Over the past year, regulators have stepped-up their efforts on a number of fronts to ensure that significant accounting judgments and estimates applied by management—fair value estimates, impairments, revenue recognition, etc.—present a fair and accurate picture of the company’s financials. Typically, these estimates are subjective, require assumptions about matters that are highly uncertain, and can vary widely (a slight change in assumptions can have a big impact)—so the focus by regulators is not unexpected.
The message from regulators is clear: Quality financial reporting requires a disciplined, robust, and unbiased process to develop accounting judgments and estimates. The PCAOB has announced a renewed focus on auditing significant accounting estimates, and expressed concern about the number and frequency of adverse inspection findings pertaining to estimates. The SEC continues to emphasize the importance of disclosures regarding critical accounting estimates, and its Division of Enforcement has formed the new Financial Reporting and Audit Task Force, which will use data analytics to analyze MD&As—a clear sign that the SEC will heighten its scrutiny in this area.
All of this points to the importance of having a robust audit committee discussion about management’s processes for establishing significant accounting judgments and estimates, as well as the audit committee’s related oversight processes. We recommend the following areas of focus:
- Understand management’s processes for establishing significant judgments and estimates.
- Consider the audit committee’s process for evaluating significant judgments and estimates.
- Benchmark the company’s disclosures regarding critical accounting estimates against peers.
- Tap the external auditor’s resources and expertise across industries and segments to help put issues in context.
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KPMG’s Audit Committee Institute.