SA 540 explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
When an accounting estimate carries a significant risk, SA 540 asks for more than the general responses. This second part covers the extra work on such estimates, how an estimate becomes a misstatement, what the auditor expects in disclosures, the indicators of management bias, written representations and documentation.
SA 540, as effective for audits of financial statements for periods beginning on or after 1 April 2009, applies to all accounting estimates, including fair value estimates. ICAI may revise standards, so check icai.org for the current text. Impairment and valuation judgements are easier to defend with the sort of assumptions papers a virtual CFO team prepares. Part 1 is at SA 540 part 1.
For estimates that give rise to significant risks, the auditor evaluates how management dealt with estimation uncertainty, whether significant assumptions are reasonable, and, where relevant, management's intent and ability. The auditor may develop a range if management has not addressed uncertainty, checks recognition and measurement, and concludes whether the estimate is reasonable or misstated. The auditor also checks disclosures, reviews for indicators of possible management bias, obtains written representations and documents the conclusion.
Extra work for significant-risk estimates (paragraphs 15-17)
Paragraph 15 adds three evaluations on top of other substantive procedures.
| Evaluation | What it means | Paragraph |
|---|---|---|
| Alternatives considered | How management looked at alternative assumptions or outcomes and why it rejected them, or how else it dealt with uncertainty | 15(a) |
| Significant assumptions | Whether the assumptions that matter most are reasonable | 15(b) |
| Intent and ability | Where relevant, whether management can and intends to carry out the courses of action assumed | 15(c) |
A sensitivity analysis is one way for management to look at alternatives: it shows how the amount moves with different assumptions, sometimes giving "pessimistic" and "optimistic" scenarios, and may show which assumptions need the auditor's attention (A103-A104). The standard does not demand a detailed process or heavy documentation; what matters is whether management has assessed how uncertainty could affect the estimate (A105). Smaller entities may use simple means, and the auditor can gather evidence by inquiry, even explaining available methods to management without changing management's responsibility (A106). An assumption is significant if a reasonable variation in it would materially affect the measurement (A107).
If the auditor judges that management has not adequately addressed the effects of uncertainty, the auditor develops, if considered necessary, a range for evaluating reasonableness (paragraph 16). A111 gives situations: evidence could not be gathered by evaluating management's approach; outcomes for similar estimates vary widely; other evidence, such as later events, is unlikely; or indicators of bias exist.
For significant-risk estimates, the auditor also obtains evidence on whether management's decision to recognise or not recognise the estimate, and the measurement basis, comply with the framework (paragraph 17). For a recognised estimate, the question is whether measurement is reliable enough to meet the recognition criteria; for an unrecognised one, whether the criteria really are not met (A113-A114). A114 also says an estimate with high uncertainty may be a key audit matter under SA 701, or call for an Emphasis of Matter, though a key audit matter cannot also be covered by an Emphasis of Matter paragraph. Where the framework presumes fair value can be measured reliably, the auditor looks at whether management's basis for overcoming that presumption is appropriate (A115).
Reasonable or misstated? (paragraph 18)
The auditor evaluates, on the evidence, whether each estimate is reasonable in the context of the framework or is misstated (paragraph 18).
| Situation | Misstatement |
|---|---|
| Evidence supports an auditor's point estimate | The difference between that and management's point estimate (A116) |
| Evidence supports an auditor's range, and management's figure lies outside it | No less than the difference between management's figure and the nearest point of the range (A116) |
| Management changed the estimate or method arbitrarily from the prior period | Possibly a misstatement, or an indicator of bias (A117) |
A118 links to SA 450: misstatements may be factual, judgmental (differences from management's judgments the auditor finds unreasonable, or from inappropriate policies) or projected, and for estimates a mix may make separate identification difficult. The same considerations apply to disclosed estimates (A119).
Disclosures (paragraphs 19-20)
The auditor obtains evidence that disclosures on estimates comply with the framework (paragraph 19). The kinds of disclosure the application material mentions are the assumptions used, the method and model, the basis for choosing the method, the effect of method changes and the sources and implications of estimation uncertainty (A120). Some frameworks require disclosure of key sources of estimation uncertainty, ranges of outcomes, the significance of fair value estimates, and qualitative and quantitative risk information (A121).
For significant-risk estimates, the auditor also evaluates whether the disclosure of estimation uncertainty is adequate, even where the minimum framework disclosure has been made; this grows in importance as the range of outcomes grows relative to materiality (paragraph 20, A122). The auditor may encourage management to describe the circumstances, and if disclosure is inadequate or misleading, SA 705 governs the effect on the report (A123).
Indicators of possible management bias (paragraph 21)
The auditor reviews management's judgments and decisions in making estimates for indicators of bias. These are not misstatements in themselves for the purpose of concluding on an individual estimate (paragraph 21). Bias may only show when estimates are looked at together or across periods (A10 of the standard). The application material gives four examples (A125):
- changing an estimate or method after a subjective view that circumstances changed;
- using the entity's own assumptions for fair value estimates when they are inconsistent with observable market assumptions;
- choosing significant assumptions that give a point estimate favourable to management's objectives; and
- choosing point estimates that show a pattern of optimism or pessimism.
Indicators affect whether risk assessment and responses remain appropriate and how the auditor evaluates the statements as a whole (A124). Where bias is intended to mislead, it is fraudulent in nature (A10); compare SA 240 part 2, which requires a retrospective review of estimates for bias.
Written representations (paragraph 22)
The auditor obtains written representations, from management and where appropriate those charged with governance, on whether they believe the significant assumptions are reasonable. Depending on nature and materiality, representations may cover the appropriateness of measurement processes and models, that assumptions reflect management's intent and ability, that estimate disclosures are complete and appropriate, and that no subsequent event requires adjustment (A126). For estimates not recognised or disclosed, they may cover the basis for concluding that criteria were not met (A127). See SA 580.
Documentation (paragraph 23)
The file records the basis for the conclusions on reasonableness and disclosure of significant-risk estimates, and any indicators of possible management bias (paragraph 23). Recording the indicators helps the auditor judge whether the risk assessment and responses remain appropriate and whether the statements as a whole are not materially misstated (A128).
The appendix
The appendix discusses fair value measurements and disclosures under different financial reporting frameworks; its headings cover how frameworks define and treat fair value, presumptions about reliable measurement, and disclosure requirements, and it is not reproduced here.
Illustrative example
Harbour Logistics Pvt Ltd is an invented company; all figures are illustrative. It carries goodwill of Rs 12 crore based on projected cash flows. The auditor treats the impairment test as a significant-risk estimate and asks management for its sensitivity analysis. Management shows that a small reduction in the growth rate cuts headroom to nearly nothing, so the growth rate is a significant assumption. The auditor checks it against the approved budget and the last three years. Management's growth rate is above past experience and the auditor develops a range using lower rates; management's point estimate falls outside the range, so the misstatement is at least the gap to the nearest point of the range. The same pattern of optimistic assumptions appears in two other estimates, and the auditor records this as an indicator of bias and asks for a representation on the assumptions.
Need help with sensitive estimates?
Estimates such as impairment, provisions and fair values are easier to defend when workings, sensitivity cases and approvals are on file. TaxClue's virtual CFO services can help your finance team prepare assumptions papers before the audit begins.
Key takeaways
- Significant-risk estimates need extra evaluation of uncertainty, assumptions and management's intent and ability.
- If the auditor's range excludes management's figure, the misstatement is at least the gap to the nearest point of the range.
- Disclosure of estimation uncertainty must be adequate even if framework minimums are met.
- Indicators of bias are reviewed and recorded but are not misstatements in themselves.
- Written representations on significant assumptions are required.
Read next
- SA 540 part 1: understanding estimates
- SA 240 part 2: management override
- SA 450: uncorrected misstatements
- SA 580: written representations
Disclaimer: Based on the Standards on Auditing and quality standards issued by the Institute of Chartered Accountants of India, in the versions named in the article, and ICAI's announcement of 31 March 2026 on SQM 1 and SQM 2, as consulted on 3 October 2026. ICAI revises standards from time to time; check the current text and effective dates on icai.org. This article is general information, not legal advice; check the official text before acting.