Section Evaluating the Appropriateness of Fair V - ASA 545 - Auditing Fair Value Measurements and Disclosures - April 2006 - Evaluating the Appropriateness of Fair Value Measurements and Disclosures | Zoe
Evaluating the Appropriateness of Fair Value Measurements and Disclosures
23 The auditor shall evaluate whether the fair value measurements and disclosures in the financial report are in accordance with the entity’s applicable financial reporting framework.
24 The auditor’s understanding of the requirements of the applicable financial reporting framework and knowledge of the business and industry, together with the results of other audit procedures, are used to assess whether the accounting for assets or liabilities requiring fair value measurements is appropriate, and whether the disclosures about the fair value measurements and significant uncertainties related thereto are appropriate under the entity’s applicable financial reporting framework.
25 The evaluation of the appropriateness of the entity’s fair value measurements under its applicable financial reporting framework and the evaluation of audit evidence depends, in part, on the auditor’s knowledge of the nature of the business. This is particularly true where the asset or liability or the valuation method is highly complex. For example, derivative financial instruments may be highly complex, with a risk that differing interpretations of how to determine fair values will result in different conclusions. The measurement of the fair value of some items, for example “in-process research and development” or intangible assets acquired in a business combination, may involve special considerations that are affected by the nature of the entity and its operations if such considerations are appropriate under the entity’s applicable financial reporting framework. Also, the auditor’s knowledge of the business, together with the results of other audit procedures, may help identify assets for which management needs to recognise an impairment by using a fair value measurement pursuant to the entity’s applicable financial reporting framework.
26 Where the method for measuring fair value is specified by the applicable financial reporting framework, for example, the requirement that the fair value of a marketable security be measured using quoted market prices as opposed to using a valuation model, the auditor ordinarily considers whether the measurement of fair value is consistent with that method.
27 Some financial reporting frameworks presume that fair value can be measured reliably for assets or liabilities as a prerequisite to either requiring or permitting fair value measurements or disclosures. In some cases, this presumption may be overcome when an asset or liability does not have a quoted market price in an active market and for which other methods of reasonably estimating fair value are clearly inappropriate or unworkable. When management has determined that it has overcome the presumption that fair value can be reliably determined, the auditor, under paragraph 7 of this Auditing Standard, needs to obtain sufficient appropriate audit evidence to support such determination, and whether the item is properly accounted for under the applicable financial reporting framework.
28 The auditor shall obtain audit evidence about management’s intent to carry out specific courses of action, and consider its ability to do so, where relevant to the fair value measurements and disclosures under the entity’s applicable financial reporting framework.
29 In some financial reporting frameworks, management’s intentions with respect to an asset or liability are criteria for determining measurement, presentation, and disclosure requirements, and how changes in fair values are reported within a financial report. In such financial reporting frameworks, management’s intent is important in determining the appropriateness of the entity’s use of fair value. Management often documents plans and intentions relevant to specific assets or liabilities and the applicable financial reporting framework may require it to do so. While the extent of audit evidence to be obtained about management’s intent is a matter of professional judgement, the auditor’s procedures ordinarily include enquiries of management, with appropriate corroboration of responses, for example, by:
considering management’s past history of carrying out its stated intentions with respect to assets or liabilities;
reviewing written plans and other documentation, including, where applicable, budgets, minutes, etc;
considering management’s stated reasons for choosing a particular course of action; and
considering management’s ability to carry out a particular course of action given the entity’s economic circumstances, including the implications of its contractual commitments.
The auditor also ordinarily considers management’s ability to pursue a specific course of action if ability is relevant to the use, or exemption from the use, of fair value measurement under the entity’s applicable financial reporting framework.
30 Where alternative methods for measuring fair value are available under the entity’s applicable financial reporting framework, or where the method of measurement is not prescribed, the auditor shall evaluate whether the method of measurement is appropriate in the circumstances under the entity’s applicable financial reporting framework.
31 Evaluating whether the method of measurement of fair value is appropriate in the circumstances requires the use of professional judgement. When management selects one particular valuation method from alternative methods available under the entity’s applicable financial reporting framework, the auditor, under paragraph 30 of this Auditing Standard, needs to obtain an understanding of management’s rationale for its selection by discussing with management its reasons for selecting the valuation method. Under paragraph 30 of this Auditing Standard, the auditor needs to consider whether:
(a) management has sufficiently evaluated and appropriately applied the criteria, if any, provided in the applicable financial reporting framework to support the selected method;
(b) the valuation method is appropriate in the circumstances given the nature of the asset or liability being valued and the entity’s applicable financial reporting framework; and
(c) the valuation method is appropriate in relation to the business, industry and environment in which the entity operates.
32 Management may have determined that different valuation methods result in a range of significantly different fair value measurements. In such cases, the auditor, under paragraph 30 of this Auditing Standard, needs to evaluate how the entity has investigated the reasons for these differences in establishing its fair value measurements.
33 The auditor shall evaluate whether the entity’s method for its fair value measurements is applied consistently.
34 Once management has selected a specific valuation method, under paragraph 33 of this Auditing Standard, the auditor needs to evaluate whether the entity has consistently applied that basis in its fair value measurement. Under paragraphs 30 and 33 of this Auditing Standard, the auditor needs to consider whether the consistency is appropriate considering possible changes in the environment or circumstances affecting the entity, or changes in the requirements of the entity’s applicable financial reporting framework. If management has changed the valuation method, the auditor ordinarily considers whether management can adequately demonstrate that the valuation method to which it has changed provides a more appropriate basis of measurement, or whether the change is supported by a change in the requirements of the entity’s applicable financial reporting framework or a change in circumstances. For example, the introduction of an active market for a particular class of asset or liability may indicate that the use of discounted cash flows to estimate the fair value of such asset or liability is no longer appropriate.