Amid the abundant press coverage of the Public Company Accounting Oversight Board’s approval last week of the first major changes in the auditor’s report in 70 years, news of two PCAOB proposals launched at the same time might well have been overlooked.
Aimed at minimizing the effects on audits of management biases in making accounting estimates, the proposals concern audits of fair value and other estimates and the use of specialists in that work. The PCAOB set an Aug. 30 deadline for public comment on both proposals.
In the first proposal, the board aims to stiffen the auditors’ skepticism when they audit the accounting estimates, including fair-value measurements, of their corporate clients. “The subjective assumptions and measurement uncertainty of accounting estimates make them susceptible to management bias,” according to the proposed standard.
Further, accounting estimates are becoming more widespread and important “as financial reporting frameworks continue to evolve and require greater use of estimates, including those based on fair-value measurements,” according to the PCAOB.
The proposed standard, which would combine provisions set forth in three existing standards in an attempt to make them easier to use, “will drive attention towards the potential for management bias in estimates,” PCAOB member Lewis H. Ferguson noted in a statement.
The measure also calls “for sustained professional skepticism from the auditors when dealing with estimates and fair-value measurements,” Ferguson said.
Specifically, the proposal would extend a number of requirements in the current standard on auditing fair-value estimates “to all accounting estimates to reflect a uniform approach to substantive testing,” according to a fact sheet, which refers to the fair-value audit standards as “the newest and most comprehensive of the existing standards on auditing accounting estimates.”
Although current PCAOB standards “address professional skepticism and management bias, the existing estimates standards are largely silent on how to address those topics in the context of auditing accounting estimates,” according to the proposal.
To help auditors with such issues, the board includes in the proposal a special topics appendix that addresses auditing the fair value of financial instruments, including the use of information from pricing sources.
“[T]he 2008 financial crisis underscored both the importance of and potential challenges associated with developing and auditing certain accounting estimates,” the board says in the proposal. “Among other things, uncertainties in the market and economy during the crisis raised questions about the valuation, impairment, and recoverability of significant categories of assets and the completeness and valuation of significant categories of liabilities reflected in financial statements.”
In a related move, the PCAOB is proposing to amend its standard on the auditor’s use of the work of specialists. “The use of specialists has grown in both frequency and significance as the use of fair-value measurements and other accounting estimates has increased,” the board says in a press release.
“I support the board acting on this proposal as our inspectors have observed auditors too often accepting the findings of specialists without first evaluating their work,” said board member Steven B. Harris.
Many companies use actuaries, reserve engineers, and valuation specialists to provide information that finance and accounting executives use in putting together their financials, especially the parts based on accounting estimates. Auditors also use in-house or outside specialists to help them collect and assess audit evidence.
Among other things, the proposed standard would provide auditors with factors for determining what evidence they need to support their conclusions when they use the work of a specialist to audit a company.