Question

Which of the following is not a reason why the auditor needs to take special care to review significant estimates in the financial statements?

a. Organizations may try to use the estimates to "smooth" earnings.

b. Organizations may create hidden reserves in unusually good years that can be used in years when real profits do not meet expectations.

c. Companies may underestimate liabilities or impairment of asset values to achieve reported earning goals in years when real profits do not meet expectations.

d. Companies may try to overestimate liabilities in computing leverage ratios.

Answer 1

The auditor needs to review significant estimates in the financial statements to ensure accuracy and transparency. Option d is not a reason because overestimating liabilities can make leverage ratios appear higher, potentially attracting more investment.

Step-by-step explanation:

The correct answer is d. Companies may try to overestimate liabilities in computing leverage ratios.

When a company overestimates its liabilities, it can make its leverage ratios, such as debt-to-equity ratio, appear higher than they actually are. This can be used by the company to make it seem less risky to investors and creditors, potentially attracting more investment.

However, it is important for the auditor to review significant estimates, including liabilities, to ensure the accuracy and transparency of the financial statements. By doing so, the auditor can detect any potential manipulation or misrepresentation of financial information.