CPA Exam — AUDAssessing Risk and Developing a Planned ResponseMedium
A client, a construction company, has a large number of estimates for unbilled revenue, warranty obligations, and contingent liabilities. When planning the audit, the auditor should consider these estimates as a significant risk primarily because they:
- AAre typically subject to strong internal controls.
- BRelate only to the completeness assertion.
- CAre often immaterial to the financial statements individually.
- DAre difficult to audit and involve a high degree of subjectivity.
Show answer & explanationAnswer & explanation
Correct answer: D. Are difficult to audit and involve a high degree of subjectivity.
Significant accounting estimates, by their nature, involve considerable judgment and subjectivity, making them inherently difficult to audit. This difficulty stems from the need to evaluate management's assumptions, data, and models, which are prone to bias or error, thus representing a significant risk.
Why the other options are wrong
- A. While controls exist, the inherent nature of estimates (judgment, subjectivity) means they remain high-risk areas even with good controls.
- B. Estimates impact multiple assertions, including valuation and allocation, completeness, and accuracy, not just completeness.
- C. Estimates, especially for unbilled revenue or contingent liabilities, can often be highly material.
Significant Risk - Estimates
Significant risks are risks of material misstatement that are identified and assessed and, in the auditor's judgment, require special audit consideration. Significant accounting estimates are often considered significant risks due to their inherent subjectivity and complexity.
- Involve high degree of management judgment.
- Based on future events, inherently uncertain.
- Often require specialized knowledge to audit.
Memory trick: Significant Risks often stem from 'Subjective Judgments'.