Auditing Challenging Fair Value Measurements: Evidence from the Field

• In Event: Auditing of Complex Estimates

Abstract

The increasing prevalence and complexity of fair value measurements (FVMs) is one of the major challenges currently facing the auditing profession. We examine auditors’ experiences in specific engagements for which auditing FVMs was particularly challenging, identifying several key issues. First, respondents often note the difficulties inherent in auditing significant and/or complex management assumptions, especially where subjectivity and uncertainty are high. Second, although we observe an overall positive association between inherent risk and estimation uncertainty, inherent risk assessments for some FVMs are low/moderate even when the range of estimation uncertainty equals or exceeds materiality (as it does in the large majority of our sample). Inherent risk assessments are also higher for Level 3 FVMs and accelerated filer companies. Third, auditors use valuation specialists more frequently than clients, and the key factor driving the auditor’s use of a specialist is whether the client is employing one. Lastly, auditor responses suggest that high estimation uncertainty and subjective management assumptions are largely responsible for the low rates of audit adjustments we observe, as auditors have difficulty proving that their assumptions and estimates are more accurate than the client’s. We further find that proposal of decreasing audit adjustments in our sample are always supported by testing management’s model, assumptions, and data, and are also more frequent when auditors develop their own independent estimate. Decreasing adjustments are less frequent for financial instruments compared with other FVMs. Together, our results suggest that major challenges face the auditing profession in providing positive assurance when risks of FVMs may be irreducible.

Authors

• Nathan Hatch Cannon, Texas State University

• Jean C Bedard, Bentley University