Statement on Auditing Standards No. 143, Auditing Accounting Estimates and Related Disclosures, was issued by the Auditing Standards Board of the AICPA in July 2020, but it only recently took effect for audits of financial statements for periods ending on or after December 15, 2023. To help you better understand this Standard, often called SAS 143, we're providing a closer look at what you need to know.
What is SAS 143?
The Statement on Auditing Standards No. 143, Auditing Accounting Estimates and Related Disclosures, was put into place as guidance for auditors on how to understand and evaluate financial statement uncertainties that exist, specifically a reporting entity’s use of accounting estimates.
Accounting estimates vary widely in nature and are required when the monetary amounts cannot be directly observed. The process of estimation involves selecting and applying a method using assumptions and data, which requires management judgment. There is generally inherent subjectivity and variation in the measurement of outcomes.
The standard provides detailed guidance for properly designing and evaluating the results of audit procedures responsive to assessed risk of material misstatement due to either fraud or error specific to accounting estimates. This would include evaluating the suitability of valuation methods used, the integrity of the underlying data used in forming accounting estimates, the reasonableness of the basis for assumptions, and the potential impact of management’s bias (whether intentional or simply a mistake).
What does SAS 143 replace?
SAS 143 was codified in AU-C 540 of the same title but replaces the existing guidance on auditing accounting estimates. Instead of creating new requirements for how to audit estimates, it improves, strengthens, modernizes, and builds upon the requirements and application material.
When is the SAS 143 effective date?
SAS 143 went into effect for audits of financial statements for periods ending on or after December 15, 2023. Early adoption was permitted.
Understanding SAS 143 and its aspects
Appropriately documenting the basis for significant judgments made and conclusions reached by the auditor is critical to successful implementation of this new standard. Auditors must focus on factors that contribute to estimation uncertainty and maintain an open, questioning mind when evaluating recognition, measurement, presentation, and disclosure. Hence, an emphasis within the standard for maintaining professional skepticism and applying sound professional judgment in the audit process was needed to improve audit quality.
Accounting estimates are defined by the standard as monetary amounts for which the measurement, in accordance with the requirements of the applicable financial reporting framework, is subject to estimation uncertainty (e.g., depreciation, obsolescence, impairment, collectability, fair valuation, and more). Accounting estimates also include monetary amounts included in disclosures.
Audit procedures related to SAS 143
A common accounting estimate and related disclosure includes fair value measurement. This is particularly true for private equity and venture capital firms, where fair value estimates are generally material to the financial statements as a whole.
Improving the quality of evaluating the propriety of these estimates and related disclosures is intended to enhance transparency and accountability for a reporting entity’s estimation process. This includes evaluating whether methods, assumptions, and data used in the estimation process are permitted under the applicable financial reporting framework. The intent is to enhance the trust that investors, potential investors, and other financial statement users have in the preparation and fair presentation of financial statements and related disclosures.
While AU-C Section 315 requires the auditor to assess risk of material misstatement at the relevant assertion level, SAS 143 specifically requires inherent risk and control risk to be separately assessed for accounting estimates. The assessment of inherent risk depends on the degree to which the risk factors affect the likelihood or magnitude of potential misstatement due to fraud or error. The degree of estimation uncertainty will vary substantially.
Accounting estimates may contain more or less inherent risk relative to other accounts, classes of transactions, or disclosures. By their nature, some accounting estimates have low estimation uncertainty. Therefore, extensive risk assessment and further audit procedures would not be necessary. When estimation uncertainty, complexity, or subjectivity are higher, the extensive of procedures would increase.
Best practices when evaluating accounting estimates under SAS 143
In summary, with SAS 143, the following are important considerations when evaluating accounting estimates in an audit:
- Is the method used by management consistent with requirements of an applicable financial reporting framework, appropriate under the specific circumstances, and consistently applied across reporting periods? A change in method should be evaluated for management bias.
- Are assumptions and judgments used by management suitable with the context of the applicable financial reporting framework, consistent with prior periods and other judgements applied in financial reporting, reflective of the potential for both positive and negative outcomes, and free of management bias that may be intentional or not?
- Is underlying data used in the estimation process both relevant and reliable? Consider the source of data (e.g., management, external information sources, specialists) and whether the source is consistent with prior periods and other judgement applied in financial reporting.
- Were alternative outcomes and assumptions properly scrutinized when management chooses a precise point estimate instead of a range?
- Are disclosures adequate to provide adequate context to the estimation process and the inherent uncertainties embedded within it?
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