private Limited) and its fellow subsidiary Hands on Trades Private Limited where the aggregate carrying value of these investments as on March 31, 2022 is INR 7,410 million. These investments are measured at Fair Value through Other Comprehensive Income ( FVTOCI ) as at the year-end. We considered the assumptions relating to future revenue growth and the valuation assumptions, specifically the assumptions relating to weighted average cost of capital and terminal growth rate, used in the fair valuation of these investments as a key audit matter due to the significance of the investment amount and the significant estimates and judgement involved in estimation of fair value Sunit Kumar Basu
Audit Procedures Performed(Deloitte) Principal audit procedures performed: Evaluated the design, implementation and tested operating effectiveness of relevant internal controls relating to determination of the fair value of investment in the said entities. Evaluated the reasonableness of the business assumptions relating to future revenue growth; Evaluated the objectivity and independence of the specialist engaged by the Company and reviewed the valuation report issued by such specialist; We have used our valuation specialists to assess overall reasonableness of the assumptions used particularly those relating to the weighted average cost of capital and terminal growth rate. Performed sensitivity analysis on the key assumptions such as weighted average cost of capital and terminal growth rate; Assessed the adequacy of the disclosures made in the financial statements
HCC LTD KAM Mar22 Walker Chandiok & Co The Company s revenue primarily arises from construction contracts which, by its nature, is complex given the significant judgements involved in the assessment of current and future contractual performance obligations. The Company recognizes contract revenue and the resultant profit/ loss on the basis of stage of completion determined based on the proportion of contract costs incurred at balance sheet date, relative to the total estimated costs of the contract at completion. The recognition of contract revenue and the resultant profit/ loss therefore rely on estimates in relation to forecast revenue and forecast contract costs.
HCC LTD KAM Mar22 Walker Chandiok & Co These contract estimates are reviewed by the management on a periodic basis. In doing so, the management is required to exercise judgement in its assessment of the revenue on contracts which may also include variable considerations that are recognised when the recovery of such consideration is highly probable. The judgment is also required to be exercised to assess the completeness and accuracy of forecast costs to complete. Changes in these judgements, and the related estimates as contracts progress can result in material adjustments to revenue and margins. As a result of the above judgments, complexities involved and material impact on the related financial statement elements, this area has been considered a key audit matter in the audit of the standalone financial statements
Audit Procedures Performed HCC Ltd Our audit procedures to address this key audit matter included, but were not limited to the following: Evaluated the appropriateness of the Company s accounting policy for revenue recognition in accordance with Ind AS 115 Revenue from contracts with customers; Obtained an understanding of the Company s processes and evaluated the design and tested the operating effectiveness of key internal financial controls with respect to estimation of forecasted contract revenue and contracts costs
Audit Procedures Performed HCC Ltd For a sample of contracts, performed the following procedures: - inspected the underlying documents such as customer contract/ agreement and variation orders, if any, for the significant contract terms and conditions; - evaluated the identification of performance obligations of the contract; - obtained an understanding of and evaluated the reasonableness of the assumptions applied in determining the forecasted revenue and cost to complete; - tested the existence and valuation of variable consideration with respect to the contractual terms and conditions and inspected the correspondence with customers; and - reviewed the legal and contracting experts note and/ or legal opinion from independent legal counsel obtained by the management with respect to certain contentious matters
Audit Procedures Performed HCC Ltd For cost incurred to date, tested samples to appropriate supporting documents and performing cut-off procedures; Tested the forecasted cost by obtaining executed purchase orders/ agreements/ relevant documents and evaluated the reasonableness of management judgements/ estimates; and Evaluated the appropriateness and adequacy of the disclosures related to contract revenue and costs in the standalone financial statements in accordance with the applicable accounting standards
HCC Ltd March 2017 - EOM Emphasis of Matters 10. We draw attention to: Note 34 to the standalone financial statements regarding uncertainties relating to recoverability of unbilled work-in-progress (other current financial assets), non-current trade receivables and current trade receivables aggregating ` 911.80 crore, ` 123.39 crore and ` 90.30 crore, respectively, as at 31 March 2017, raised in the earlier years in respect of projects suspended or substantially closed and where the claims are currently under negotiations / discussions / arbitration. Pending the ultimate outcome of these matters, which is presently unascertainable, no adjustments have been made in the accompanying stand alone financial statements. Our opinion is not qualified in respect of this matter.
