Estimation uncertainty
Estimation uncertainty is the susceptibility of an accounting estimate and
related disclosures to an inherent lack of precision in its measurement. The
greater the estimation uncertainty, the more the client will need to explore the
effect of different models and assumptions to make an appropriate estimate. For
example, long-term receivables are subject to high estimation uncertainty. In
that case, the client will need to test how sensitive the estimates are to discount
or assumed default rate changes. If estimation uncertainty is lower, less work
will be required by the client in determining the estimate, and also less
corroborative evidence needs to be obtained by the auditor.
The auditor’s response is graded depending on whether a risk identified is
regular or significant. A significant risk is one that the auditor judges to have
high estimation uncertainty. The item's size in the draft financial statements may
give a misleading view of its potential significance. Suppose an item is
estimated to have a low value but is subject to high estimation uncertainty. In
that case, that figure may well be significantly understated when compared with
the eventual outcome of the estimate. Hence ISA 540 directs the auditor’s work
from a starting point of uncertainty rather than the materiality of the draft figure
in the financial statements. The greater the estimation uncertainty, rather than
the size of the draft figure, the greater the amount of evidence that the auditor
will need to obtain [ACCA Global].
For entities of all types and sizes, management has to make accounting
estimates, which have estimation uncertainty and may also be complex. Making
these estimates involves selecting and applying a method using assumptions and
data, which requires judgment. The nature, timing, and extent of the audit
procedures will vary regarding the estimation uncertainty and the assessment of
the related risks of material misstatement [IFAC].
Audit of estimates and fair values. ACCA Global. Retrieved from: https://www.accaglobal.com/hk/en/student/exam-support-resources/professional -exams-study-resources/p7/technical-articles/audit-of-estimates.html
Auditing Accounting Estimates. IFAC. Retrieved from:https://www.ifac.org/knowledge-gateway/supporting-international-standar ds/discussion/auditing-accounting-estimates