FINANCIAL statements are the cornerstone of informed decision-making – but beneath the numbers often lie layers of uncertainty. Whether it’s the valuation of assets, recognition of revenue, or assessment of liabilities, ambiguity is inherent in financial reporting. For us auditors, the challenge is not to eliminate uncertainty but rather to navigate it with rigour and independence. Our role is critical: to bring clarity to the unknown so that the public can rely on financial statements with confidence.
One of the key elements of accounting is measuring transactions or assigning values to the economic impact of an underlying transaction for an entity. For some transactions, the process is straightforward, being based on the actual cost incurred to acquire an asset or settle a liability. However, certain elements of the financial statements may entail estimations and judgments. Standard-setting bodies have responded to this reality by issuing guidance that (1) provides a basis for measurement and (2) sets acceptable limits within which preparers of financial statements can operate during their valuation exercises.
Ethical accounting and independent auditing
Estimations and judgments give rise to uncertainty. Ethical accounting and auditing call for integrity amidst such ambiguity. Preparers of financial statements are expected to ensure that their inherent biases do not compromise the objectivity of their reporting. For us auditors, independence is the cornerstone of the profession. We must perform adequate procedures to challenge the assumptions used by management in these estimations and judgments.
When estimations and judgements are involved, the complexity of our audit work increases. As vanguards of public trust, we must ask probing questions and sign off only when sufficient comfort is achieved, that is, when the risk of being blindsided by unavoidable uncertainty is reduced to an acceptable level.
Uncertainties in the financial statements
To better understand how uncertainty manifests in practice, let’s examine specific items in the financial statements and illustrate how these may affect users of financial statements
Asset valuation. Preparers are required to measure certain assets beyond their cost. For example, inventories are recorded based on the costs incurred to bring them to a salable condition. However, users of financial statements are more concerned with how much the unsold inventories can be sold for – whether their realisable values match their recorded costs. A company may report a million pesos’ worth of inventory, but the expected recovery of these assets may already be reduced by half.
Probable obligations. In some cases, management must assess whether an obligation has been created and, if so, determine the extent of liability. Judgement is critical here. For instance, when legal cases are filed against an entity, the resolution process can be lengthy. This creates a situation where a potential liability is neither settled nor clearly determined as of the reporting date. Management faces both accounting and ethical dilemmas: whether to disclose the facts and their financial impact despite the uncertainty, and more importantly, by how much, if any? Is there a reasonable basis? The uncertainty hinges on how the entity believes the cases will be resolved – favourably or not. Estimates of liability could range from a nominal amount to as much as the entirety of the entity’s assets in extreme cases.
Revenue recognition. For the sale of goods, transactions are easily tracked – a transaction punched into the point-of-sale machine signifies a definite sale. But in other industries, such as construction, revenue is recognised based on progress measured through physical milestones,
such as the number of floors completed. In a reporting period, a construction firm must estimate the extent of work completed to recognise revenue. If a reasonable basis for estimation cannot be established, assessing revenue becomes difficult.
Going concern. When reporting financial results, management is required to confirm that the business is expected to continue operating for at least the next twelve months – unless there are clear indications that it may close or significantly downsize. This assessment involves reviewing the company’s performance, cash flow, and future plans to ensure it can meet its obligations and sustain operations. The key judgement involved here is how confident management is in stating that the business will not wind up within the next twelve months.
These uncertainties underscore the importance of our mindset and approach as auditors.
Applying professional skepticism
The public relies on us. They cannot perform the audit themselves; it is logistically impossible. A sign-off from an auditor signifies that the public may place greater confidence in the financials prepared by management.
Assurance. We perform procedures on an entity’s financial statements to achieve reasonable assurance that management’s representations are free from material misstatements. An audit does not lead to absolute assurance due to inherent limitations. In the context of auditing financial statement items involving uncertainty, we perform procedures not to eliminate such uncertainties, but only to determine if the underlying assumptions used in management’s estimates and judgments are reasonable.
Independence. In all circumstances, we are required to maintain independence in both mind and appearance. If an element of uncertainty is involved in the balances being audited, we maintain an independent view. This means not relying on management representations but challenging the reasonableness of such assumptions.
Professional skepticism. We ask questions – and then we ask more. We do not stop asking until we are satisfied with the responses, and only when the gathered evidence is both sufficient and appropriate. If management estimates an obligation to be a certain amount, we challenge the basis and evaluate whether it is reasonable. If financial statements show sales based on estimated completion, we ask how completeness is defined. When management represents that their business will remain a going concern, we ask how they support that assertion.
Auditing uncertain balances requires a heightened level of skepticism. It is, quite literally, navigating through the unknown. But we dare to ask the hard questions to achieve a reasonable level of certainty amidst the uncertainty.
The value of reasonably assessed uncertainty
Some may argue that uncertainties affect mostly “paper items.” That may be true to an extent. But these “paper items” approximate the values of underlying economic transactions that will be realised in the future.
Having an indicative value now is a tool one can use, especially when circumstances demand an urgent financial decision. Relying on a reasonably assessed uncertainty is better than having nothing to rely on at all.
Uncertainty may be inevitable in financial reporting, but it need not be a barrier to trust. When we apply professional skepticism, maintain independence, and challenge assumptions, we transform ambiguity into assurance. In a world where financial decisions hinge on what is reported today, the public depends on us to ensure that even uncertain balances are reasonably assessed.
That is the true value of auditing with certainty.
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Mannel Hernandez is a Senior Manager for the Audit & Assurance Practice Area at P&A Grant Thornton. One of the leading audit, tax, advisory, and outsourcing firms in the Philippines, P&A Grant Thornton is composed of 29 Partners and 1,500 staff members. We’d like to hear from you! Connect with us on LinkedIn and like us on Facebook: P&A Grant Thornton and email your comments to business.development@ph.gt.com. For more information, visit our website: www.grantthornton.com.ph.
