Fair value measurements (FVMs) and asset impairment testing were among the most prevalent deficiencies found in audits in the wake of the economic crisis of 2008. Consulting firm Acuitas Inc. gives tips on how to mitigate some of the more common trouble spots:
Examine
projected financial information (PFI) assumptions. Assess
the reasonableness of improved margins and the change in weights
assigned to various indications of value. Do not use PFI from a period
prior to a reorganization. Evaluate the reasonableness of assumptions
relating to revenue growth rates; capital expenditures; terminal
growth rates and discount rates; customer attrition rates; the risk
premium in the issuer’s weighted average cost of capital; and any
significant difference between value indications from market and
income approaches. Regarding impairment, test the model, inputs, and
assumptions used to value a loan portfolio in connection with goodwill
impairment analysis.
Adequately
comprehend FVM pricing methods. FVM deficiencies can result
from the use of poor pricing methods. Examine models and assumptions
used by pricing services or valuation specialists. Ensure that the
correct yield or discount rate applicable to the securities is used;
investigate major differences between prices from different sources
and adjustments made to third-party prices by issuers.
Look
for weaknesses in testing. Test the assertion that there
was no material change in value during interim testing, data provided
to outside valuation specialists, and all items in a selected sample.
Perform substantive tests and do not place sole reliance on internal
controls or internal audit findings.
Look
for weaknesses in FVM hierarchy disclosure testing.
Identify and test controls over FVM hierarchy disclosures and test
Level 2 and Level 3 FVM hierarchy classifications. Ensure an
assessment is completed of whether an input is observable or
unobservable when testing the FVM hierarchy classification.
Investigate
and test controls over inputs to FVMs. Examine resolutions
of pricing differences, the budgetary process, and classification of
securities available for sale. Do not set risk thresholds too high, so
as to obscure material errors. Be sure to identify weaknesses due to
lack of supervision by qualified personnel in testing of hard-to-value
financial instruments.
Examine
other-than-temporary impairments (OTTI). Test controls over
classification of securities as OTTI and the issuer’s evaluation of
securities as potentially OTTI. Evaluate assumptions, calculations,
and completeness of an issuer’s OTTI test.
Identify
weaknesses in risk assessment and controls. Examine whether
there was a failure to test asset impairment. Assess and identify
deficiencies in the issuer’s methodology for determining fair value of
reporting units and whether the timing of the impairment charge was
appropriate. Identify deficiencies in controls related to triggering
events. Test the issuer’s assertion that assets weren’t impaired,
ignoring evidence that triggering events had occurred.
Identify
asset mismatches. Identify mismatches between the group of
assets being tested for impairment and the group of assets included in
the calculation of carrying value. Identify an issuer’s departure from
GAAP by allocating goodwill to reporting units.
For more, see Acuitas Inc.’s Survey of Fair Value Audit Deficiencies, which is available at tinyurl.com/9w9gzs3.
—By Morris E. Harris, CPA, CGMA (
mharris@aicpa.org
), an AICPA manager for member specialization and credentialing.
