SAE 3400 The Examination of Prospective Financial Information

Introduction

The objective of this Standard on Assurance Engagement (SAE) is to establish standards and provide guidance on engagements to examine and report on prospective financial information, including examination procedures for best estimates and hypothetical assumptions. Although many of the procedures outlined herein may be suitable for such an examination, this SAE does not apply to the examination of prospective financial information expressed in general or narrative terms, such as that found in management’s discussion and analysis in an entity’s annual report. Further, the principles laid down in the other Standards on Auditing, issued by the Institute of Chartered Accountants of India, should be used by the auditor, to the extent practicable.

In a prospective financial information examination engagement, the auditor should obtain sufficient and appropriate evidence to determine whether:

• The prospective financial information is based on management’s best estimates, which are reasonable and, in the case of hypothetical estimates, are consistent with the information’s intended use;
• The prospective financial information is properly prepared on the basis of the assumptions;
• All material assumptions are adequately disclosed, including whether they are best-estimate assumptions or hypothetical assumptions, and the prospective financial information is presented correctly.
• Using the proper accounting principles, the prospective financial information is prepared in a manner that is consistent with the historical financial statements.

The Auditor’s Assurance Regarding Prospective Financial Information

Financial information that has yet to happen or that may never happen is referred to as “prospective.” While there may be evidence to back up the hypotheses that underlie prospective financial information, this evidence is typically future-oriented and therefore speculative, as opposed to the evidence that is typically available when examining historical financial data. Therefore, the auditor is not in a position to render a judgment on the likelihood that the outcomes indicated by the prospective financial information will be realized.

Additionally, given the various types of evidence that can be used to evaluate the assumptions that the prospective financial information is based on, the auditor might find it challenging to reach a level of satisfaction necessary to express a positive opinion that the assumptions are free of material misstatement. As a result, the auditor offers only a moderate level of assurance in this SAE when reporting on the validity of management’s assumptions.

Acceptance of Engagement

The auditor would take into account, among other things, the following before accepting an engagement to review potential financial information.

• The intended use of the information;
• Whether the information will be for general or limited distribution;
• The nature of the assumptions, that is, whether they are best estimates or hypothetical assumptions;
• The elements to be included in the information; and
• The period covered by the information.

When there are unrealistic assumptions or when the auditor believes the prospective financial information will be inappropriate for its intended use, then the Auditor should not accept or should withdraw from such engagement.

Knowledge of the Business

The auditor should obtain a sufficient level of business knowledge to be able to assess whether all significant assumptions needed to prepare the prospective financial information have been identified. The auditor would also need to become familiar with the entity’s process for preparing prospective financial information, for example, by considering:

• The internal control over the system;
• The nature of audit documentation;
• The extent to which mathematical, statistical, and computer-aided methods are employed.
• The methods used to develop and apply assumptions
• The accuracy of prospective financial information prepared in prior periods, if any, and the reasons for any significant variances therein.

To determine whether the prospective financial information has been prepared on a basis consistent with the historical financial information and to provide a historical yardstick for evaluating management’s assumptions, the auditor must be aware of the entity’s historical financial information. The auditor will need to determine, for instance, whether pertinent historical information was audited or reviewed and whether acceptable accounting principles were applied in its preparation.

Examination Procedure

When determining the nature, timing and extent (NTE) of examination procedures, the auditor should consider matters such as:

• The knowledge obtained during any previous engagements;
• Management’s competence regarding the preparation of prospective financial information;
• The likelihood of material misstatement;
• The extent to which the prospective financial information is affected by the management’s judgment;
• The sources of information considered by the management for the purpose, their adequacy, reliability of the underlying data, including data derived from third parties, such as industry statistics, to support the assumptions;
• The stability of the entity’s business; and
• The engagement team’s experience with the business and the industry in which the entity operates and with reporting on prospective financial information.

The auditor would evaluate whether all significant implications of any used hypothetical assumptions had been taken into account and auditor’s need to satisfy that the hypothetical assumptions are consistent with the purpose of the prospective financial information, and that there is no reason to believe them; they are clearly unrealistic.

The auditor must be satisfied that management’s assumptions were used to properly prepare the prospective financial information.

The auditor should obtain written representations from management regarding the intended use of the prospective financial information, the completeness of significant management assumptions, and management’s acceptance of its responsibility for the prospective financial information.