This SAE is effective in relation to reports on projections/forecasts issued on or after April 1, 2007.
The purpose of this (SAE) is to establish standards and provide guidance on engagements to examine and report on prospective financial information (PFI) including examination procedures for best-estimate and hypothetical assumptions. 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, though many of the procedures outlined herein may be suitable for such an examination.
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 applying this SAE.
2. In an engagement to examine prospective financial information, the auditor should obtain sufficient appropriate evidence as to whether:
(a) management’s best-estimate assumptions on which the prospective financial information is based are not unreasonable and, in the case of hypothetical assumptions, such assumptions are consistent with the purpose of the information;
(b) the prospective financial information is properly prepared on the basis of the assumptions;
(c) the prospective financial information is properly presented and all material assumptions are adequately disclosed, including a clear indication as to whether they are best-estimate assumptions or hypothetical assumptions; and
(d) the prospective financial information is prepared on a consistent basis with historical financial statements, using appropriate accounting principles.
Sufficient appropriate evidence on all the points mentioned above is must for an auditor for the purpose of an examination of the PFI since these information/data will form the basis on which the report is released. The best-estimate assumptions should be reasonable enough to ensure that the prospective financial information does lead to probable future outlook of a company to a certain extent.
For example, the Revenue of the current financial year amounting to INR 40M is projected as INR 80M in the PFI, which does not seems reasonable unless the same is backed by increase in installation capacity or outsourcing decision, demand generation and environment factors, etc. Therefore, assumptions are to be disclosed in detail- whether each one of them is best estimate or hypothetical assumptions so as to understand the background/ basis on which the PFI is drawn. Ideally the best estimate assumptions should far outweigh the hypothetical assumptions.
Further the PFI should be properly presented on a consistent basis with historical financial statements to provide a clear picture of the future variables which will have an impact on the future earnings of the company. Consistency is the key here which means it is not optional on part of the company to provide PFI in one period and skip on the other. This is because in the current economic scenario, the dynamics of any industry can change within a short span of time and hence regular update on the entity/ industry as a whole does help from shareholders point of view.
“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. Prospective financial information can be in the form of a forecast, a projection, or a combination of both, for example, a one year forecast plus a five -year projection.
Prospective financial information can include financial statements or one or more elements of financial statements and may be prepared:
(a) as an internal management tool, for example, to assist in evaluating a possible capital investment; or
(b) for the distribution/submission to third parties in, for example:
– a prospectus to provide potential investors with information about future expectations.
– an annual report to provide information to shareholders, regulatory bodies and other interested parties.
-a document, for example, cash flow forecasts, for the information of lenders.
PFI does covers the hypothetical assumptions about future events and management actions which are not necessarily expected to take place, such as when some entities are in a start-up phase or are considering a major change in the nature of operations. Such information illustrates the possible consequences as of the date the information is prepared if the events and actions were to occur (a “what-if” scenario).
Management is responsible for the preparation and presentation of the prospective financial information, including the identification and disclosure of the sources of information, the basis of forecasts and the underlying assumptions. The auditor may be asked to examine and report on the prospective financial information to enhance its credibility, whether it is intended for use by third parties or for internal purposes.
PFI is highly subjective in nature and therefore judgement plays an important role in its preparation. A judgement can be right or wrong but a judgement based on best- estimate and hypothetical assumptions when appropriately disclosed as part of PFI and further examined and reported by the auditor does lead to future insights to a certain extent to its intended users and hence the need of PFI.
PFI may provide insights on many factors such as the projected cash flows, projected market capitalization, projected demand outlook, projected Return on Capital employed (ROCE) and projected Earnings per share (EPS),etc. These parameters along with other financial variables does help the intended users in making informed decisions.
3. Auditor’s Assurance – Prospective Financial Information
Prospective financial information relates to events and actions that have not yet occurred and might not occur. While evidence may be available to support the assumptions on which the prospective financial information is based, such evidence is itself generally future- oriented and, therefore, speculative in nature, as distinct from the evidence ordinarily available in the examination of historical financial information. The auditor is, therefore, not in a position to express an opinion as to whether the results shown in the prospective financial information will be achieved.
PFI is generally future looking document and hence speculative. The auditor in no way can be convinced that the outlook shown in PFI will be accomplished and hence the level of assurance is always moderate.
4. Acceptance of Engagement
The auditor should consider the following before accepting an engagement to examine prospective financial information:
i. The intended use of the information
ii. whether the information will be for general or limited distribution
iii. Nature of assumptions – whether best estimate or hypothetical
iv. Elements to be included in the information
v. Period covered by the information
The above points highlight the basic requirement of auditing. An audit engagement should be backed by understanding on the terms of the engagement on part of both the auditor and the auditee. This will enable the purpose of the engagement be detailed out in terms of scope, analysis and the reporting. The assumptions adopted should be realistic and the intended use of the same should be just and fair.
5. Knowledge of Business
The auditor should obtain a sufficient level of knowledge of the business to be able to evaluate whether all significant assumptions required for the preparation of 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:
(a) The internal controls over the system used to prepare prospective financial information and the expertise and experience of those persons preparing the prospective financial information.
(b) The nature of the documentation prepared by the entity supporting management’s assumptions.
(c) The extent to which statistical, mathematical and computer-assisted techniques are used.
(d) The methods used to develop and apply assumptions.
(e) The accuracy of prospective financial information prepared in prior periods, if any, and the reasons for any significant variances therein.
It is utmost important that sufficient knowledge of the business is obtained by the auditor before entering into the engagement since without the same, the analysis and ultimately be report cannot be delivered as per requisite standard. Few such factors are Organizational structure- whether simple or complicated, audited historical financial statements, prevalent internal controls, IT and General Controls, usage of IT tools, methods to develop assumptions, pending litigations at various forums, prior PFI reports, knowledge about the industry and its future outlook, environment and political controls, etc.
The knowledge would equip the auditor with necessary wherewithal in conducting the exercise and form an opinion thereon.
For example, the prior period reports when compared with the actual results does lead to significant variances, it would be reasonable to find out the reasons for the same in order to have necessary judgement build up in the new/upcoming PFI report to be prepared and published accordingly.
6. Period Covered
The auditor should consider the period of time covered by the prospective financial information. Since assumptions become more speculative as the length of the period covered increases, as that period lengthens, the ability of management to make best-estimate assumptions decreases. The period would not extend beyond the time for which management has a reasonable basis for the assumptions. The following are some of the factors that are relevant to the auditor’s consideration of the period of time covered by the prospective financial information
The period of time covered by the prospective financial information should be determined by considering some of the factors mentioned below:
i. The operating cycle eg. The time required to complete the project may dictate the period covered
ii. The need of users eg. Information used by investors in connection with the issue of securities to illustrate the intended use of the proceeds in the subsequent period
Since there is no minimum or maximum period for which PFI can be prepared, the period analysis is importance since the assumptions used by the management would change over a period of time. Hence the period should be reasonable to warrant justification to the underlying assumptions used in preparing the PFI.
7. Examination Procedures
When determining the nature, timing and extent of examination procedures, following points are to be considered by the auditor:
i. Knowledge obtained during the previous engagements
ii. Management’s competence regarding the preparation of prospective financial information
iii. Likelihood of material misstatement
iv. the extent to which the prospective financial information is affected by the management’s judgment
v. 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;
vi. Stability of entity’s business
vii. the engagement team’s experience with the business and the industry in which the entity operates and with reporting on prospective financial information.
This para reflects the procedures to be followed by the auditor in conducting the examination of the PFI.
Source and reliability of the evidence (internal or external) supporting the management’s assumptions should be analyzed. Internal sources may include budgets, patents, reputation of the management, etc. whereas external sources include government and industry publications, economic forecast, proposed laws and regulations, etc.
Auditor needs to be satisfied that the hypothetical assumptions are consistent with the purpose of the PFI and should be realistic.
Areas which are sensitive to variation and would have a material/significant effect on PFI should be thoroughly reviewed by the auditor for evaluating appropriate and adequate audit evidence.
Interrelationship between various components of the financial statements should be considered by the auditor in cohesiveness since the impact on one component may have significant impact on the other.
Auditor should obtain written representations from the management regarding:
i. The intended use of the prospective information
ii. Completeness of significant management assumption;
iii. Management acceptance of its responsibility for the prospective financial information including but not limited to identification and disclosure of uncontrollable factors, outstanding litigations, commitments or any other material factors that are likely to have an impact on PFI.
8. Presentation and Disclosure
When assessing the presentation and disclosure of the prospective financial information and the underlying assumptions, in addition to the specific requirements of any relevant statutes, regulations as well as the relevant professional pronouncements, the auditor will need to consider whether:
(a) the presentation of prospective financial information is informative and not misleading;
(b) the accounting policies are clearly disclosed in the notes to the prospective financial information;
(c) the assumptions are adequately disclosed in the notes to the prospective financial information. It needs to be clear whether assumptions represent management’s best-estimates or are hypothetical and, when assumptions are made in areas that are material and are subject to a high degree of uncertainty, this uncertainty and the resulting sensitivity of results needs to be adequately disclosed;
(d) the date as of which the prospective financial information was prepared is disclosed. Management needs to confirm that the assumptions are appropriate as of this date, even though the underlying information may have been accumulated over a period of time;
(e) the basis of establishing points in a range is clearly indicated and the range is not selected in a biased or misleading manner when results shown in the prospective financial information are expressed in terms of a range; and
(f) there is any change in the accounting policy of the entity from that disclosed in the most recent historical financial statements and whether reason for the change and the effect of such change on the prospective financial information has been adequately disclosed.
This para provides guidance to the auditor to satisfy himself whether the presentation and the disclosure of the facts and figures in the PFI is just and reasonable so as to opine thereon.
The auditor should document the following:-
i. Evidence to support the auditor’s report on examination of prospective financial information
ii. Evidence that examination was carried out as per this SAE
iii. Working papers include sources of information, the basis of forecast and the assumptions made in arriving the forecasts, etc.
iv. Evidence supporting the assumptions, both best estimate and hypothetical assumptions and completeness of material assumptions.
v. Management representation regarding intended use and distribution of information;
vi. Management’s acceptance of its responsibilities for the information;
vii. Audit plan, the nature, timing and extent of examination procedures
viii. If auditors express modified opinion or withdraw from engagement, the reason for forming such an opinion.
An audit is incomplete without adequate documentation. Documentation forms the backbone and acts as a shield specifically for the auditor. Hence all the relevant documentation will help auditor in case of any future investigation by any authorized third party and be the basis on which the opinion was formed.
It need not be mentioned here that Confidentiality too should be taken care by the auditor in any engagement.
10. Report on Examination of Prospective Financial information
Auditor’s report should contain the following:
iii. Identification of the prospective financial information
iv. Reference to the applicable standards on auditing applicable to PFI
v. Statement that management is responsible for PFI including underlying assumptions
vi. When applicable, a Reference to the purpose and/or restricted distribution of prospective financial information
vii. Statement that the examination procedures included examination, on a test basis, of evidence supporting the assumptions, amounts and other disclosures in the forecast or projection;
viii. Statement of negative assurance as to whether the assumptions provide a reasonable basis for the prospective financial information;
ix. Opinion as to whether the prospective financial information is properly prepared on the basis of the assumptions and is presented in accordance with the relevant financial reporting framework;
x. Appropriate caveats concerning the achievability of the results indicated by the prospective financial information;
xi. Date of report
xii. Place of signature and Signature
This para states the broad coverage (not the exhaustive list) of PFI. The auditor would need to state whether the assumptions does provide a reasonable basis or not for PFI based on his examination.
Further an expression of opinion is required by auditor to state whether the relevant financial reporting framework has been adhered or not.
Auditor should provide and qualified or adverse opinion or withdraw from the engagement when it is believed that the presentation and disclosure of PFI is not adequate.
This Standard on Assurance Engagement (SAE) outlines the importance of standards governing the report on prospective financial information. Since this is document which may be used as an marketing tool by the Organization, the same needs to be regulated very carefully and diligently in the interest of the intended users.
While the report may not be conclusive due to forward looking aspect and hence speculative, the same does provide the intended user a reasonable understanding of the proposed outlook of the company.
Disclaimer – ICAI website has been referred while preparing this article. This article is meant for understanding purposes only and in no way be deemed to be an advice or solicit any marketing whatsoever. Any decisions based on this article would not held me liable for any action whatsoever. Please get in touch with your auditor/legal consultant to understand the impact on your industry. Thanks!