SAE 3400 provides guidelines on the engagement to examine and report on prospective financial information which includes examination procedures for best estimates and hypothetical assumptions.
Let’s understand in detail about Standard on Assurance Engagement SAE 3400 – The Examination of Prospective Financial Information.
SAE 3400 is not applicable to expression in general or narrative terms and the principles of standards on auditing should be used as much as possible by the auditor. Management is responsible for the preparation of prospective financial information and the auditor is required to validate and report on the same.
“Prospective financial information” means financial information based on assumptions about events that may occur in the future and possible actions by an entity. It is highly subjective in nature and its preparation requires the exercise of considerable judgment. It can be in the form of forecast and projections including financial statements and can be prepared:
Prospective financial information is the management’s estimate of future results and is based on evidence which is generally future-oriented and speculative in nature. The auditor will not be able to express an opinion if those results will be achieved or if they are free from material misstatement. Therefore per SAE 3400, the auditor can provide only a moderate level of assurance on the reasonableness of management’s assumptions.
The auditor should consider the following before accepting an engagement to examine prospective financial information:
The auditor should not accept an engagement if the assumptions are clearly unrealistic or the prospective financial information will be inappropriate for intended use. Auditor and the client should agree on the terms of engagement per SA 210.
It is important for the auditor to obtain sufficient knowledge of the business to evaluate the significant assumptions required for the preparation of prospective financial information and also know the following:
If the prior period historical information was other than a clear report, then the auditor should consider the relevant facts and effect on the current examination
The period of time covered by the prospective financial information should be determined by considering some of the factors mentioned below:
A. In determining the nature, timing and extent of examination procedures, following to be considered by the auditor:
B. Source and reliability of the evidence (internal or external) supporting the management’s best-estimate assumptions should be analysed. Internal sources include budgets, projects, royalty agreements etc whereas external sources include government and industry publications, economic forecast etc
C. All significant implications are considered when using hypothetical assumptions and they are not clearly unrealistic Eg. If sales are assumed to increase beyond entity’s current capacity if the prospective financial information provides for necessary investment to expand plant capacity etc
D. If management’s assumptions are appropriately considered in preparation of prospective financial information. Eg making checks such as re-computation and reviewing the internal consistency
E. Areas which are sensitive to variation and would materially affect the prospective financial information should be focused by the auditor for evaluating appropriate and adequate audit evidence
F. All the components of financial statements including the interrelationship between those components should be considered by the auditor
G. If the elapsed portion of the current period is included in the prospective financial information, procedures related to historical information should be applied H. Auditor to obtain written representations from the management for:
An auditor should consider the following while assessing the prospective financial information:
The auditor should document the following:
Auditor’s report should contain the following: