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A New Framework and Credential for Financial Instrument Valuation

Global accounting standards increasingly call for financial measurements and disclosures that comply with a defined measurement objective, such as fair value.  Additionally, financial instruments are becoming increasingly complex in their terms, conditions, and structure.  As a result, the AICPA has announced the creation of a new Disclosure Framework for the Valuation of Financial Instruments (the “DF-FI”) and a new professional credential relating to financial instruments called the CVFI (Certified in Valuation of Financial Instruments).  The financial instruments covered by the new framework include securities such as equities, debt, derivatives, hybrid securities, structured products, and other assets or liabilities that meet the definition of a financial instrument. An Exposure Draft of the DF-FI  was published in June 2017.

The DF-FI provides guidance on the level of documentation necessary for a professional working with securities and financial instruments to effectively demonstrate the valuation performed. Valuation professionals who have earned the CVFI credential will be required to adhere to the DF-FI.  Further, the AICPA task force which developed the DF-FI believes that adhering to the DF-FI should be considered best practice by any valuation professional that performs fair value measurements of financial instruments.

According to its authors, the DF-FI provides benefits to both valuation professionals and the users of financial reports (including entity management, auditors, and external stakeholders).

Valuation professionals receive:

  • A method to align a valuation engagement with procedures that meet the needs of the client in response to greater regulatory scrutiny
  • A resource to identify and mitigate ineffective, inefficient, or incomplete valuation procedures in order to achieve sufficient support for, and auditability of, the final conclusion of value
  • A resource for the valuation review process.

Users of financial reports receive:

  • Greater confidence that valuations will meet the entity’s internal and external reporting requirements.
  • Greater confidence in the valuation professional’s process, analysis, and documentation.
  • Greater understanding of inputs, estimates, and industry information used in the valuation
  • Greater consistency in documentation among valuation professionals.

One overall goal of the documentation requirements of the DF-FI is to enable an experienced professional not involved in the valuation engagement to “understand the significant inputs, analyses, and outputs and how they support the final conclusion of value.”  The exposure draft of the DF-FI sets forth the minimum scope of work and documentation requirements for valuation professionals.

The DF-FI defines two types of documentation – source documents and analysis documents.  Source documents that provide evidence contrary to the concluded value must be explained and included in the final report.  Analysis documents (such as spreadsheets and computations) are required to be saved as part of the work file and should be included in the final report if applicable.

Regarding the extent of documentation requirements, valuation professionals complying with the DF-FI must provide sufficient documentation that would allow an experienced professional (who may or may not be a valuation professional) to:

  • Identify the subject financial instrument
  • Understand the standard of value
  • Understand the purpose, nature, scope, and results of valuation procedures used
  • Understand all approaches and methods used, and understand why commonly used approaches and methods were not used (if applicable)
  • Understand inputs, judgments, and assumptions made, and the sources and supporting data for the inputs, judgment, and assumptions made
  • Identify relevant market information used
  • Understand key risk factors considered
  • Determine who performed the work and their qualifications
  • Identify intended users of the report
  • Identify the sources and supporting data for the inputs, judgments, and assumptions made
  • Identify the measurement date

The exposure draft also identifies the required components of engagement letters, document requirements for conducting management interviews, and the narrative components required for the final report.

A secondary document issued by the AICPA concurrently with the DF-FI is the Application of the Disclosure Framework for the CVFI. The Application document applies the DF-FI to selected areas of professional valuation practice that are misapplied or insufficiently supported or documented (or all) in valuations prepared in compliance with specific measurement objectives. The Application document also identifies and applies the DF-FI to the most common components of financial instrument valuation engagements, including cash flows, discount rate derivation, risk-neutral models, and valuations of specific types of securities.

At this time, the DF-FI has not been finalized and the exact qualifications and requirements to attain the CVFI credential have yet to be announced.  We will continue to monitor developments surrounding this new professional credential and believe that it will ultimately benefit both clients and their stakeholders via a higher level of consistency and quality in the work product.

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Mercer Capital monitors the latest financial reporting news relevant to CFOs and financial managers. The Financial Reporting Blog is updated weekly. Follow us on Twitter at @MercerFairValue.