This thesis is explaining, analyzing, and reflecting on the roles of both management and auditor when working with estimates arising from earn-out agreements.
The estimates made by management regarding earn-out agreements will typically be based on internal data and assumptions, and therefore might be subject to management bias, as the pre-parers might have an interest in using the estimate to manipulate the financial statement one way or another. Estimates like this will give rise to high risk from an auditor’s point of view, in terms of securing a true and fair view in the financial statements. Furthermore, an estimate based on in-ternal data and assumptions will challenge the auditor in regards of collecting sufficient audit evi-dence.
This thesis is explaining, analyzing, and reflecting on key points of the conceptual framework, and current relevant rules regarding the handling earn-out agreements arising from business combi-nations, in the financial statements. The thesis will explain and analyze the relevant international audit standards (ISA), and especially ISA 540(R), to conclude on the key challenges the auditor is facing and how these challenges can be overcome.
The analysis of the roles of both management and auditor, are built as practical examples of how to carry out the estimate, under both IFRS and Danish local GAAP, and how the auditor can obtain sufficient audit evidence over the relevant financial statement items. The use of practical exam-ples is enabling the reader to understand the mechanisms, and clearly see the challenges set out in the process of preparing and auditing accounting estimates arising from earn-out agreements.
In conclusion the analysis shows that the preparation of the estimate, will mainly be based on in-ternal data and assumptions, depending on the actual contents of the earn-out agreement. It also shows that this will create a clear possibility for the preparer to manipulate the numbers in one way or another. Naturally this rises great risk to the auditor, and the thesis concludes on how these risks can be mitigated by following the prescribed practice in ISA 540(R). Furthermore, the reflec-tions made to both the current relevant financial reporting standards and the ISA 540(R), shows that there might be a slight discrepancy between the way the financial reporting standards and the ISA 540 (R) is structured, and thus the different standards are not supporting each other.