Skip Ribbon Commands
Skip to main content
Stay Connected: Twitter Facebook Flickr RSS E-Mail

Click Plus Sign Icon to expand menu items
Click Minus Sign Icon to collapse menu items

Skip Navigation Links.
ExpandAS No. 1: References in Auditors’ Reports to the Standards of the Public Company Accounting Oversight Board
ExpandAS No. 3: Audit Documentation
ExpandAS No. 4: Reporting on Whether a Previously Reported Material Weakness Continues to Exist
ExpandAS No. 5: An Audit of Internal Control Over Financial Reporting That Is Integrated with An Audit of Financial Statements
ExpandAS No. 6: Evaluating Consistency of Financial Statements
ExpandAS No. 7: Engagement Quality Review
ExpandAS No. 8: Audit Risk
ExpandAS No. 9: Audit Planning
ExpandAS No. 10: Supervision of the Audit Engagement
ExpandAS No. 11: Consideration of Materiality in Planning and Performing an Audit
ExpandAS No. 12: Identifying and Assessing Risks of Material Misstatement
ExpandAS No. 13: The Auditor's Responses to the Risks of Material Misstatement
ExpandAS No. 14: Evaluating Audit Results
ExpandAS No. 15: Audit Evidence
ExpandAS No. 16: Communications with Audit Committees
ExpandAS No. 17: Auditing Supplemental Information Accompanying Audited Financial Statements
ExpandAU Section 100 - Statements on Auditing Standards -- Introduction
ExpandAU Section 200 - The General Standards
CollapseAU Section 300 - The Standards of Field Work
AU Section 315 - Communications Between Predecessor and Successor Auditors
AU Section 316 - Consideration of Fraud in a Financial Statement Audit
AU Section 317 - Illegal Acts by Clients
AU Section 9317 - Illegal Acts by Clients: Auditing Interpretations of Section 317
AU Section 322 - The Auditor's Consideration of the Internal Audit Function in an Audit of Financial Statements
AU Section 324 - Service Organizations
AU Section 9324 - Service Organizations: Auditing Interpretations of Section 324
AU Section 325 - Communications About Control Deficiencies in an Audit of Financial Statements
AU Section 9325 - Communication of Internal Control Related Matters Noted in an Audit: Auditing Interpretations of Section 325
AU Section 9326 - Evidential Matter: Auditing Interpretations of Section 326
AU Section 328 - Auditing Fair Value Measurements and Disclosures
AU Section 329 - Substantive Analytical Procedures
AU Section 330 - The Confirmation Process
AU Section 331 - Inventories
AU Section 332 - Auditing Derivative Instruments, Hedging Activities, and Investments in Securities
AU Section 333 - Management Representations
AU Section 9333 - Management Representations: Auditing Interpretations of Section 333
AU Section 334 - Related Parties
AU Section 9334 - Related Parties: Auditing Interpretations of Section 334
AU Section 336 - Using the Work of a Specialist
AU Section 9336 - Using the Work of a Specialist: Auditing Interpretations of Section 336
AU Section 337 - Inquiry of a Client's Lawyer Concerning Litigation, Claims, and Assessments
AU Section 9337 - Inquiry of a Client's Lawyer Concerning Litigation, Claims, and Assessments: Auditing Interpretations of Section 337
AU Section 341 - The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern
AU Section 9341 - The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern: Auditing Interpretations of Section 341
AU Section 342 - Auditing Accounting Estimates
AU Section 9342 - Auditing Accounting Estimates: Auditing Interpretations of Section 342
AU Section 350 - Audit Sampling
AU Section 390 - Consideration of Omitted Procedures After the Report Date
ExpandAU Section 400 - The First, Second, and Third Standards of Reporting
ExpandAU Section 500 - The Fourth Standard of Reporting
ExpandAU Section 600 - Other Types of Reports
ExpandAU Section 700 - Special Topics
ExpandAU Section 800 - Compliance Auditing
ExpandAU Section 900 - Special Reports of the Committee on Auditing Procedures

AU Section 342

Auditing Accounting Estimates

Source: SAS No. 57.
See section 9342 for interpretations of this section.
Effective for audits of financial statements for periods beginning on or after January 1, 1989, unless otherwise indicated.

.01

[The following paragraph is effective for audits of fiscal years beginning on or after December 15, 2010. See PCAOB Release No. 2010-004. For audits of fiscal years beginning before December 15, 2010, click here.]

This section provides guidance to auditors on obtaining and evaluating sufficient appropriate evidential matter to support significant accounting estimates in an audit of financial statements in accordance with generally accepted auditing standards. For purposes of this section, an accounting estimate is an approximation of a financial statement element, item, or account. Accounting estimates are often included in historical financial statements because—

  1. The measurement of some amounts or the valuation of some accounts is uncertain, pending the outcome of future events.
  2. Relevant data concerning events that have already occurred cannot be accumulated on a timely, cost-effective basis.

.02

Accounting estimates in historical financial statements measure the effects of past business transactions or events, or the present status of an asset or liability. Examples of accounting estimates include net realizable values of inventory and accounts receivable, property and casualty insurance loss reserves, revenues from contracts accounted for by the percentage-of-completion method, and pension and warranty expenses. fn 1

.03

Management is responsible for making the accounting estimates included in the financial statements. Estimates are based on subjective as well as objective factors and, as a result, judgment is required to estimate an amount at the date of the financial statements. Management's judgment is normally based on its knowledge and experience about past and current events and its assumptions about conditions it expects to exist and courses of action it expects to take.

.04

The auditor is responsible for evaluating the reasonableness of accounting estimates made by management in the context of the financial statements taken as a whole. As estimates are based on subjective as well as objective factors, it may be difficult for management to establish controls over them. Even when management's estimation process involves competent personnel using relevant and reliable data, there is potential for bias in the subjective factors. Accordingly, when planning and performing procedures to evaluate accounting estimates, the auditor should consider, with an attitude of professional skepticism, both the subjective and objective factors.

Developing Accounting Estimates

.05

Management is responsible for establishing a process for preparing accounting estimates. Although the process may not be documented or formally applied, it normally consists of—

  1. Identifying situations for which accounting estimates are required.
  2. Identifying the relevant factors that may affect the accounting estimate.
  3. Accumulating relevant, sufficient, and reliable data on which to base the estimate.
  4. Developing assumptions that represent management's judgment of the most likely circumstances and events with respect to the relevant factors.
  5. Determining the estimated amount based on the assumptions and other relevant factors.
  6. Determining that the accounting estimate is presented in conformity with applicable accounting principles and that disclosure is adequate.

The risk of material misstatement of accounting estimates normally varies with the complexity and subjectivity associated with the process, the availability and reliability of relevant data, the number and significance of assumptions that are made, and the degree of uncertainty associated with the assumptions.

Internal Control Related to Accounting Estimates

.06

An entity's internal control may reduce the likelihood of material misstatements of accounting estimates. Specific relevant aspects of internal control include the following:

  1. Management communication of the need for proper accounting estimates
  2. Accumulation of relevant, sufficient, and reliable data on which to base an accounting estimate
  3. Preparation of the accounting estimate by qualified personnel
  4. Adequate review and approval of the accounting estimates by appropriate levels of authority, including—
    1. Review of sources of relevant factors
    2. Review of development of assumptions
    3. Review of reasonableness of assumptions and resulting estimates
    4. Consideration of the need to use the work of specialists
    5. Consideration of changes in previously established methods to arrive at accounting estimates
  5. Comparison of prior accounting estimates with subsequent results to assess the reliability of the process used to develop estimates
  6. Consideration by management of whether the resulting accounting estimate is consistent with the operational plans of the entity.

Evaluating Accounting Estimates

.07

[The following paragraph is effective for audits of fiscal years beginning on or after December 15, 2010. See PCAOB Release No. 2010-004. For audits of fiscal years beginning before December 15, 2010, click here.]

The auditor's objective when evaluating accounting estimates is to obtain sufficient appropriate evidential matter to provide reasonable assurance that—

  1. All accounting estimates that could be material to the financial statements have been developed.
  2. Those accounting estimates are reasonable in the circumstances.
  3. The accounting estimates are presented in conformity with applicable accounting principles fn 2 and are properly disclosed. fn 3

Identifying Circumstances That Require Accounting Estimates

.08

In evaluating whether management has identified all accounting estimates that could be material to the financial statements, the auditor considers the circumstances of the industry or industries in which the entity operates, its methods of conducting business, new accounting pronouncements, and other external factors. The auditor should consider performing the following procedures:

  1. Consider assertions embodied in the financial statements to determine the need for estimates. (See paragraph .16 for examples of accounting estimates included in financial statements.)
  2. Evaluate information obtained in performing other procedures, such as—
[The following subparagraph is effective for audits of fiscal years beginning on or after December 15, 2010. See PCAOB Release No. 2010-004. For audits of fiscal years beginning before December 15, 2010, click here.]
    1. Information about changes made or planned in the entity's business, including changes in operating strategy, and the industry in which the entity operates that may indicate the need to make an accounting estimate (Auditing Standard No. 12, Identifying and Assessing Risks of Material Misstatement).
    2. Changes in the methods of accumulating information.
    3. Information concerning identified litigation, claims, and assessments (section 337, Inquiry of a Client's Lawyer Concerning Litigation, Claims, and Assessments), and other contingencies.
    4. Information from reading available minutes of meetings of stockholders, directors, and appropriate committees.
    5. Information contained in regulatory or examination reports, supervisory correspondence, and similar materials from applicable regulatory agencies.
  1. Inquire of management about the existence of circumstances that may indicate the need to make an accounting estimate.

Evaluating Reasonableness

.09

In evaluating the reasonableness of an estimate, the auditor normally concentrates on key factors and assumptions that are—

  1. Significant to the accounting estimate.
  2. Sensitive to variations.
  3. Deviations from historical patterns.
  4. Subjective and susceptible to misstatement and bias.

The auditor normally should consider the historical experience of the entity in making past estimates as well as the auditor's experience in the industry. However, changes in facts, circumstances, or entity's procedures may cause factors different from those considered in the past to become significant to the accounting estimate. fn 4

.10

In evaluating reasonableness, the auditor should obtain an understanding of how management developed the estimate. Based on that understanding, the auditor should use one or a combination of the following approaches:

  1. Review and test the process used by management to develop the estimate.
  2. Develop an independent expectation of the estimate to corroborate the reasonableness of management's estimate.
[The following subparagraph is effective for audits of fiscal years ending on or after November 15, 2007. See PCAOB Release No. 2007-005A. For audits of fiscal years ending before November 15, 2007, click here.]
  1. Review subsequent events or transactions occurring prior to the date of the auditor's report.

Note: When performing an integrated audit of financial statements and internal control over financial reporting, the auditor may use any of the three approaches. However, the work that the auditor performs as part of the audit of internal control over financial reporting should necessarily inform the auditor's decisions about the approach he or she takes to auditing an estimate because, as part of the audit of internal control over financial reporting, the auditor would be required to obtain an understanding of the process management used to develop the estimate and to test controls over all relevant assertions related to the estimate.

.11

Review and test management's process. In many situations, the auditor assesses the reasonableness of an accounting estimate by performing procedures to test the process used by management to make the estimate. The following are procedures the auditor may consider performing when using this approach:

  1. Identify whether there are controls over the preparation of accounting estimates and supporting data that may be useful in the evaluation.
  2. Identify the sources of data and factors that management used in forming the assumptions, and consider whether such data and factors are relevant, reliable, and sufficient for the purpose based on information gathered in other audit tests.
  3. Consider whether there are additional key factors or alternative assumptions about the factors.
  4. Evaluate whether the assumptions are consistent with each other, the supporting data, relevant historical data, and industry data.
  5. Analyze historical data used in developing the assumptions to assess whether the data is comparable and consistent with data of the period under audit, and consider whether such data is sufficiently reliable for the purpose.
  6. Consider whether changes in the business or industry may cause other factors to become significant to the assumptions.
  7. Review available documentation of the assumptions used in developing the accounting estimates and inquire about any other plans, goals, and objectives of the entity, as well as consider their relationship to the assumptions.
  8. Consider using the work of a specialist regarding certain assumptions (section 336,Using the Work of a Specialist).
  9. Test the calculations used by management to translate the assumptions and key factors into the accounting estimate.

.12

Develop an expectation.    Based on the auditor's understanding of the facts and circumstances, he may independently develop an expectation as to the estimate by using other key factors or alternative assumptions about those factors.

.13

[The following paragraph is effective for audits of fiscal years ending on or after November 15, 2007. See PCAOB Release No. 2007-005A. For audits of fiscal years ending before November 15, 2007, click here.]

Review subsequent events or transactions.    Events or transactions sometimes occur subsequent to the date of the balance sheet, but prior to the date of the auditor's report, that are important in identifying and evaluating the reasonableness of accounting estimates or key factors or assumptions used in the preparation of the estimate. In such circumstances, an evaluation of the estimate or of a key factor or assumption may be minimized or unnecessary as the event or transaction can be used by the auditor in evaluating their reasonableness.

.14

[The following paragraph is effective for audits of fiscal years beginning on or after December 15, 2010. See PCAOB Release No. 2010-004. For audits of fiscal years beginning before December 15, 2010, click here.]

Paragraphs 24 through 27 of Auditing Standard No. 14, Evaluating Audit Results, discuss the auditor's responsibilities for assessing bias and evaluating accounting estimates in relationship to the financial statements taken as a whole.

Effective Date

.15

This section is effective for audits of financial statements for periods beginning on or after January 1, 1989. Early application of the provisions of this section is permissible.

Appendix

Examples of Accounting Estimates

.16

The following are examples of accounting estimates that are included in financial statements. The list is presented for information only. It should not be considered all-inclusive.

Receivables: Revenues:
Uncollectible receivables Airline passenger revenue
Allowance for loan losses Subscription income
Uncollectible pledges Freight and cargo revenue
  Dues income
Inventories: Losses on sales contracts
Obsolete inventory  
Net realizable value of inventories where future
selling prices and future costs are involved
Contracts:
Losses on purchase commitments Revenue to be earned
  Costs to be incurred
Financial instruments: Percent of completion
Valuation of securities  
Trading versus investment security classification Leases:
Probability of high correlation of a hedge Initial direct costs
Sales of securities with puts and calls Executory costs
  Residual values
Productive facilities, natural resources and intangibles:  
Useful lives and residual values Litigation:
Depreciation and amortization methods Probability of loss
Recoverability of costs Amount of loss
Recoverable reserves  
  Rates:
Accruals: Annual effective tax rate in interim reporting
Property and casualty insurance company loss
reserves
Imputed interest rates on receivables and payables
Compensation in stock option plans and deferred
plans
Gross profit rates under program method of
accounting
Warranty claims  
Taxes on real and personal property Other:
Renegotiation refunds Losses and net realizable value on disposal of
segment or restructuring of a business
Actuarial assumptions in pension costs Fair values in nonmonetary exchanges
  Interim period costs in interim reporting
  Current values in personal financial statements

Footnotes (AU Section 342 — Auditing Accounting Estimates):

fn 1 Additional examples of accounting estimates included in historical financial statements are presented in paragraph .16.

fn 2 Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles, discusses the auditor's responsibility for evaluating conformity with generally accepted accounting principles. [Title of section 411 amended, effective for reports issued or reissued on or after June 30, 2001, by Statement on Auditing Standards No. 93.]

[The following footnote is effective for audits of fiscal years beginning on or after December 15, 2010. See PCAOB Release No. 2010-004. For audits of fiscal years beginning before December 15, 2010, click here.]

fn 3 See paragraph 31 of Auditing Standard No. 14, Evaluating Audit Results.

fn 4 In addition to other evidential matter about the estimate, in certain instances, the auditor may wish to obtain written representation from management regarding the key factors and assumptions.

Copyright © 1997, 1998, 2001, American Institute of Certified Public Accountants, Inc.