International changes to ISA 540: Road test springs a leak

The AASB road-tested the IAASB’s proposed revisions to ISA 540. This exercise proved invaluable in that the AASB were able to identify both implementation challenges and areas that might require more guidance.

The comment period on the International Auditing and Assurance Standards Board (IAASB)’s proposed revisions to International Standard on Auditing (ISA) 540, Auditing Accounting Estimates and Related Disclosures, ended August 1, 2017. The AASB’s road test of the proposals revealed that while stakeholders were supportive of the need for changes to ISA 540 and many of the proposals, further improvements are needed.

The Canadian Auditing and Assurance Standards Board (AASB) recognized the importance of assessing whether ISA 540 will work in practice so it decided to road test the proposals with stakeholders on “live” accounting estimates, a first on an IAASB proposal. There were a few speed bumps, as set out in the AASB’s response letter to the IAASB. Here are some of the key areas where they raised concerns.


A focus of the revisions is to assist auditors to respond to new accounting standards dealing with financial instruments, including expected credit loss models for loan loss provisions. Small and medium-sized practitioners noted, however, that addressing these types of estimates has made ISA 540 complex and difficult to read. Further, the revisions do not focus enough on commonly encountered estimates, such as goodwill and intangible assets. As a result, some practitioners do not believe that ISA 540 is appropriately scalable for a wide range of estimates.

The IAASB addressed scalability concerns by distinguishing between accounting estimates when the inherent risk is low versus when inherent risk is not low. While there was support for this approach, practitioners wanted to see more guidance on the work effort required to make such a determination. Further, they also wanted to understand how this approach fits within the context of the existing audit risk model set out in other standards.

Work effort to respond to risks

The determination of inherent risks is important because ISA 540 prescribes the auditor’s procedures based on whether inherent risk is low or not low. However, practitioners were confused about whether they were able to use procedures specified for low risk accounting estimates in situations when this is an effective response for estimates when the risk is not low.

Using factors to design procedures that respond to risks

For accounting estimates where the inherent risk is not low, ISA 540 requires the auditor to take into account the extent to which the estimate is affected by three factors: complexity, judgment and uncertainty. These factors drive the audit procedures the practitioner performs. Practitioners found the factors helpful in identifying and assessing the risks of material misstatement. However, they struggled when it came to using the factors to design appropriate procedures to respond to the risks. They find the factors are not mutually exclusive or precisely defined so some practitioners identify different procedures to respond to similar risks based on how they interpret the meaning of the factors.


ISA 540 is a key tool to enhancing audit quality. It is evident that the IAASB tried to respond to key concerns in current practice identified by audit inspectors and others, while modernizing ISA 540 for an evolving environment. Hopefully, the IAASB can resolve some of the practical challenges identified from the Canadian road testing.

In my view, the use of road testing of standards proposals is worth the extra effort. Not only does it provide the AASB with relevant feedback on how operational proposals are, but it also brings to light where implementation guidance may ultimately be needed. I would not be surprised if we see more of this going forward.

Keep the conversation going

Do you think the AASB should continue to use a road testing approach in its standard-setting activities? How should it go about this on different projects?

Post a comment below; or email me directly.

Conversations about Audit Quality is designed to create an exchange of ideas on global audit quality developments and issues and their impact in Canada.

About the Author

Eric Turner, CPA, CA

Director, Auditing and Assurance Standards, CPA Canada