Auditing and Attestation- Certified Public Accountant (CPA) Practice Exam -

What aspect should an auditor evaluate related to management's estimates?

1. Whether they are disclosed in the footnotes.

2. Whether they are reasonable.

3. Whether they meet industry standards.

4. Whether they have been audited in the past.

The correct answer is: Whether they are reasonable.

An auditor should evaluate whether management's estimates are reasonable because the accuracy and reliability of these estimates directly impact the financial statements' overall credibility. Management often uses estimates for items such as allowances for doubtful accounts, warranty obligations, and fair value measurements. These estimates are inherently subjective and can be influenced by various factors, such as economic conditions and the management's judgment. The auditor's assessment of reasonableness involves examining the methodologies used, the assumptions made, and whether there is sufficient and appropriate evidence to support those estimates. Reasonable estimates align with the underlying data and reflect an entity's actual circumstances, ensuring that the financial statements present a true and fair view of the company's financial position. While disclosure in footnotes is important for transparency, it does not address the validity of the estimates themselves. Meeting industry standards can indicate general compliance, but it may not guarantee the accuracy of estimates in a specific context. The history of past audits may provide context but does not focus on the current year's estimates, which may vary significantly from prior periods. Hence, evaluating the reasonableness of management's estimates is crucial for an auditor to ensure the integrity of the financial reporting process.