Corporate & Securities Law

By Jim Hamilton

As the debate over fair value accounting rages, and the FASB and IASB have moved to ameliorate fair value accounting standards, the International Auditing and Assurance Standards Board has issued a practice alert to assist auditors of financial statements in this time of market uncertainty. The practice alert follows on an earlier PCAOB audit practice alert on matters related to auditing fair value measurements of financial instruments. The IAASB?s practice alert is similar to the PCAOB?s practice alert, which highlighted requirements in the auditing standards related to fair value measurements and disclosures in the financial statements and certain aspects of GAAP that are particularly relevant to the current economic environment. The IAASB focused on IFRS rather than GAAP.

According to the IAASB, obtaining reliable information relevant to fair values in the current climate has been one of the greatest challenges faced by preparers, and conse­quently by auditors. The nature and reliability of informa­tion available to management to support the making of a fair value accounting estimate varies widely, and thereby affects the degree of estimation uncertainty associated with that fair value. If markets become inactive, said the Board, market price information becomes unavailable and estimates need to be made on the basis of other information, often using models, some of which incorporate inputs that are unobservable.

International Auditing Standard No. 545 establishes standards and provides guidance on audit­ing fair value measurements and disclosures contained in financial statements. At the end of day, under IAS 545, the issuer?s management is responsible for establishing an accounting and financial reporting process for determining fair value measurements. The standard deals with the overarching requirement for the auditor to obtain sufficient appropriate audit evidence that fair value measurements and disclosures are in accordance with the entity?s applicable financial reporting frame­work. The auditor must also understand the measurement process, no matter how complex, in order to identify and assess the risks of material misstatement in order to determine the nature, timing and extent of the further audit procedures.

In an illiquid market, the degree of estimation uncertainty increases and affects, in turn, the risks of material misstatement. What may in the past have been a routine valuation problem may become the source of a significant risk. In such circumstances, said the Board, there are limits to the infor­mation that management possesses or can obtain and that therefore may be available to the auditor as audit evidence. Nevertheless, whether inputs are observable or not, preparers of financial statements need to have evidence to support them, emphasized the Board, and auditors need to obtain sufficient appropriate audit evidence recognizing that the evidence may be different from what has previously been available.

While estimation of fair values has proved to be extremely difficult in light of market uncertainty, it has not proved impossible to obtain sufficient information to record these fair values in financial statements. Also, while fair values are commonly thought to relate primar­ily to financial assets and financial liabilities, the use of fair value is more widespread. Depending on the financial reporting framework, the impact of fair value accounting may be seen with regard to management?s determination of pension liabilities, the value of goodwill and intangibles acquired in a business combination, real estate, endowment funds, share-based payments, non-monetary exchanges and other classes of assets and liabilities.

Full post as published by Jim Hamilton's World of Securities Regulation on October 27, 2008 (boomark / email).