3. Accounting estimates

Accounting estimates are imprecise and can be influenced by management judgment. These judgments may involve unintentional or intentional management bias. The  susceptibility of an accounting estimate to management bias increases with the subjectivity involved in making it. The degree of estimation uncertainty affects, in turn, the risks of material misstatement of accounting estimates, including their susceptibility to unintentional or intentional management bias.

The auditor should determine whether accounting estimates with high estimation uncertainty give rise to significant risks. Significant risks require special audit consideration (i.e., more detailed review of documents). Additionally, the auditor must evaluate whether an accounting estimate identified as having a high degree of estimation uncertainty is a key audit matter to be communicated in the auditor's report.

4. Evaluating contingencies

The auditor should ask management about contingent liabilities, including pending litigation or possible future litigation and about controls adopted to identify, evaluate, and account for such items. In conjunction with these inquiries, the auditor should perform the following procedures:

• Review the minutes of meetings of stockholders, board of directors, and other executive committees.

• Review correspondence and invoices from lawyers. 

• Review contracts, loan agreements, loan guarantees, leases, and correspondence from taxing authorities.

• Review bank confirmations for hidden bank loans, discounted drafts, guarantee of notes, etc.

5. Related party transactions

Except for very routine transactions, it is virtually impossible to determine whether a transaction would have taken place in exactly the same manner if the parties weren't related. Therefore, a related party transaction is not considered to be an arm's-length transaction. For this reason, the substance of a related party transaction may be very different from its form, and GAAP requires that such transactions be disclosed.

When auditors are performing an audit of financial statements, they are responsible for identifying any related party transactions encountered during the course of the audit and for determining whether the transactions have been properly accounted for and disclosed in the financial statements. An understanding of related party transactions and  relationships is also relevant to the auditor's evaluation of fraud risk because fraud is more easily committed through related parties. Related parties may include the reporting entity's affiliates, principal owners, management, and members of their immediate families.