September 10, 2018
Auditing fair value measurements (FVM) – i.e. intangible assets – is a challenging task because FVM often involves subjectivity, technical difficulty, and inherent uncertainty in forecasting future outcomes. Although auditors should “obtain sufficient appropriate audit evidence to provide reasonable assurance that FV measurements and disclosures are in conformity with GAAP” (PCAOB AS 2502), PCAOB inspection reports repeatedly highlight that audits of FVM are a key area of audit deficiencies. The specific experience of auditors with FVM estimates has been addressed in recent academic research.
Researchers at Northeastern and Bentley Universities confirm various positive effects of auditor’s specific experience with fair value measurements (Ahn, Hoitasch, Hoitasch; Auditor Fair Value Expertise, June 2018). One such effect is the increased audit quality associated with specific auditor’s expertise in auditing Level 3 fair value estimates, resulting in less comment letters and restatements.
Another remarkable finding relates to the value relevance of level 3 disclosures. Originally, the requirement of FV disclosures was intended to improve the value relevance of the disclosed information to market participants. Opponents of FV disclosure have questioned its reliability because they are susceptible to measurement errors. Auditors are required to gain enough confidence that the measurements and disclosures in the financial reports are in conformity with GAAP. Therefore, auditors can potentially play a pivotal role in assuring the reliability of FVM and the related disclosures. The research confirms that the extent of auditor FV expertise is associated with increased value relevance of FV level 3 disclosures.
What does this mean for valuation? Appraisers sometimes express their displeasure with annoying auditor scrutiny. They shouldn’t. As a profession, it must be in the best interest of valuation that auditors are informed and experienced enough to discuss the results of an appraisal on “equal terms”. Auditor experience with fair value measurements increases the quality and relevance of valuations. Experienced auditors are not enemies of valuation, but rather ambassadors and custodians. Valuation associations should think about offering more FV-specific education for auditors.