ISAE 3400

The Examination of Prospective Financial Information

1Objective and scope

ISAE 3400 (formerly ISA 810) establishes standards and provides guidance on engagements to examine and report on prospective financial information (PFI), including examination procedures for best-estimate and hypothetical assumptions. It does not apply to the examination of PFI expressed in general or narrative terms, such as in management discussion and analysis, though many of its procedures are relevant. PFI is highly subjective: it is based on assumptions about events that may not occur and on actions management may not take, so the practitioner cannot express an opinion on whether the results will be achieved. Typical engagements: a cash flow forecast supporting a bank loan application, a profit forecast in a prospectus or a takeover document under the Capital Markets Authority's rules, projections for a business plan presented to investors, and the going concern forecast a lender asks to be examined.

In an engagement to examine PFI, the practitioner obtains sufficient appropriate evidence as to whether management's best-estimate assumptions on which the PFI is based are not unreasonable and, for hypothetical assumptions, whether they are consistent with the purpose of the information; whether the PFI is properly prepared on the basis of the assumptions; whether it is properly presented and all material assumptions are adequately disclosed, including a clear indication as to whether they are best-estimate or hypothetical; and whether it is prepared on a consistent basis with historical financial statements, using appropriate accounting principles. The engagement provides only a moderate level of assurance on the assumptions.

2Key definitions

3Requirements

Acceptance and knowledge of the business

• Before accepting, consider the intended use of the information (internal or external, general or limited distribution), whether the information will be for general or limited distribution, the nature of the assumptions (best-estimate or hypothetical), the elements to be included, and the period covered. Do not accept, or withdraw, when the assumptions are clearly unrealistic or when the practitioner believes the PFI will be inappropriate for its intended use.
• Agree the terms in an engagement letter covering the matters above, management's responsibility for the assumptions and the PFI, and the form of the report.
• Obtain a sufficient level of knowledge of the business to be able to evaluate whether all significant assumptions required for the preparation of the PFI have been identified: the entity's history and track record (the reliability of past forecasts compared with actual results), its planning and budgeting process, the industry and economic conditions, and the internal controls over the system used to prepare the PFI.
• Consider the extent to which reliance on historical financial information is justified; where the historical statements have been audited or reviewed, the practitioner's own or another auditor's knowledge is relevant; where not, the practitioner considers the need for procedures on the historical base.

Examination procedures

The nature, timing and extent of procedures are determined by the likelihood of material misstatement, the knowledge obtained during previous engagements, management's competence regarding the preparation of PFI, the extent to which the PFI is affected by management's judgement, and the adequacy and reliability of the underlying data. The period covered matters too: the longer the period, the less reliable the assumptions and the less the practitioner can do beyond assessing reasonableness, so the practitioner considers whether a period is so long as to make assurance meaningless.

• Assess the source and reliability of the evidence supporting management's best-estimate assumptions: obtain evidence from internal sources (budgets, board minutes, contracts, order books, capital expenditure approvals) and external sources (industry forecasts, market data, published interest rate expectations), and consider whether the assumptions are consistent with each other and with the practitioner's knowledge of the business and the economy (a sales growth assumption against capacity, a margin assumption against input price trends, an interest assumption against the loan agreement).
• For hypothetical assumptions, consider whether all significant implications of the assumptions have been taken into consideration (a doubling of volume implies more working capital, more capacity and more staff) and whether the assumptions are consistent with the purpose of the PFI; there is no need to gather evidence that they are likely to occur.
• Check that the PFI is properly prepared from the assumptions: perform clerical checks such as recomputation, review the internal consistency of the model (the cash flow forecast agrees with the forecast statement of financial position; tax follows profit; depreciation follows capital expenditure), and consider whether the actions management assumes are consistent with each other and with its stated plans.
• When any elapsed portion of the current period is included, consider the extent to which procedures need to be applied to the historical information: the actual results to date are the strongest evidence for the assumptions about the rest of the period.
• Focus on areas that are particularly sensitive to variation and that will have a material effect on the results (sensitivity analysis on the key drivers) and on the adequacy of the disclosure of those sensitivities.
• Obtain written representations from management regarding the intended use of the PFI, the completeness of significant management assumptions, and management's acceptance of its responsibility for the PFI.

Presentation and disclosure

The practitioner assesses whether the presentation of the PFI is informative and not misleading; whether the accounting policies are clearly disclosed in the notes; whether the assumptions are adequately disclosed, including a clear indication of which are best-estimate and which hypothetical and an indication of their sensitivity; whether the date of preparation is disclosed and management confirms the assumptions are appropriate as at that date; whether the basis of establishing points in a range is clearly indicated and the range is not selected in a biased or misleading manner; and whether any change in accounting policy since the most recent historical statements is disclosed with the reason and the effect.

4Documentation and reporting

• The report on an examination of PFI contains: a title; an addressee; identification of the PFI; a reference to ISAE 3400; a statement that management is responsible for the PFI including the assumptions on which it is based; where applicable, a reference to the purpose and/or restricted distribution of the PFI; a statement of negative assurance as to whether the assumptions provide a reasonable basis for the PFI ('nothing has come to our attention which causes us to believe that these assumptions do not provide a reasonable basis for the forecast'); an opinion as to whether the PFI is properly prepared on the basis of the assumptions and is presented in accordance with the relevant financial reporting framework; appropriate caveats concerning the achievability of the results indicated (actual results are likely to be different since anticipated events frequently do not occur as expected and the variation may be material; for a projection, that it is prepared for a stated purpose using a set of assumptions that include hypothetical assumptions about future events and management actions that are not necessarily expected to occur); the date of the report (the date procedures were completed); the location; and the signature.
• When the practitioner believes the presentation and disclosure of the PFI is not adequate, express a qualified or adverse opinion or withdraw. When one or more significant assumptions do not provide a reasonable basis for the PFI (or hypothetical assumptions are not consistent with the purpose), express an adverse opinion or withdraw. When the examination is affected by conditions that preclude application of one or more necessary procedures, withdraw or disclaim the opinion and describe the scope limitation.
• Documentation records the knowledge of the business, the assumptions and the evidence obtained for each significant one, the sensitivity analysis, the checks on preparation and internal consistency, the evaluation of presentation, the representations, and the basis for the report.

5Examinable focus