CPA Exam — AUDPerforming Further Procedures and Obtaining EvidenceMedium
An auditor is reviewing a client's significant estimates, such as inventory obsolescence. Which of the following procedures would be MOST effective in evaluating the reasonableness of management's estimates?
- AObtaining written representations from management confirming the reasonableness of the estimates.
- BVouching a sample of transactions related to the estimate to supporting documentation.
- CDeveloping an independent expectation of the estimate and comparing it to management's estimate.
- DConfirming the estimate with third-party experts engaged by management.
Show answer & explanationAnswer & explanation
Correct answer: C. Developing an independent expectation of the estimate and comparing it to management's estimate.
Developing an independent expectation and comparing it to management's estimate is a highly effective way to evaluate the reasonableness of estimates. This approach provides objective, auditor-generated evidence to challenge or corroborate management's judgment.
Why the other options are wrong
- A. Written representations are required but are not sufficient audit evidence on their own for the reasonableness of estimates; they corroborate other procedures.
- B. Vouching transactions supports the accuracy and existence of underlying data, but not necessarily the reasonableness of the *estimate* itself (e.g., the obsolescence percentage).
- D. While useful, relying on third-party experts engaged by management requires the auditor to evaluate the expert's objectivity and competence. Developing an *independent* expectation is generally more direct for initial evaluation of reasonableness.
Auditing Accounting Estimates
Auditing accounting estimates involves evaluating the reasonableness of management's judgments in areas like inventory obsolescence, fair value measurements, and warranty reserves, which are inherently uncertain.
- Involves high degree of judgment and uncertainty.
- Auditor must assess management's process and assumptions.
- Common procedures include developing independent estimates or reviewing management's process.
Memory trick: To judge an estimate, you need YOUR OWN benchmark.