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http://www.journalofaccountancy.com/Issues/2003/Jun/TheAuditorSApp...
EXECUTIVE SUMMARY
STATEMENT ON AUDITING STANDARDS (SAS) NO. 101, Auditing Fair Value Measurements and Disclosures, gives
auditors guidance on understanding how an entitys management calculates fair value and on determining whether that
measurement conforms with GAAP.
THE SASs PROVISIONS ARE EFFECTIVE FOR AUDITS of financial statements for periods beginning on or after June
15, 2003.
TO DESIGN EFFECTIVE PROCEDURES FOR A FAIR VALUE audit, an auditor must be familiar with the expertise of
personnel who performed the measurement, the assumptions they used, how they monitored and revised the assumptions
over time and the involvement, if any, of external fair value specialists management may have engaged.
SOME COMPANIES DONT HAVE STAFF WHO CAN accurately estimate the fair value of their assets. So, they
engage valuation specialists. But even when management seeks such help, it still is responsible for the accuracy of each fair
value estimate in its financial statements.
AUDITORS SHOULD ASSESS THE RISK OF MATERIALLY misstated fair value estimates. In doing so, they should
consider the number, significance and subjectivity of assumptions used to make the estimates.
THE ASB DEVELOPED SAS NO. 101 WITH IFAC. This unprecedented collaboration influenced the style in which the
standard was written. For example, when the SAS says an auditor performs an action, it means the auditor is required to do
so.
SUSAN L. MENELAIDES, CPA, is a partner with Altschuler, Melvoin, and Glasser LLP and a member of the auditing
standards board. Her e-mail address is Susan.L.Menelaides@aexp.com . LYNFORD E. GRAHAM, CPA, is director of audit
policy with BDO Seidman LLP and a member of the auditing standards board. His e-mail address is lgraham@bdo.com .
GRETCHEN FISCHBACH is a technical manager on the AICPA audit and attest standards team. Her e-mail address is
gfischbach@aicpa.org .
he auditing standards board (ASB) issued Statement on Auditing Standards (SAS) no. 101, Auditing Fair Value
Measurements and Disclosures, in January. The standard, which is effective for audits of financial statements for periods
beginning on or after June 15, contains significantly expanded guidance for auditing fair value measurements and disclosures.
This article will help practitioners understand its more significant aspects.
The requirement to measure some financial statement items at fair value has been in the accounting literature for many
years, but until now, the source of general auditing guidance has been SAS no. 57, Auditing Accounting Estimates. Fair value
estimates differ from other accounting estimates because when market prices are not available management must estimate fair
value using an appropriate approach and assumptions that reflect those that individuals in the marketplace would make. This
unique aspect, combined with an increase in the number of accounting standards that require fair value measurements and
disclosures, the complexity of some of those measurements and their significance to the financial statements, requires auditing
guidance that is specific to such measurements.
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Its important to note that while SAS no. 101 (see Official Releases, page 103) provides a general
framework for auditing fair value measurements and disclosure, it does not establish detailed guidance
for auditing specific types of fair value estimates. Instead, the SAS provides guidance on understanding
managements process for developing fair value estimates and evaluating whether the measurement
conforms to generally accepted accounting principles (GAAP). Consequently, the auditor evaluates the
significant assumptions, considers the appropriateness of the valuation model and tests the underlying
data. The auditor does this even when management uses a valuation specialist to prepare the estimate.
What Auditors
Must
Understand
About Fair Value
How the
reporting entity
estimates fair
value
How to
use a fair value
measurement
specialist
GAAPs
fair value
requirements
The ABV
The AICPA awards the Accredited in Business Valuation (ABV) credential to candidates with the required
education and experience who have passed a full-day rigorous examination. An ABV candidate must hold a valid
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CPA license.
Yet, even when management uses a qualified and objective specialist, it cannot abdicate responsibility for the fair value
measurement it uses for financial reporting purposes. Management is responsible for the data that form the basis for the
measurement, as well as the approach, methods and assumptions the specialist used in arriving at the fair value of an item.
The auditor should determine whether managements specialist has experience in fair value measurements and has used a
fair value concept consistent with GAAP. Some specialists may be more familiar with value concepts they use when preparing
valuations for other than financial reporting purposes. Those concepts may or may not be consistent with GAAP. Two examples
are investment value , which is the value to a particular investor based on individual requirements and expectations, and
liquidation value , which is the net amount a business can realize when it terminates and sells its assets piecemeal. Investment
value takes into account the benefits that a particular buyer of an asset expects; but a fair value estimate under GAAP must take
into account only the benefits that overall market participants expect. Likewise, for fair value measurements under GAAP
liquidation value is rarely appropriate because it presumes a forced sale. Thus, the willing seller concept, which is integral to
fair value under GAAP, does not exist in this context.
While many CPA firms offer professional valuation services, management needs to be aware that the Sarbanes-Oxley Act of
2002 prohibits a public companys audit firm from providing valuation services to it.
AUDITING FAIR VALUE ESTIMATES
Often, when observable market prices are not
available, management will use a valuation method,
such as the discounted cash flow method, to make
the fair value estimate. GAAP requires such a
method to incorporate assumptions that
marketplace participants would use in their
estimates. Measurements made using valuation
techniques involve uncertainty and subjectivity. For
that reason auditors should assess the risk that the
estimate could be misstated by considering factors
such as
The length of the forecast period (for estimates
made using the discounted cash flow method).
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For example, it may not be appropriate to use a discounted cash flow model for valuing an investment in a start-up entity
because there are no revenues on which to reliably base the cash flow forecast.
Testing the data behind the estimate. The auditor also should test the data that management or its specialist used to
develop the fair value estimate. In testing those data, the auditor should consider whether they came from a reliable source,
were complete, mathematically accurate, relevant and consistent with other information he or she has obtained during the audit.
Some auditors may use their own valuation models to test the fair value measurements and disclosure. In doing so, an
auditor may be able to eliminate or reduce the above tests by using his or her own model and assumptions and managements
data. The auditor should test any such data from management that he or she uses in arriving at the fair value estimate.
Also, instead of testing the fair value estimate by evaluating the assumptions, determining the appropriateness of the model
and testing managements data, the auditor sometimes may be able to test it by examining subsequent events or transactions
that would confirm or refute the estimate. Auditors using their own models to assess a fair value measurement should be
particularly mindful that the Sarbanes-Oxley Act prohibits them from performing such services for their publicly held clients.
The auditor should carefully read the report of a specialist management has used; it may disclose additional relevant
information that needs to be considered during the audit. Also, the timing of the specialists engagement to measure fair value is
important to management and the auditor. A timely report leads to timely financial reporting by management, which in turn gives
the auditor time to plan and perform procedures he or she considers necessary to properly evaluate the measurement.
In some cases, an auditor may need to use a specialist to evaluate the entitys fair value measurement. If the specialist is an
employee of the audit firm or an outside person and that individual functions as a member of the audit engagement team, SAS
no. 22, Planning and Supervision, applies. In other cases, SAS no. 73, Using the Work of a Specialist, applies.
Because SAS no. 101 provides specific guidance for auditing fair value measurements and disclosure, we recommend that
auditors review their approaches to make sure they incorporate the statements requirements.
OTHER GUIDANCE: CURRENT AND TO COME
SAS no. 101 does not provide guidance on auditing specific assets, liabilities, components of equity, transactions or industryspecific practices. That guidance is currently available in
Other standards, such as SAS no. 92, Auditing Derivative Instruments, Hedging Activities, and Investments in Securities
(AICPA, Professional Standards, vol. 1, AU sec. 332).
Nonauthoritative publications such as the auditors tool kit titled Auditing Fair Value Measurements and Disclosures:
Allocations of the Purchase Price Under FASB Statement of Financial Accounting Standards no. 141, Business Combinations,
and Tests of Impairment Under FASB Statements no. 142, Goodwill and Other Intangible Assets, and no. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets. Although developed before the issuance of SAS no. 101, the AICPA practice
aid titled Assets Acquired in a Business Combination to Be Used in Research and Development Activities: A Focus on Software,
Electronic Devices, and Pharmaceutical Industries discusses fair value concepts in the context of in-process research and
development costs.
In the future, the ASB plans to issue a guide on auditing fair value measurements and disclosure relating to other specific
assets, liabilities, components of equity or transactions.
Copyright 2013 American Institute of Certified Public Accountants. All rights reserved.
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