October 22, 2021
Audits of fair value measurements (FVM) are challenging because the valuations are typically developed by management (or third-party valuation professionals retained by management) using significant professional judgment and other qualitative inputs. This challenge is caused, in part, by a gap in understanding by each profession of what the other profession requires to successfully deliver its services. To cope with this challenge, both sides continuously strive to develop and improve valuation and auditing standards, i.e. technically through ASC 820, IFRS 13, and organizationally through the MPV (mandatory performance framework), or the PCAOB standard AS 1210.
There are new findings from academic research about the collaboration between valuation professionals and auditors. Jacqueline Hammersley, Professor of Public Accounting at University of Georgia, and Emily Griffith, Associate Professor of Accounting and Information Systems at University of Wisconsin, recently published a paper “The Role of Valuation Specialists in Audits of Fair Values”, based on empiric research and survey (download the paper in full here.)
Reading their most interesting paper suggest that there is still a long way to go to improve the alignment of the two sides. The findings suggest – among other – that at least those auditors reviewing specialists’ work and interacting with specialists at key moments would benefit from greater valuation knowledge.
Management, the valuation professionals, and the auditors should be aligned on the scope of the valuation and how the work of the valuation professional will be used, ideally well before the valuation begins.
Management, or its third-party valuation professionals, will typically develop a model for valuing something like a business or intangible assets. Regardless of whether management or a retained third-party valuation professional prepares the model, management is responsible for providing the information that will be used as the model’s inputs. Inputs may include “management assumptions” (e.g., revenue growth of 5% over the next eight years) that are classified as “unobservable,” meaning that someone outside of the company would be unable to confirm this information with publicly available data.
Auditors should understand and document underlying assumptions and management’s rationale in arriving at fair values. For auditors, the challenge is to adequately document the work that was performed, including what was known or knowable at the valuation date. Procedures that are commonly used and documented to assess the reasonableness of management’s FVM include, but are not limited to, comparing management’s assumptions for reasonableness to third-party reports, market research, third-party vendor databases, and financial statements of similar companies.
MARKABLES supports this process between valuation professionals and auditors, by providing comparable third part data to improve professional judgment of valuation professionals.