What is the first step required by ISA 540 when responding to estimates?

The first step required by ISA 540 in responding to estimates involves understanding how management has made the estimates, which is typically encapsulated in the testing of the methodology, assumptions, and data used by management. This step is crucial as it helps auditors assess whether the estimates made by management are reasonable and based on sound principles.

Testing how management made the estimate allows auditors to evaluate any inherent assumptions and the overall process followed to arrive at those estimates. They look at the techniques applied, the significance of past performance, and the appropriateness of the inputs. Moreover, it establishes a foundation for further audit procedures, including evaluating the potential for management bias and considering whether the estimates fall within an acceptable range.

The other options, while relevant to the audit process in their own right, follow this crucial initial assessment. Obtaining evidence of subsequent events, developing their own estimate, and forming an overall conclusion on estimates are actions that typically come after understanding and testing the estimates made by management. This initial step is fundamental to ensuring that the auditor has a strong grasp of the estimates in question before moving on to subsequent evaluations or evidence collection.