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01 May 2020

Standards on AuditingSA 540 : Accounting Estimates

SA 570 : Going Concern

01 May 2020

CA Gautam ShahKhimji Kunverji & Co LLP

CA Gautam Shah 1

Structure of Presentation

▪ Setting the Context

▪ SA 540 – Accounting Estimates

▪ SA 570 – Going Concern

2CA Gautam Shah01 May 2020

01 May 2020 CA Gautam Shah 3

Setting the Context


Client

5

Independent

Financial Information

Entity

Expression of Opinion

Examination

Reasonable ASSURANCE

What is an Audit??

01 May 2020 CA Gautam Shah

6

Obtain reasonable assurance

Express an opinion on

Report on the financial statements and communicate

That financial statements are free from material misstatement (due to fraud or error)

Whether the financial statements are in accordance with the applicable Financial Reporting Framework

The auditor’s findings - as required by the Standards on Auditing

Overall Objectives of the Auditor

01 May 2020 CA Gautam Shah

it is subjective…….

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Nature of

AssignmentAudit Review Compilation

Agreed upon

Procedures

Comparative

level of

Assurance

provided by the

auditor

Report Provided

Positive

Assurance on

assertion(s)

Negative

Assurance on

assertion(s)

Factual findings

of procedures

Identification of

information

compiled

No AssuranceNo Assurance

Moderate

Assurance

(Limited)

High, but not

absolute

assurance

(Reasonable)

Auditing Related Services

Assurance Level

CA Gautam Shah01 May 2020

Standards

General Principles and Responsibilities

Risk Assessment and Response to Assessed Risks

Audit Evidence

Using work of Others

Audit Conclusion and reporting

Specialised Areas

9 Standards: SA 200, SA 210, SA 220, SA 230, SA 240, SA 250, SA 260, SA 265, SA 299

6 Standards: SA 300, SA 315, SA 320, SA 330, SA 402, SA 450

11 Standards: SA 500, SA 501, SA 505, SA 510, SA 520, SA 530, SA 540, SA 550, SA 560, SA 570, SA 580

3 Standards: SA 600, SA 610, SA 620

6 Standards: SA 700, SA 701, SA 705, SA 706, SA 710, SA 720

3 Standards: SA 800, SA 805, SA 810

8

Standards on Auditing

CA Gautam Shah01 May 2020

Total 38 SAs

Compliance with SAs

◼ Mandatory – S/143 of the Companies Act, 2013

◼ Departure only if alternate audit procedures achieve objectiveof SAs

▪ Document reasons for departure

▪ Document alternative procedures

◼ Report to draw attention

◼ SA not applicable if situation outlined in SA is absent –Document alternative procedures performed


When we do audit – we focus more on AS/ IndAS and we miss out many

aspects of compliances of SAs primarily documentation….

When Auditor’s review/ audit is done (QRB/ NFRA), most focus is on

compliance with SAs by auditors while performing audit.


SA 540 : Accounting Estimates


Accounting Estimate

Accounting estimate :

Approximation of a monetary amount in the absence of a precise means of

measurement

Financial Statements

• Transactions recorded based on evidence or contracts – sale of goods to A

• Transactions recorded based on estimation – provision of doubtful debts

from A

Which transaction will have more challenges for Auditors???

Evolution of Estimates


• Traditional basis of accounting

• Less estimates on accounting

Cash basis

• a more accurate measurement of a business's periodic net income

• Rule-based

Accrual basis• Fair value accounting

& measurement

• Higher level of estimates

• Principles-based

IndAS/ IFRS

Accounting

• Local Trading

• Small, less complex business and transactions

Local

• Multinational

• Global presence

• Complex

Global• Uberisation of

business

• Ola, Airbnb, Amazon

Digital

Business

◼ Auditor’s responsibility for AE, fair value AE, and related disclosures

◼ Application of SA 315 and SA 330 in relation to AE – Risk Assessment

◼ Requirement and guidance on misstatements of individual AE, and indicators of possible management bias


Scope

Nature of Accounting Estimates

◼ FS items that cannot be measured precisely but can only beestimated : Provisions, NRV

◼ Measurement objective for some AE – to forecast the outcomeof one or more transactions, events or conditions : Gratuity

◼ Measurement objective for fair value AE – expressed in termsof the value of a current transaction or FS item : ESOP

Difference between outcome of an AE and amount originallydisclosed in FS does not necessarily represent a misstatement ofFS, particularly for fair value AE.


Examples of Accounting Estimates



Accounting Estimates & Financials

Balance Sheet

Equity – ESOP, Convertible Instruments

Financial Instruments

Trade Receivables

Inventories

Advances/ NPA – Banks

Actuarial Liability – Insurance/ Employee Benefits

PL

Revenue Estimation

Provision for Expenses

Fair Value Gain/ Loss


Objective

Obtain SAAE in context of applicable FRF:

⚫ AE including fair value AE in the FS are reasonable

⚫ Related disclosures in the FS are adequate

Requirements of SA 540

◼ Evaluating the Reasonableness of the Accounting Estimates(AE), and Determining Misstatements

◼ Disclosures Related to Accounting Estimates

◼ Indicators of Possible Management Bias

◼ Written Representations

◼ Documentation


Risk Assessment Substantive Procedures


Risk Assessment

To obtain understanding

◼ Financial Reporting Framework – IndAS requiring FV

◼ Management Process

▪ Identification of Transaction, Event or Condition

▪ To make AE – Method, Assumptions and Data

◼ Auditor to review outcome of AE included in prior period FS,or, where applicable, their subsequent re-estimation forpurpose of current period

◼ Methods for making AE are appropriate and have been appliedconsistently

Three basic approaches for Auditing AE◼ Testing management’s process: Auditors evaluate the

reasonableness and consistency of management’sassumptions, as well as test whether the underlying data iscomplete, accurate, and relevant.

◼ Developing an independent estimate: Using management’sassumptions (or alternative assumptions), auditors come upwith an estimate to compare to what is reported on theinternally prepared financial statements.

◼ Reviewing subsequent events or transactions: Thereasonableness of estimates can be gauged by looking atevents or transactions that happen after the balance sheetdate but before the date of the auditor’s report.


Confirmation is not a basic approach for auditing most accounting estimates


Substantive Audit

Evaluation of Estimation Uncertainty◼ Alternative assumption/ outcomes and why it has rejected

◼ whether significant assumptions used are reasonable

◼ Development of a range with which to evaluate thereasonableness of the AE

Recognition and Measurement Criteria◼ Decision to recognise, or to not recognise, the AE in the FS; and

◼ The selected measurement basis for AE

Next Steps

◼ Evaluating the Reasonableness of the Accounting Estimates(AE), and Determining Misstatements

◼ Disclosures Related to Accounting Estimates

◼ Indicators of Possible Management Bias

◼ Written Representations

◼ Documentation



Highest Inspection Areas – PIE audits

IFIAR - 2019

Supplemental Details on Nature of Findings


Inspection Theme Theme sub-category

Accounting Estimates, including Fair Value Measurement

▪ When testing an accounting estimate, failure to assess thereasonableness of assumptions including consideration ofcontrary or inconsistent evidence where applicable;

▪ Failure to sufficiently test the accuracy of the data;▪ Failure to perform sufficient risk assessment procedures;▪ Failure to adequately consider indicators of bias;▪ Failure to evaluate how management considered alternative

assumptions;▪ Failure to take relevant variables into account.

Source : IFIAR - 2019

COVID + Accounting Estimates


Area Impact on Accounting Estimates

Impairment of non-current assets andgoodwill

• Problems of low demand for the products/services, restrictionsimposed by the Government, dependence on supply chains orproduction facilities etc;

• Impairment trigger situations and would require impairmenttesting;

• Challenge in estimation of future cash flows;• Updation of discount rates used in valuations to reflect the risk;• Robust disclosures required.

Onerous contractprovisions

• Suppliers unable to fulfil their obligations as a result of closure orreduced production - would necessitate recognition of provision;

• Delay in fulfillment of contractual obligations would result inpenalties to be provided for;

• Meaningful disclosures about judgements and estimatesrequired

Valuation of inventory Significant impact on account of forced plant shutdowns, decline inNRV due to reduction in demand and non-fulfillment of sales andpurchase contract.

COVID + Accounting Estimates


Area Impact on Accounting Estimates

Expected Credit losses(ECLs)

• Consider impact of COVID-19 appropriately while recognisingECLs;

• Challenge for Companies to incorporate into their measurementof ECLs the forward-looking information relating to impact ofCOVID-19 that is available without undue cost or effort at thereporting date;

• Relevant disclosures - credit risk, timing and uncertainty offuture cash flows.

Deferred Tax assets The recoverability of deferred tax assets may be impacted bychanges to future forecasts.

Insurance claims Evaluation of terms of the insurance policies and estimation ofpossible compensation surrounding loss of profits and businessdisruption, etc. including timing of recognition of such claims.


SA 570


Going Concern

Going Concern:

Fundamental accounting principle in preparing financial statements

Indicators : Operations, Financials, Regulatory and Others

Why Important :

Based on the assessment of going concern, recognition and measurement

principles of assets and liability gets defined

The financial statements of same entity on going concern or non-going concern

will differ a lot

Hence as an auditors, it is extremely important for auditors to assess “Going

Concern” Principle used by the Company


• Traditional basis of accounting

• Less estimates on accounting

Cash basis

• a more accurate measurement of a business's periodic net income

• Rule-based

Accrual basis• Fair value accounting

& measurement

• Higher level of estimates

• Principles-based

IndAS/ IFRS

Accounting

• Local Trading

• Small, less complex business and transactions

Local

• Multinational

• Global presence

• Complex

Global• Uberisation of

business

• Ola, Airbnb, Amazon

Digital

Business

Going Concern

Scope

◼ Deals with Auditor’s Responsibilities in audit of financialstatements (FS) relating to Going Concern (GC)

and

◼ Implications for the Auditor’s Report


Responsibilities of the Auditor◼ Obtain Sufficient Appropriate Audit Evidence (SAAE)

regarding and conclude on the appropriateness ofmanagement’s use of going concern Basis of Accounting inpreparation of FS, and

◼ Based on audit evidence obtained, conclude whether a“Material Uncertainty” exists about the entity’s ability tocontinue as going concern

◼ Absence of any reference to a material uncertainty aboutthe entity’s ability to continue as going concern in auditor’sreport cannot be viewed as guarantee to entity’s ability tocontinue as going concern


Requirements of SA 570

◼ Risk Assessment Procedures and Related Activities

◼ Evaluating Management’s Assessment

◼ Period Beyond Management’s Assessment

◼ Additional Audit Procedures when Events or Conditions areIdentified

◼ Auditor Conclusions

◼ Implications for the Auditor’s Report

◼ Communication with Those Charged with Governance


Risk Assessment Procedures

▪ To assess GC, while performing Risk Assessment procedures

▪ Determine if Management has performed preliminary assessment of

GC –

▪ Assessment period (12 months) + Inquiry for beyond the

assessment period

▪ Inclusion of all facts known by the Auditors

▪ Remain alert throughout audit for audit evidence of events

/conditions that may cast significant doubt on the entity’s ability to

continue as GC.


▪ Request to make GC assessment if not yet performed

▪ Evaluate plans for future actions (e.g., restructure debt, delayexpenditures etc.):

▪ Whether outcome of plans likely to improve situation

▪ Whether plans are feasible in the circumstances

▪ Consider whether any additional facts/information have become

available since date of management’s assessment.

Additional Procedures – Events identified


◼ Analysis of cash flow forecast prepared by the entity.

◼ Request written representations from mgt. and those chargedwith governance (TCWG) regarding their plans for futureactions and their feasibility

Additional Procedures – Events identified


◼ Evaluate whether SAAE obtained regarding and conclude onappropriateness of Mgt. use of GC basis of accounting inpreparation of FS

◼ Conclude whether in auditor’s judgment a material uncertaintyexists related to events/conditions which individually/collectivelymay cast significant doubt on entity’s ability to continue as GC.

Auditor’s Conclusion


Material uncertainty exists


Case 1 - But the use of going concern assumption is

appropriate

Auditors’ duty to determine whether the financial statements :-

• Adequately describe the principal events or conditions that may

cast significant doubt on the entity’s ability to continue as a

going concern;

• Disclose clearly that there is a material uncertainty related to

events or conditions that may cast significant doubt on the

entity’s ability to continue as a going concern;

• Therefore, that it may be unable to realise its assets and

discharge its liabilities in the normal course of business

Material uncertainty exists


Auditor’s Report:

o In case where adequate disclosure is made in the FS -

Unmodified/ Clear Opinion & a paragraph in the Auditor’s Report

with the heading ‘Material Uncertainty relating to Going

concern’.

o In case where adequate disclosure is not made in the FS –

Qualified / Adverse Opinion.

Case 2 - But the use of going concern assumption is not

appropriate

Adverse Opinion

Communication with TCWG


In both the cases, the auditor shall communicate with the

TCWG that:-

• Whether the events or conditions constitute a material

uncertainty;

• Whether the use of the going concern assumption is

appropriate in the preparation and presentation of the

financial statements;

• The adequacy of related disclosures in the financial

statements.

General guidelines on Going concern paragraph◼ Be as specific as possible about how the entity is affected. Disclose the

consequences of the current situation with regard to - for example:

▪ turnover (declining markets, significant drop in demand in majormarkets);

▪ customers (impact of effects of COVID-19 on customers);

▪ suppliers (a production process that largely depends on the supply ofgoods from an infected area);

▪ employees (consequences of possible lockdowns on productivity);

▪ liquidity, including availability of funding and credit facilities (possiblereluctance to refinance in the medium term) and thereby the short-and/or longer-term uncertainty arising from these aspects on theentity’s ability to continue as a going concern in the foreseeablefuture.

◼ Be complete. If not only COVID-19, but also other factors may castsignificant doubt upon the entity’s ability to continue as a going concern


General guidelines on Going concern paragraph

◼ Expect the unexpected.

In addition to specific disclosures about how the entity’s ability tocontinue as a going concern is affected by the implications ofCOVID-19 and government measures that are currently known, ageneral statement that it is uncertain how things may change andhow that would affect the entity.

◼ Describe mitigating actions.

In addition to a description of the uncertainties, it is expected that theentity also discloses the measures it is taking to mitigate the possiblenegative impacts of the COVID-19 outbreak.


Examples : Going concern

◼ An oil and gas firm is stopped by a court from carrying outoperations. The firm is not a going concern, because it has toshut down operations because of the said directions from thecourt.

◼ A bank is in serious financial troubles and the government isnot willing to bail it out. The Board of Directors has passed aresolution to liquidate the business. The bank is not a goingconcern.


Examples : Going concern

◼ Nationalized refinery is in cash flows problems but thegovernment of the country provided a guarantee to the refineryto help it out with all payments, the refinery is a going concerndespite poor financial position, since it has a support of thecountry’s government.

◼ A company is having significant cash and bank balances but doesnot carry any business activities. The net worth is positive andthere are no borrowings. The company is going concern as thereare no negative indicators.


Impact on Reporting


COVID + Going ConcernGoing Concern:

◼ Assess the business’ ability to continue as a going concern taking into accountall available information about the future.

◼ Consider the current impacts to business, as well as the anticipated futureeffects that the COVID-19 outbreak could have on their business.

◼ Examples of considerations include the impact of:

▪ Staff shortages,

▪ Supply chain breakdown,

▪ Reduced stock levels,

▪ Unavailability of debt finance

▪ Impact of transport/travel suspension,

▪ Fluctuating interest rates and foreign exchange rates,

▪ WIP contract clauses, and recoverability of accounts receivables.


COVID + Going ConcernGoing Concern:

◼ The entity still has sufficient liquidity to continue to meet itsobligations as they fall due;

◼ Consider plans to manage costs, strategy to manage fundingrequirement, different scenarios and its impact on cashflows whilemaking aforesaid assessment;

◼ Consider all relevant information available up to the date thefinancial statements are approved for issue.

◼ Appropriateness of disclosures should be evaluated to ensure thatfinancial statements describe the significant judgements andestimates made regarding going concern.

◼ An auditor would need to determine the implications of thedisclosure in relation to going concern while issuing his/her auditor’sreport.


Questions???

49CA Gautam Shah01 May 2020

Gautam ShahKhimji Kunverji & Co [email protected]

50

powerpoint presentation - icai...title powerpoint presentation author shabbir created date 4/30/2020...

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