With financial reporting frameworks requiring more complex accounting estimates with high estimation uncertainty, auditors have increased responsibility when it comes to the auditing of these estimates and its related disclosures in the financial statements.

1.   Main components of an estimation process

The 3 main components in the process when determining accounting estimates are:

Methods & models – prescribed/alternative/self-developed/licensed/acceptable industry methods/consistency/complexity/subjectivity

Assumptions Data – significance/consistency/complexity/subjectivity nature/source/volume/relevance/reliability/accuracy/completeness/consistency/integrity during processing/complexity/subjectivity

2.   Auditor’s responsibilities when auditing accounting estimates

The key changes in the audit process around accounting estimates and the possible impact on management are indicated in the table below:

Management should expect the following questions to be asked by auditors about the estimation process:

• What are your control processes around accounting estimates?
• How are relevant significant transactions, conditions or events communicated to the person(s) responsible for making the accounting estimate(s)?
• Do you review the outcome(s) of previous accounting estimates and how do you respond to the results of the review?
• How is compliance with your financial reporting framework requirements regarding accounting estimates achieved?
• How are regulatory factors relevant to the accounting estimates accounted for?
• How is the need for specialized skills, including the use of a management expert, identified and applied?
• What is your risk assessment process to identify and address risks relating to accounting estimates?
• How do you identify the relevant methods/models, assumptions and data in the estimation process? How do you determine the need for changes in them?
• How to you address the degree of estimation uncertainty in selecting your final point estimates?
• How do you describe these processes for deriving your accounting estimates and degrees of estimation uncertainty in the financial statements (disclosures)?
• Is there oversight and governance in place over the financial reporting process of accounting estimates?

3.   Management responsibilities in determining when accounting estimates are needed

Determining whether accounting estimates are needed require proper processes and controls to identify any transactions, events or conditions that give rise to such estimates. The need for accounting estimates will depend on the nature of the entity, the environment, transactions entered into and other events, conditions or circumstances.

Management would need to think about (1) transactions that require accounting estimates or changes to them and (2) conditions/events that may require accounting estimates or changes to them.

Cash receipts and cash payments must be classified as operating, investing, or financing activities on the basis of the nature of the cash flow.

Cash flows should be grouped into operating, investing or financing activities to enable investors and creditors to evaluate significant relationships within and between those activities.

Investing Activities

Investing activities include making and collecting loans and acquiring and disposing of debt or equity instruments and property, plant, and equipment and other productive assets, that is, assets held for or used in the production of goods or services by the entity (other than materials that are part of the entity’s inventory). Investing activities exclude acquiring and disposing of certain loans or other debt or equity instruments that are acquired specifically for resale.

Financing activities

Financing activities include obtaining resources from owners and providing them with a return on, and a return of, their investment; receiving restricted resources that by donor stipulation must be used for long-term purposes; borrowing money and repaying amounts borrowed, or otherwise settling the obligation; and obtaining and paying for other resources obtained from creditors on long-term credit.

Certain cash receipts and payments may have aspects of more than one class of cash flows. In such circumstances, entities must determine the appropriate classification by considering when to (1) separate cash receipts and cash payments and classify them into more than one class of cash flows and (2) classify the aggregate of those cash receipts and payments into one class of cash flows based on predominance.

Operating Activities

Operating activities include all transactions and other events that are not defined as investing or financing activities. Operating activities generally involve producing and delivering goods and providing services. Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income.

Specific Considerations

• Changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary should be accounted for as equity transactions (investments by owners and distributions to owners acting in their capacity as owners). Accordingly, payments to acquire noncontrolling interests in a subsidiary, or those associated with the sale of noncontrolling interests in a subsidiary, should be classified as financing activities in the statement of cash flows.
• An entity that actively and frequently purchases, sells, or trades equity securities, intending to sell them in the near term (e.g., hours or days) to generate short-term profits, would generally present such cash flow activity as operating activities; otherwise, presentation within investing activities would generally be required.
• When an entity pays for capital expenditures or operating expenses before the reimbursement of government grant monies, it should present the receipt of the government grant in the statement of cash flows in a manner consistent with the presentation of the related cash outflow. For example, a government grant that is intended to reimburse an entity for qualifying operating expenses would be presented in the statement of cash flows as an operating activity if the grant was received after the operating expenses were incurred.
• When an entity receives the government grant before incurring the related capital or operating expenses, it should present the receipt of the government grant as a financing cash inflow in the statement of cash flows.
• Lease payments made to repay a finance lease liability should be classified as follows: (1) the principal portion of the payments as cash outflows from financing activities and (2) the interest portion of the payments as cash outflows from operating activities.
• Cash flows related to the purchases and sales of businesses; property, plant, and equipment; and other productive assets are presented as investing activities in the statement of cash flows. In a business combination, all cash paid to purchase the business is presented as a single line item in the statement of cash flows, net of any cash acquired.
• Acquisition-related costs such as advisory, legal, accounting, valuation, and professional and consulting fees in a business combination should be reflected as operating cash outflows in the statement of cash flows.
• The effects of exchange rate changes on cash should be shown as a separate line item in the statement of cash flows as part of the reconciliation of beginning and ending cash balances.

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The Companies Act requires full disclosure of the remuneration of directors and prescribed officers (whether executive, non-executive or alternate directors) in the financial statements of companies that require an audit in terms of the Act. This requirement may become quite cumbersome where a Group of Companies consists of multiple companies.

Note: The Act requires that each company that is required to have its annual financial statements audited, must provide the directors disclosure as required by Section 30 of the Companies Act.

In terms of section 30(5), the disclosure must show the amount of any remuneration or benefits paid to or receivable by persons in respect of:

• services rendered as directors or prescribed officers of the company; or
• services rendered while being directors or prescribed officers of the company-
  – as directors or prescribed officers of any other company within the same group of companies; or
  – otherwise in connection with the carrying on of the affairs of the company or any other company within the same group of companies.

1. The act defines a “group of companies” as a holding company and all of its subsidiaries.
2. If a person serves as director and/or prescribed officer of more than one company in a group of companies, that person’s total remuneration would be disclosed in the annual financial statements of all the companies in the group that are required to disclose remuneration, i.e. all companies where that person is a director/prescribed officer or employee carrying out affairs of company (see below).
3. If a person is a director of a company in a group of companies and the same person is also an employee of another company in the group, the company where the person is a director will have to disclose in its AFS the person’s remuneration received as director of the company AND the salary earned as an employee of the other company within the same group of companies (i.e. for the carrying on of the affairs of the company)
4. The Act requires the company to disclose all amounts payable to or received by its directors/prescribed officers in respect of services rendered as directors/prescribed officers of the “company”. Therefore, any amounts paid to directors/prescribed officers in respect of services rendered to a trust or a foreign company within the group would not be disclosed, since trusts and foreign companies are not “companies” as defined by the Act.