Auditing procedures for historical financial information are well established. However companies often prepare and publish prospective financial information such as profit forecasts. In order that the forecasts should have credibility the company may ask the auditor to examine and express an opinion on the prospective financial information. This examination does not amount to an audit. However, users of the prospective financial information do get some assurance from an examination of the prospective financial information by the auditor.
According to International standard on Assurance engagements No. 3400 The Examination of Prospective Financial Information, ‘Prospective financial information’ (PFI) 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 forecast, a projection or a combination of both, for example, a one year forecast plus a five year projection.
The purpose of the ISAE 3400 is to establish standards and provide guidance on engagement to examine and report on prospective financial information including examination procedures for best –estimate and hypothetical assumptions. This ISAE does not a 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
ISAE 3400 defines a ‘forecast’ as prospective financial information prepared on the basis of assumptions as to future events which management expects to take place and the actions management expects to take as of the date the information is prepared (best –estimate assumptions).
A ‘projection’ is defined as prospective financial information prepared on the basis of:
(a) 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, or
(b) a mixture of best-estimate and hypothetical assumptions
PFI can include financial statements or one or more elements of financial Statements.
In effect a forecast is an informed opinion on what will happen and a projection is an opinion on what might happen in certain circumstances. Often a one-year forecast is given together with a five year projection.
Acceptance of engagement
Before accepting an engagement to examine prospective financial information, the auditor would consider, among other things:
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 –estimate or hypothetical assumptions
The elements to be included in the information; and
The period covered by the information.