The Auditor's Approach to Fair Value: SAS No. 101 Expands Auditors' Role in Assessing Fair Value Measurements
The auditing standards board (ASB) issued Statement on Auditing Standards (SAS) no. 101, Auditing Fair Value Measurements and Disclosures, in January. The standard, which is effective for audits of financial statements for periods beginning on or after June 15, contains significantly expanded guidance for auditing fair value measurements and disclosures. This article will help practitioners understand its more significant aspects. The requirement to measure some financial statement items at fair value has been in the accounting literature for many years, but until now, the source of general auditing guidance has been SAS no. 57, Auditing Accounting Estimates. Fair value estimates differ from other accounting estimates because when market prices are not available management must estimate fair value using an "appropriate" approach and assumptions that reflect those that individuals in the marketplace would make. This unique aspect, combined with an increase in the number of accounting standards that require fair value measurements and disclosures, the complexity of some of those measurements and their significance to the financial statements, requires auditing guidance that is specific to such measurements. It's important to note that while SAS no. 101 (see Official Releases, page 103) provides a general framework for auditing fair value measurements and disclosure, it does not establish detailed guidance for auditing specific types of fair value estimates. Instead, the SAS provides guidance on understanding management's process for developing fair value estimates and evaluating whether the measurement conforms to generally accepted accounting principles (GAAP). Consequently, the auditor evaluates the significant assumptions, considers the appropriateness of the valuation model and tests the underlying data. The auditor does this even when management uses a valuation specialist to prepare the estimate. KNOW THE BASICS Understanding how management develops its FVM&D is a critical first step that gives the auditor a foundation for designing auditing procedures. The auditor bases this understanding on his or her knowledge of * The experience and expertise of the personnel involved in the measurement. * The significant assumptions and data management used to develop the estimate. * How management identified and used relevant market information when developing assumptions. * How management monitored changes in the assumptions. * The extent to which management used a specialist to develop the fair value estimate. The auditor also must understand GAAP requirements for the particular fair value estimate. This can be a challenge because GAAP does not specify methods or processes for measuring items at fair value. Rather, GAAP indicates that fair values must be based on observable (for example, quoted) market prices. If observable market prices are not available, the techniques management uses for estimating fair value measurements should incorporate assumptions that individuals in the marketplace would use. If that information is not available, then GAAP permits an entity to use its own assumptions as long as there is no indication marketplace participants would use different assumptions. WHEN MANAGEMENT USES A VALUATION SPECIALIST Many recent important accounting pronouncements, including FASB Statement no. 141, Business Combinations, and FASB Statement no. 142, Goodwill and Other Intangible Assets, require the use of fair value estimates. This trend likely will continue, encouraging more entities to consult with valuation professionals who specialize in fair value measurements. While GAAP does not require management to engage an outside specialist to perform fair value measurements, many entities do so either because they do not have employees who can perform high-quality fair value measurements or because they want the objectivity, professional experience and skills of an outside specialist. …