4 The purpose of this Auditing Standard is to establish mandatory requirements and to provide explanatory guidance on auditing fair value measurements and disclosures contained in a financial report. In particular, this Auditing Standard addresses audit considerations relating to the measurement, presentation and disclosure of material assets, liabilities and specific components of equity presented or disclosed at fair value in a financial report. Fair value measurements of assets, liabilities and components of equity may arise from both the initial recording of transactions and later changes in value. Changes in fair value measurements that occur over time may be treated in different ways under different financial reporting frameworks. For example, some financial reporting frameworks may require that such changes be reflected directly in equity, while others may require them to be reflected in income.
5 While this Auditing Standard establishes mandatory requirements and provides explanatory guidance on auditing fair value measurements and disclosures, audit evidence obtained from other audit procedures also may provide audit evidence relevant to the measurement and disclosure of fair values. For example, inspection procedures to verify existence of an asset measured at fair value also may provide relevant audit evidence about its valuation (such as the physical condition of an investment property).
6 Under ASA 500 Audit Evidence, the auditor needs to use assertions in sufficient detail to form a basis for the assessment of risks of material misstatements and the design and performance of further audit procedures in response to the assessed risks. Fair value measurements and disclosures are not in themselves assertions, but may be relevant to specific assertions, depending on the applicable financial reporting framework.
7 The auditor shall obtain sufficient appropriate audit evidence that fair value measurements and disclosures are in accordance with the entity’s applicable financial reporting framework.
8 Under ASA 315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement, the auditor needs to obtain an understanding of the entity’s applicable financial reporting framework.
9 Management is responsible for making the fair value measurements and disclosures included in the financial report. As part of fulfilling its responsibility, management needs to establish an accounting and financial reporting process for determining the fair value measurements and disclosures, select appropriate valuation methods, identify and adequately support any significant assumptions used, prepare the valuation and ensure that the presentation and disclosure of the fair value measurements are in accordance with the entity’s applicable financial reporting framework.
10 Many measurements based on estimates, including fair value measurements, are inherently imprecise. In the case of fair value measurements, particularly those that do not involve contractual cash flows or for which market information is not available when making the estimate, fair value estimates often involve uncertainty in both the amount and timing of future cash flows. Fair value measurements also may be based on assumptions about future conditions, transactions or events whose outcome is uncertain and will therefore be subject to change over time. The auditor’s consideration of such assumptions is based on information available to the auditor at the time of the audit and the auditor is not responsible for predicting future conditions, transactions or events which, had they been known at the time of the audit, may have had a significant effect on management’s actions or management’s assumptions underlying the fair value measurements and disclosures. Assumptions used in fair value measurements are similar in nature to those required when developing other accounting estimates. ASA 540 Audit of Accounting Estimates provides guidance on auditing accounting estimates. This Auditing Standard, however, addresses considerations similar to those in ASA 540 as well as others in the specific context of fair value measurements and disclosures in accordance with an applicable financial reporting framework.
11 Different financial reporting frameworks require or permit a variety of fair value measurements and disclosures in a financial report. They also vary in the level of guidance that they provide on the basis for measuring assets and liabilities or the related disclosures. Some financial reporting frameworks give prescriptive guidance, others give general guidance, and some give no guidance at all. In addition, certain industry-specific measurement and disclosure practices for fair values also exist. While this Auditing Standard establishes mandatory requirements and provides explanatory guidance on auditing fair value measurements and disclosures, it does not address specific types of assets or liabilities, transactions, or industry-specific practices. Appendix 1 discusses fair value measurements and disclosures under different financial reporting frameworks and the prevalence of fair value measurements, including the fact that different definitions of “fair value” may exist under such frameworks. For example, Australian Accounting Standard AASB 139 Financial Instruments: Recognition and Measurement, defines fair value as “the amount for which an asset could be exchanged or a liability settled, between knowledgeable, willing parties in an arm’s length transaction”.
12 In most financial reporting frameworks, underlying the concept of fair value measurements is a presumption that the entity is a going concern without any intention or need to liquidate, curtail materially the scale of its operations, or undertake a transaction on adverse terms. Therefore, in this case, fair value would not be the amount that an entity would receive or pay in a forced transaction, involuntary liquidation, or distress sale. An entity, however, may need to take its current economic or operating situation into account in determining the fair values of its assets and liabilities if prescribed or permitted to do so by its financial reporting framework and such framework may or may not specify how that is done. For example, management’s plan to dispose of an asset on an accelerated basis to meet specific business objectives may be relevant to the determination of the fair value of that asset.
13 The measurement of fair value may be relatively simple for certain assets or liabilities, for example, assets that are bought and sold in active and open markets that provide readily available and reliable information on the prices at which actual exchanges occur. The measurement of fair value for other assets or liabilities may be more complex. A specific asset may not have an active market or may possess characteristics that make it necessary for management to estimate its fair value (for example, an investment property or a complex derivative financial instrument). The estimation of fair value may be achieved through the use of a valuation model (for example, a model premised on projections and discounting of future cash flows) or through the assistance of an expert, such as an independent valuer.
14 The uncertainty associated with an item, or the lack of objective data may make it incapable of reasonable estimation, in which case, the auditor ordinarily considers whether the auditor’s report needs modification to comply with ASA 700 The Auditor’s Report on a General Purpose Financial Report.