Can PCAOB Fair-Value Guidance Calm Jittery Auditors?

The Public Company Accounting Oversight Board counsels accountants about their responsibilities in the fast-changing world of mark to market.
David KatzApril 22, 2009

Now that accounting rulemakers have weighed in on how to measure fair value in illiquid markets and how to deal with other than temporary impairments, the Public Company Accounting Oversight Board is advising auditors on how to assess their client’s mark-to-market assessments.

 Time will tell, but the practice alert may take some of the steam out of one of the alleged causes of the credit crunch. When market valuations started to head south last year, auditors, fearful of being sued, pressed their banking clients to mark their assets to the lowest possible market values, bankers have charged. With their balance sheets depleted by the low valuations, the banks became wary of lending-or so the theory goes.

Perhaps new guidance issued yesterday by PCAOB will help make auditors feel more secure in the rapidly evolving world of fair value.  Following hard on the heels of the April 9 issuance trio of Financial Accounting Standards Board staff alerts amending FASB’s controversial standard No. 157, Fair Value Measurements, the PCAOB has issued an alert purporting to guide auditors through their own new fair-value responsibilities.

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One of the FASB staff alerts concerns how companies should gauge fair value when market activity has largely shut down and when transactions shouldn’t be deemed “orderly” and thus appropriate to be marked to market. A second guidance, which divided the credit and noncredit components of impaired debt securities that are not expected to be sold, tells issuers that mark their assets to market how recognize and present other than temporary impairments. A third FASB alert instructs financial statement preparer about how to measure the fair value of financial instruments between quarters.

In yesterday’s PCAOB alert, the accounting oversight board acknowledges the tough task auditors face in assessing the measurement processes of their clients when they try to mark illiquid assets to market.

Under previous auditing rules, auditors must obtain a grasp of how their client companies determine fair value measurements. Contingent on whether the auditor finds a significant enough risk of material misstatement to go forward, the auditor should test the entity’s mark-to-market measurements.

But there’s “a wide range of possible fair value measurements, from relatively simple to complex,” the board notes. Also, there are various levels of risk that a material misstatement can stem from companies’ processes for measuring fair values. As a result “the auditor’s planned audit procedures can vary significantly in nature, timing, and extent,” according to the new alert.

 Among other things, the PCAOB notes, auditors can test management’s major assumptions and companies’ valuation models and their underlying data. Auditors can also develop independent fair-value estimates to corroborate what management says. Or they can review later events and transactions to gauge the effectiveness of their clients’ methods.