3 Ways to Test Fair Value Measurements
Measuring accounting estimates involves some level of uncertainty. As a result, accounting estimates — such as allowances for doubtful accounts, impairments of long-lived assets, and valuations of financial and nonfinancial assets — require extra attention from auditors. Here’s a closer look at the current standards for auditing estimates and examples of specialists who may be hired to provide independent estimates.
Applying the auditing standards
Some estimates may be easily determinable, but many are inherently subjective or complex. Auditing standards generally provide three approaches for substantively testing fair value measurements and other accounting estimates:
- Testing 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.
- Developing an independent estimate. Using management’s assumptions (or alternative assumptions), auditors come up with an estimate to compare to what’s reported on the internally prepared financial statements.
- Reviewing 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.
Independence guidelines generally prohibit auditors from providing certain services for their public audit clients. To obtain independent accounting estimates, companies often turn to outside specialists.
Relying on specialists
Examples of specialists used to prepare accounting estimates include:
- Actuaries to determine employee benefit obligations,
- Engineers to determine obligations regarding environmental remediation,
- Appraisers to determine the value of intangible assets or real estate,
- Geologists to estimate mineral deposits or oil reserves for mining and energy companies, and
- Lawyers to forecast the potential losses from a legal proceeding.
Auditors often help direct these specialists to minimize the risk of misstatement, especially when specialists aren’t subject to the audit firm’s training, resources and quality control systems.
Business transactions have grown more complicated in recent years, leading companies to make a significant number of subjective estimates and rely more heavily on outside parties to bring in specialized knowledge. We understand how to apply the auditing standards to accounting estimates made in-house and/or using outside specialists. Contact us for additional information.
James L. Noteman, CPA
With more than 30 years of experience in public accounting, Jim Noteman is relied on by a wide range of clients for his audit and advisory expertise. Since joining Moore Stephens Doeren Mayhew in 1999, Jim’s focus has been on assisting clients in the manufacturing, distribution and retail industry sectors, as well as multi-national corporations. Contact Jim at email@example.com or (248) 244-3250.