PCAOB Mulls New Fair-Value Rules

The PCAOB contemplates new rules for how auditors review fair-value assessments.
Sarah JohnsonOctober 12, 2009

For the past couple of years, regulators have nudged auditors to get more skeptical when it comes to evaluating fair-value measurements. In the meantime, the controversial accounting rules governing how companies apply fair value have been tweaked and companies’ use of judgment for assigning fair-value price estimates to their financial instruments has grown.

The Public Company Accounting Oversight Board is dipping into contentious waters again by suggesting that new fair-value auditing rules are necessary. The board’s staff has long contended that the use of estimates based on market value — rather than historical cost — adds uncertainty and subjectivity to financial reporting and an added risk of material misstatements. At the same time, the regulator has been slow-footed on previous attempts to change its rules when it comes to auditing fair-value calculations.

Later this week, the PCAOB will ask its advisory board to consider whether the board should create new rules, such as guidance for reviewing the work of specialists who are hired by either a company or its accounting firm to make technical valuations. Other changes could include a directive for the auditors to specifically consider whether a company’s explanations for its estimates are forthcoming and understandable. And the PCAOB may list factors that auditors should consider for deciding the level of veracity attached to a fair-value measurement, such as the degree of judgment involved and how susceptible the calculation is to management’s manipulation or override.

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Under the current guidance, “some auditors may not be exercising sufficient professional skepticism when performing audit procedures and evaluating results in higher risk areas of the audit,” the PCAOB’s staff wrote in a briefing paper for the upcoming two-day Standing Advisory Group meeting.

More than two years ago, before the financial crisis, the SAG discouraged the PCAOB from creating a new fair-value auditing standard. Instead, the SAG members said, education was the way to go for auditors so as to get more comfortable evaluating whether companies have made the right choices in their valuations. Education would also enable auditors to expand their technical know-how on how to deal with complex estimates of assets and liabilities that are thinly traded or not at all, the advisory group said.

Now, however, the PCAOB believes that “it is appropriate to have another discussion due to auditing challenges associated with auditing fair value in the current economic environment,” the staff wrote in the 17-page briefing paper.

Indeed, the task of evaluating estimates that were based on models, rather than publicly available market data, may be harder now than when the PCAOB first began discussing how to address the increased use of fair-value accounting. In today’s financial market, the PCAOB noted, “it may be more challenging for auditors to obtain observable evidence that supports an estimate of what a hypothetical market participant would pay for an asset at the measurement date.”

While the board hasn’t changed its fair-value rules recently, it has kept its focus on the subject by issuing staff alerts and criticisms of accounting firms its inspectors believe should have been more inquisitive about experts’ fair-value calculations and the data companies give to valuation specialists.

Indeed, the use of specialists will be part of the discussion at the SAG meeting this week. The board will ask its advisers if it should bolster its related rules. The PCAOB has said auditors need to evaluate the relationships between companies and their specialists, understand specialists’ methods and assumptions, and test the data that the issuer initially sent to specialists. However, PCAOB inspectors have found that firms are not doing all of those procedures.