Auditing Fair Value Measurements: A Synthesis of Relevant Research

Abstract

To contribute to the PCAOB project on auditing fair value measurements (FVMs), we synthesize relevant academic literature to offer insights, conclusions, and future research directions for auditors, standard-setters, and academics focusing on auditing FVMs. We structure our synthesis along two dimensions: (1) an emphasis on the auditor's need to understand how FVMs are prepared, and (2) the audit steps and procedures necessary to verify and attest to FVMs, including an awareness of the potential biases inherent in auditing FVMs. Drawing primarily from the judgment and decision-making literature, we highlight a number of potential biases and limitations in the preparation and audit of FVMs. Additionally, we note that the specialized valuation knowledge necessary to effectively audit FVMs will be difficult for auditors to gain and maintain.

Current Practices and Challenges in Auditing Fair Value Measurements and Complex Estimates: Implications for Auditing Standards and the Academy

“…To cope with the challenges of auditing complex FVMs, auditors often turn to pricing services and valuation specialists to evaluate complex finance and economic models (Martin, Rich, and Wilks 2006;Bratten et al 2013;Griffith et al 2015a;PCAOB 2015). However, extensive reliance on pricing services and valuation specialists has led to PCAOB criticisms (e.g., PCAOB 2010a(e.g., PCAOB , 2010b(e.g., PCAOB , 2012a(e.g., PCAOB , 2014bBratten et al 2013).…”

“…Research in the area of auditing FVMs is limited (Martin et al 2006;Bratten et al 2013); however, a number of concurrent studies are underway.…”

Budgeting Audit Time: Effects of Audit Step Frame and Verifiability

“…Consistent with this suggestion, Martin, Rich, and Wilks (2006) warn that the step wording for auditing complex estimates may encourage auditors to search for evidence that corroborates management's assertions, suggesting a possibility that positively worded audit steps in the setting of auditing complex estimates may lead to under-auditing. However, Fukukawa and Mock (2011) do not find a frame effect on risk assessment in valuation assertion testing.…”

Top 10 Wish List for Audit Research

“…It is unlikely going forward that we can rely exclusively on the work of outside specialists if fair-value assertions become endemic to an increasing number of management assertions. Research studying these and other aspects of fair-value accounting would be both welcome and helpful ͑see Martin et al 2006͒.…”