The Public Company Accounting Oversight Board (PCAOB) is currently soliciting public feedback on the need for changes to auditing standards on the use of accounting estimates and fair value measurements. The preliminary effort may lead to a universal standard for issues that have grown more complex in recent years and been the subject of several amendments to U.S. Generally Accepted Accounting Principles (GAAP).
Estimates and fair value measurements create uncertainty
Accounting estimates may be based on subjective or objective information (or both) and involve some level of measurement uncertainty. Some estimates may be easily determinable, but many are inherently subjective or complex. Examples of accounting estimates include allowances for doubtful accounts, impairments of long-lived assets and valuations of financial and nonfinancial assets.
Fair value measurements are another type of accounting estimate. Under GAAP, a fair value measurement represents “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”
Accounting estimates and fair value measurements involve a high degree of subjectivity and judgment and may be more susceptible to misstatement. Therefore, they require more auditor focus.
Auditing standards generally provide three approaches for substantively testing accounting estimates and fair value measurements. When performing an audit, the auditor selects one or a combination of these approaches:
Test management’s process. Auditors evaluate the reasonableness and consistency of management’s assumptions, as well as test whether the underlying data is complete, accurate and relevant.
Develop an independent estimate. Using management’s assumptions (or alternate assumptions), auditors come up with an estimate to compare to what’s reported on the internally prepared financial statements.
Review subsequent events or transactions. The reasonableness of estimates can be gauged by looking at events or transactions that happen after the balance sheet date but before the date of the auditor’s report.
Regulators seek public input
PCAOB Chairman James Doty recently said, “Accounting estimates and fair value measurements can be subjective and complex, yet they can be an important part of a company’s financial statements and critical to investors’ decision-making.” Accounting regulators have had these complex issues on the agenda for a number of years, because they’ve proven challenging to auditors, leading to significant audit deficiencies by firms of all sizes. Auditors often blame these deficiencies on inconsistencies in the existing auditing standards.
In August, the PCAOB Standing Advisory Group (SAG) published a staff consultation paper as part of its outreach efforts to seek input related to the need for changes to auditing standards for accounting estimates and fair value measurements.
Currently, a number of auditing standards address how auditors consider accounting estimates, fair value measurements, derivatives and investments in securities. While the staff continues to analyze a number of alternatives, it’s considering developing a single auditing standard to replace the following standards:
- AU Section 342, Auditing Accounting Estimates,
- AU Section 328, Auditing Fair Value Measurements and Disclosures, and
- Certain or all requirements of AU Section 332, Auditing Derivative Instruments, Hedging Activities, and Investments in Securities.
A potential new standard would strive to promote greater consistency and effectiveness in application and be better aligned with the risk assessment standards.
PCAOB wants your input
Public company and foreign audit regulators have identified auditing requirements related to the use of accounting estimates and fair value measurements as areas of continued concern. The PCAOB wants your feedback on its staff consultation paper by November 3. Public input could eventually lead to a single, consistent auditing standard that simplifies and strengthens current auditing practices.
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