Auditing accounting estimates has become more rigorous under Statement on Auditing Standards No. 143 (SAS 143), which took effect for 2023 year-end audits. This standard gives auditors updated guidelines on the nature of estimates and how to evaluate them during an engagement. If your financial statements contain estimates, and nearly all do, you should expect meaningful changes in how your audit is conducted and what disclosures you may need to provide.
SAS 143 reflects a broader shift in the auditing profession toward greater transparency around estimation uncertainty. The standard requires auditors to apply deeper scrutiny to the methods, assumptions, and data that management uses when developing accounting estimates. For businesses, this means the audit process may take longer, require more documentation from your team, and result in enhanced disclosures in your financial statements.
Understanding what qualifies as an accounting estimate, how auditors now test those estimates, and what you can do to prepare will help your organization move through these changes with minimal disruption. The team at Pease Bell CPAs brings this perspective to its audit and assurance services, where evaluating management estimates is central to every engagement.
What counts as an accounting estimate in financial statements
Accounting estimates are monetary amounts in financial statements where precise measurement is not possible. Instead, management applies judgment to arrive at a reasonable figure based on available information. Many business owners are surprised by how many accounting estimates examples appear in a typical set of financial statements.
The following are among the most common accounting estimates that auditors encounter:
- Allowance for credit losses on accounts receivable. This is an estimate of the portion of receivables that may not be collected. Even a zero allowance is itself an accounting estimate because it reflects a judgment that all receivables are collectible.
- Estimated salvage value and useful life of depreciable assets. When you purchase property or equipment, management must estimate how long the asset will remain in service and what it will be worth at the end of that period. Both figures directly affect annual depreciation expense.
- Self-insured liabilities for claims incurred but not reported (IBNR). Organizations that self-insure must estimate the cost of claims that have occurred but have not yet been filed or settled. These estimates rely on actuarial data, historical trends, and professional judgment.
- Variable consideration in contracts with customers. Under ASC 606, revenue from contracts that include variable pricing, such as performance bonuses, rebates, or penalties, requires management to estimate the transaction price using either the expected value or most likely amount method. The FASB Accounting Standards Codification sets the recognition and measurement rules that govern many of these estimates.
Beyond these examples, your financial statements may include estimates for warranty obligations, pension liabilities, impairment of long-lived assets, fair value measurements, and contingent liabilities arising from litigation. The more estimates your statements contain, the more attention your auditor will pay under SAS 143.
How auditors test accounting estimates under SAS 143
SAS 143 requires auditors to evaluate whether the methods and data management selected were appropriate, particularly when alternative methods or data sources were available. This represents a more demanding standard than what many organizations experienced in prior audit cycles. The AICPA developed the standard to align auditor procedures more closely with the risks that estimates pose to financial reporting.
Consider the allowance for credit losses as an example of how auditors approach this analysis. Management might calculate the allowance in one of several ways:
1. Percentage-of-revenue method. Applying a historical loss rate to current revenue or receivable balances.
2. Specific identification. Reviewing individual accounts receivable and flagging those where collection is doubtful.
3. Informal judgment. Making an estimate based on general experience without documented support, sometimes called a “seat of the pants” estimate.
Auditors are far more likely to accept the first two approaches because they rely on verifiable data and a defined methodology. An estimate based solely on informal judgment will face significant additional scrutiny and may result in audit adjustments.
Regardless of how management arrives at its estimate, auditors will initially test the estimate using one of three procedures:
- Subsequent events testing. Examining transactions and events that occur after the financial statement date to determine whether the estimate was reasonable. For example, if the allowance for credit losses was set at a given level and post-year-end collections confirm that figure is close, the auditor gains comfort.
- Evaluating management’s process. Reviewing the methodology, assumptions, and supporting documentation that management used to develop the estimate. The auditor assesses whether the process is sound and whether the inputs are reliable.
- Independent estimate. Developing the auditor’s own estimate using a different methodology to compare against management’s figure. This approach is common when management’s documentation is thin or when the auditor identifies potential management bias in accounting estimates. These procedures are often part of the broader work performed under risk advisory services, where assessing the risk of misstatement drives the depth of testing.
Under SAS 143, auditors will also look more carefully at how management selected the point estimate from a range of possible outcomes. When the range of reasonable estimates is wide, the auditor’s work increases proportionally because the risk of material misstatement is higher.
Why estimation uncertainty disclosures matter more now
One of the most significant changes under SAS 143 involves disclosures about estimation uncertainty in financial statements. While the standard summary of significant accounting policies has always included a mention of estimates, SAS 143 raises the bar for what qualifies as an adequate disclosure.
Auditors are now required to evaluate whether the disclosures pertaining to estimation uncertainty are sufficient given the facts and circumstances involved. In practice, this means that boilerplate language used in prior years may no longer pass muster. If an estimate has a wide range of possible outcomes relative to its materiality, the auditor may require the company to provide more specific disclosure about the nature of the uncertainty, the key assumptions used, and the sensitivity of the estimate to changes in those assumptions.
This focus on estimation uncertainty disclosures serves two purposes. First, it gives users of financial statements, including lenders, investors, and regulators, a clearer picture of where judgment was exercised and where outcomes could differ from what is reported. Second, it creates a documented record that auditors can point to when evaluating whether the financial statements as a whole are presented fairly.
For businesses, this means your finance team should review existing estimate-related disclosures well before the audit begins. Waiting until the auditor raises a concern can delay the completion of the engagement and increase costs.
How management bias affects the audit of accounting estimates
SAS 143 places increased emphasis on the auditor’s responsibility to evaluate whether management bias has influenced accounting estimates. Management bias in accounting estimates occurs when the assumptions, methods, or data selections consistently push estimates in a direction that favors a particular financial outcome, for example, understating liabilities or overstating asset values.
Auditors are trained to look for indicators of bias, such as:
- Consistently selecting assumptions at the optimistic end of a reasonable range.
- Changing estimation methods from year to year without a clear business rationale.
- Ignoring contradictory evidence or data that would suggest a different estimate.
- Selecting point estimates that consistently result in favorable financial reporting outcomes.
When an auditor identifies potential bias, additional procedures are required. These may include expanding the sample of estimates tested, engaging specialists to evaluate complex assumptions, or requiring management to provide additional documentation supporting their choices.
For management, the best defense against a bias finding is a well-documented estimation process that clearly explains why specific methods and assumptions were selected. Transparency about alternative approaches considered, and why they were rejected, demonstrates good faith and typically satisfies auditor concerns.
How to prepare your organization for auditing accounting estimates
Financial statement preparers can take several practical steps to ensure their estimates withstand increased auditor scrutiny under SAS 143. Proactive preparation reduces audit friction, speeds up the engagement timeline, and can minimize unexpected adjustments.
Document your estimation methodology. For each significant estimate, maintain a written description of the method used, the data inputs relied upon, and the key assumptions applied. If you considered alternative methods, note why you chose the one you did.
Support your assumptions with evidence. Link each significant assumption to observable data wherever possible. If you used historical loss rates to calculate the allowance for credit losses, retain the underlying data and show how you applied it. If you relied on third-party data, such as actuarial reports or industry benchmarks, keep copies in your audit file.
Evaluate your disclosures early. Review the estimate-related disclosures in your prior-year financial statements and assess whether they adequately describe the nature of each estimate, the methods used, and the degree of uncertainty involved. Consider whether additional disclosure is needed, particularly for estimates with a wide range of possible outcomes.
Engage your auditor in advance. Before year-end, discuss any significant changes in estimation methods, new estimates that will appear for the first time, or areas where you anticipate a wide range of possible outcomes. Early communication gives both parties time to align on expectations.
Strengthen internal controls over estimates. Ensure that your process for developing estimates includes review and approval by someone independent of the preparer. Segregation of duties in the estimation process is a strong indicator of a well-controlled environment.
Taking these steps will not eliminate auditor scrutiny, since SAS 143 ensures that thorough evaluation is the baseline, but it will position your organization to move through the process efficiently and with fewer surprises.
Frequently Asked Questions
What are accounting estimates in auditing?
Accounting estimates are monetary amounts in financial statements that cannot be measured precisely and instead require management judgment. Common examples include the allowance for credit losses, depreciation estimates, warranty accruals, and litigation contingencies. Auditors evaluate these estimates to determine whether they are reasonable and free from material misstatement.
What is SAS 143 and when did it take effect?
SAS 143, formally titled “Auditing Accounting Estimates and Related Disclosures,” is an auditing standard issued by the AICPA that took effect for audits of financial statements with periods ending on or after December 15, 2023. It provides updated guidance on how auditors should evaluate the methods, assumptions, and data used in accounting estimates.
How do auditors test accounting estimates?
Auditors test accounting estimates using one of three primary approaches: reviewing events that occurred after the financial statement date, evaluating management’s estimation process and supporting documentation, or developing an independent estimate using a different methodology. The approach selected depends on the nature of the estimate and the quality of management’s documentation.
What disclosures are required for accounting estimates under SAS 143?
SAS 143 requires auditors to evaluate whether financial statement disclosures adequately describe the estimation uncertainty involved. This means standard boilerplate language may no longer be sufficient. Companies may need to disclose the methods used, key assumptions applied, and the sensitivity of estimates to changes in those assumptions, particularly when the range of possible outcomes is material.
How can management prepare for an audit of accounting estimates?
Management should document the methodology and data behind each significant estimate, retain supporting evidence for key assumptions, review prior-year disclosures for adequacy, and communicate with auditors early about any changes in estimation methods. A well-documented process with clear internal controls is the most effective way to streamline the audit. Working with an experienced firm such as Pease Bell CPAs across its accounting services can help align your estimation process with auditor expectations before fieldwork begins.
What is management bias in accounting estimates?
Management bias occurs when the assumptions or methods used to develop accounting estimates consistently favor a particular financial outcome. Auditors under SAS 143 are specifically required to evaluate estimates for indicators of bias, such as consistently selecting optimistic assumptions or changing methods without a documented rationale. Transparent documentation of the decision-making process is the best way to address auditor concerns about bias.
