PCAOB Inspection Scrutiny of Fair Value Measurement Continues

Fair value measurement has been a hot topic during the last few years, increasingly attributable to PCAOB identified audit deficiencies and heightening scrutiny over the existing fair value framework and related auditing standards.  In this post, we take a look at the causes of attention and recent responses from professionals and professional organizations.

The Public Company Accounting Oversight Board (PCAOB) originated in 2002 with the passing of the Sarbanes-Oxley Act as a response to widespread accounting scandals such as Enron, Tyco, and WorldCom, among others.  The PCAOB is regulatory board reporting to the SEC with objectives to conduct inspections on auditors of public companies on the effectiveness of the firm’s quality control policies and procedures in order to protect investors and the public through the preparation of accurate and transparent audit reports.  Two key provisions are Section 302, which requires management to certify the accuracy of the reported financial statement, and Section 404, which requires that management and auditors establish internal controls and reporting methods on the adequacy of those controls.

On August 30, 2017, the PCAOB issued a staff inspection brief regarding forthcoming 2017 inspections. The brief is intended to help investors, auditors, and others understand the areas of significant audit risks targeted by PCAOB inspectors and encourage auditors to work to improve audit quality.  According to the brief, the key areas of inspection focus will include:

• Recurring audit deficiencies (including fair value measurements) – areas in which the most frequent and recurring audit deficiencies were identified in previous inspections, including procedures performed related to the audit of internal control over financial reporting, assessing and responding to risks of material misstatement, and auditing accounting estimates.
  • Deficiencies in this area related to evaluating impairment analyses for goodwill and other long-lived assets, and the valuations of assets and liabilities acquired in business combinations. Inspections staff continues to take a close look at auditors’ procedures performed to understand how estimates were developed as well as auditors’ testing of data and evaluation of the assumptions used by management that are significant to the estimate.
• Economic factors – areas affected by recent economic development, including the high rate of merger and acquisition activity and business combinations, low interest rate environment, and the fluctuations in oil and natural gas prices.

As noted by Compliance Week, analysis by Acuitas indicates that the PCAOB identified deficiencies in 31.6% of audits inspected in 2015, down from 39.2% in 2014 and 42.9% in 2013.

The same research found that in 2015, 31.0% of audit deficiencies were attributable to fair value measurements and impairment, up from the 25.9% of total deficiencies in 2014.  The increase in business combinations (i.e. higher merger and acquisition activity) has impacted the frequency and need for financial reporting of fair value measurement.  In 2015, 68.0% of fair value measurement deficiencies were due to business combinations, up from 56.0% in 2014.

In response to the significant number of deficiencies identified in reviewed audits and the increased prevalence/significance of accounting estimates, the PCAOB has issued proposals to strengthen requirements for an auditor’s use of the work of specialists and for auditing accounting estimates, including fair value measurements.  The proposal can be found here. Highlights include:

• Adding explicit requirements for auditors to test and evaluate the work of company specialists.
• The proposal on using the work of specialists would expand the requirements for evaluating the work of a company’s specialist and apply a risk-based approach to supervising and evaluating the work of specialists employed or engaged by the auditor.
• The proposal on estimates would amend auditing standards and create a uniform approach for auditing estimates that would incorporate procedures auditors currently are required to perform for fair value measurements.

As fair value measurement has become an area of concern, professional organizations such as the American Institute of Certified Public Accountants (AICPA), the  American Society of Appraisers (ASA) and the Royal Institute of Chartered Surveyors (RICS) have responded through the creation of a Certified in Entity and Intangible Valuations (CEIV) credential, which we have written about previously.

Mercer Capital provides a comprehensive suite of valuation services to assist boards of directors, portfolio managers, financial managers, and others with financial reporting requirements.  In an environment of increasingly complex fair value reporting standards and burgeoning regulatory scrutiny, Mercer Capital helps clients resolve financial reporting valuation issues successfully.  We have the capability to serve the full range of fair value valuation needs, providing valuation opinions that satisfy the scrutiny of auditors, the SEC, and other regulatory bodies.  We also have broad experience with fair value issues related to public and private companies, financial institutions, private equity firms, start-up enterprises, and other closely held businesses.  National audit firms consistently refer financial reporting valuation assignments to Mercer Capital.