Auditing Fair Value Estimates: The Effect of Management’s Supporting Evidence on Auditors’ Assessments of Aggressive Assumptions

• In Event: Auditing Estimates

Abstract

This study examines whether the presentation format of the evidence that management provides as support for a complex fair value estimate affects auditors’ reasonableness assessments of aggressive underlying assumptions. One hundred fifty-four practicing audit partners and managers participated in a case involving the annual impairment analysis of an intangible asset. As part of the audit of the impairment testing, participants were asked to assess the reasonableness of management’s key assumptions used to estimate the fair value of the asset. Relying on Construal Level Theory, we predict and find that auditors assess the aggressive assumptions as less reasonable when the evidence is presented in a graphical format as compared to a word format. Additionally, we find that a simple judgment framework in which auditors are asked to consider how management arrived at a particular assumption encourages auditors to take into consideration information that is inconsistent with management’s assumptions, leading to lower reasonableness assessments of those aggressive assumptions. Further, we find that auditors who complete the how judgment framework provide the lowest reasonableness assessments of the aggressive assumptions, as well as the highest likelihood that the asset is impaired, when the evidence provided by management is presented graphically. These results inform auditors, investors, and regulators concerned about the audit of complex fair value estimates.

Authors

• Ann Backof, University of Virginia

• Jane Miller Thayer, The University of Georgia

• Tina Carpenter, The University of Georgia