AS 2501, Auditing Accounting Estimates, Including Fair Value Measurements, is the PCAOB standard for estimates in audits of issuers and other entities under PCAOB rules. Its core instruction is short: test an estimate using one of three approaches or a combination of them. Firms that audit under both sets of standards need to know where the AICPA's AU-C 540 matches and where it differs. For the AICPA standard on its own, see auditing accounting estimates under AU-C 540.
What is the objective?
The auditor obtains sufficient appropriate evidence to determine whether accounting estimates in significant accounts and disclosures are properly accounted for and disclosed (AS 2501.03). An accounting estimate is a measurement or recognition (or a decision not to recognize) that generally involves subjective assumptions and measurement uncertainty, and a fair value measurement is a form of estimate (.02).
Risk assessment comes from AS 2110: identify estimates in significant accounts, understand how they are developed, and assess risks, including which estimates carry significant risks (.04). Responses come from AS 2301 (.05).
What are the three approaches?
Paragraph .07 says the auditor should test an estimate using one or a combination of these, and the note adds that the choice should be informed by the auditor's understanding of the company's process and the results of any controls testing:
| Approach | Paragraphs | What the auditor does |
|---|---|---|
| Test the company's process | .09 to .20 | Evaluate the methods, data and significant assumptions management used |
| Develop an independent expectation | .21 to .26 | Build the auditor's own estimate or range and compare it to the company's |
| Evaluate events after the measurement date | .27 to .29 | Use later events or transactions as evidence of the measurement date amount |
Testing the company's process
- Methods (.10 to .11). Are they in conformity with the framework and appropriate for the account? If the company changed methods, determine why and whether the change is appropriate.
- Data (.12 to .14). Company-produced data is tested for accuracy and completeness and sufficient precision, as AS 1105 requires; external data for relevance and reliability. Also ask whether the data is relevant to the measurement objective, consistent with its use elsewhere, and whether the source changed from last year.
- Significant assumptions (.15 to .18). The auditor identifies which assumptions are significant: those important to recognition or measurement. The listed examples are assumptions sensitive to small changes, susceptible to manipulation or bias, involving unobservable data or company adjustments of observable data, or depending on company intent and ability. The auditor then evaluates reasonableness individually and in combination, including whether the company has a reasonable basis and whether assumptions are consistent with industry and economic factors, objectives and strategies, market information, historical experience and assumptions in other estimates. For assumptions about intent and ability, consider the company's history of carrying out its intentions, written plans, stated reasons, and resources and ability to act (.17). For critical accounting estimates, understand how management analyzed sensitivity to other reasonably likely outcomes (.18).
Developing an independent expectation
The auditor uses some or all of the auditor's own methods, data and assumptions (.21). When the auditor uses company data, assumptions or methods, they must be tested under the same paragraphs as above (.24). If the expectation is a range, it must include only reasonable outcomes supported by sufficient appropriate evidence (.25). Differences between the expectation and the company's estimate are evaluated under AS 2810.13 (.26). For a recorded estimate outside a supported range, AS 2810.13 treats the difference between the recorded amount and the closest reasonable estimate as a misstatement. Example: the auditor's supported range for an accrual is $410,000 to $470,000 and the company recorded $395,000. The misstatement is $410,000 - $395,000 = $15,000, not the distance to the midpoint of $440,000.
Evaluating events after the measurement date
Later events and transactions are relevant to the extent they reflect conditions at the measurement date (.27). The auditor evaluates whether the evidence is sufficient, reliable and relevant and whether it supports or contradicts the estimate (.28), taking into account changes in circumstances between the event and the measurement date; the longer the gap, the more likely conditions changed (.29). A footnote says this is a substantive test that differs from the procedures under AS 2801 on subsequent events.
What about third-party pricing information?
When third-party pricing information is significant to the valuation of financial instruments, the auditor evaluates whether the company used it appropriately and whether it provides sufficient appropriate evidence (.20). Appendix A (.A2 to .A9) sets out the requirements for pricing services and for brokers and dealers; the application to Level 2 prices is covered in auditing Level 2 pricing sources.
How does AU-C 540 compare?
| Topic | PCAOB AS 2501 | AICPA AU-C 540 |
|---|---|---|
| Approaches | Three, used singly or in combination (.07) | Three listed in .17: events up to the report date, testing how management made the estimate, developing the auditor's point estimate or range |
| Risk framing | Significant assumptions and risk factors from AS 2110 | Inherent risk factors: estimation uncertainty, complexity, subjectivity and others (.04, .15) |
| Significant risk | No equivalent paragraph in AS 2501 (AS 2110 and AS 2301 govern) | For significant risks, substantive procedures alone must include tests of details (.19) |
| Management has not addressed uncertainty | No equivalent paragraph | Auditor requests more from management, develops own point estimate or range if needed, and evaluates control deficiency (.26) |
| Bias | Evaluated individually and in aggregate under AS 2810 (.30, .31) | Evaluate indicators of possible management bias even when individual judgments are reasonable (.32) |
| Retrospective review | In AS 2401.64 for fraud risk estimates | Required as a risk assessment procedure (.13) |
The two structures map closely. The AU-C approach "events up to the date of the auditor's report" corresponds to evaluating events after the measurement date, and "testing how management made the estimate" corresponds to testing the company's process. AU-C 540 is more explicit that testing must address bias at the level of methods, assumptions and data (.22b, .23b, .24b), and it requires documenting indicators of bias (.38d).
Frequently asked questions
Can an auditor use all three approaches?
Yes. The note to .07 says any of the three may be used individually or in combination.
Is the retrospective review part of AS 2501?
The review is in AS 2401.64 and .65 and is directed at estimates with an assessed fraud risk. See retrospective review of prior-year estimates.
Sources
- PCAOB, AS 2501, Auditing Accounting Estimates, Including Fair Value Measurements, paragraphs .01 to .31 and Appendix A: https://pcaobus.org/oversight/standards/auditing-standards/details/AS2501
- PCAOB, AS 2810, Evaluating Audit Results, paragraph .13: https://pcaobus.org/oversight/standards/auditing-standards/details/AS2810
- PCAOB, AS 2401, Consideration of Fraud in a Financial Statement Audit, paragraphs .64 and .65: https://pcaobus.org/oversight/standards/auditing-standards/details/AS2401
- AICPA, AU-C Section 540, Auditing Accounting Estimates and Related Disclosures, paragraphs .04, .13, .15, .17, .19, .22 to .26, .32 and .38: https://www.aicpa-cima.com/resources/landing/aicpa-professional-standards
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