PCAOB: Can Auditors Handle Fair Value?

Auditor ignorance of valuation techniques used by companies making fair value calculations is a top concern for the PCAOB, says chairman Mark Olson.
Sarah JohnsonJune 7, 2007

As companies begin to expand their use of fair value accounting, their auditors may not be fully ready to evaluate that work. The Public Company Accounting Oversight Board is concerned that fair value accounting could put reliable auditing of financial reporting at risk, says PCAOB chairman Mark Olson.

The PCAOB is monitoring how firms are addressing the potential risk, Olson said. While calculating assets and liabilities based on current market value may be more relevant for investors than using a historical basis, he worries that the data may not be reliable. “The increased use of fair value accounting poses a challenge for auditors and the PCAOB,” he said during a conference on Thursday.

Olson’s concern is focused on the various means that companies can use to come up with their fair value measurements. Auditors, he said, may not have the extensive training in valuation techniques to verify companies made the right choices. “Auditors should be mindful that financial statement preparers can be biased (even if unknowingly so) in their assessments of fair value,” Olson said, according to his prepared statement for the Compliance Week annual conference in Washington, D.C. Olson also cautioned that auditors need to remember that internal controls surrounding fair value measurements may differ from those over typical business transactions.

Drive Business Strategy and Growth

Drive Business Strategy and Growth

Learn how NetSuite Financial Management allows you to quickly and easily model what-if scenarios and generate reports.

The generally accepted accounting principles used in the U.S. currently include a mix of ways to value assets and liabilities. While many are based on historic cost, accounting standards increasingly rely on fair value — a calculation, or estimate, of current market value — to value an asset or liability. Most recently, FAS 159, The Fair Value Option for Financial Assets and Liabilities gives companies the option to account for certain financial assets and liabilities using the fair-value method of accounting. Effective for most companies on November 15 along with FAS 157, Fair Value Measurements, the Financial Accounting Standards Board’s standard applies to measurements for stocks, bonds, loans, warranty obligations, and interest rate hedges.

Olson is not the only regulator to express concern about the integrity of valuation methods. In a speech earlier this month, Securities and Exchange Commission chief economist Chester Spatt said this has been a concern for years, particularly when it came to the contentious debate over how to expense at-the-money stock option grants. “The underlying measurement goal of the accounting standard is to obtain a valuation that reflects what a willing buyer and seller would pay with respect to the cost of the firm’s exposure,” he noted. “There could be tension between the language of the accounting standard and the desires and claims by product innovators that a particular design of a market instrument will lead to valuations that are a fraction of model prices.”

4 Powerful Communication Strategies for Your Next Board Meeting