Auditors fair value checks ‘inadequate’

It’s almost as if they were coordinated. In the week that the UK’s Audit
Inspection Audit goes public, for the first time, with comments about the flaws
in home grown audits, its US counterpart issues its own four-year report.

The warning from the US watchdog is stark. It continues to find deficiencies
in ‘important audit areas’ that it describes as ‘critical and high-risk’ ­ such
as revenue, fair value, management’s estimates and determination of materiality
and audit scope.

But amid the current ‘credit crunch’ and economic crisis, the most damning
criticism is the fair value problem. In passages that will no doubt fuel the
debate over fair value, the
PCAOB says it came across
significant problems. There are those that blame fair value for the crisis still
gripping financial markets and the observations of the US regulator will give
them ammunition.

Testing management’s fair value estimates of company assets was the major
issue. The report says: ‘For example the inspectors identified instances where
significant assumptions, such as the future revenue growth rate, operating
margins, discount rates and terminal values, were either not tested at all or
were tested only through discussions with management.’

The PCAOB then adds the damning line: ‘In some of these situations
management’s assumptions were that revenues would increase significantly in the
near future despite evidence to the contrary, such as recent declining revenue
trends or known increases in competition in the issuer’s industry.’

Critics will say inflated prices are a direct result of using fair value.
Wayne Abernathy, executive vice president of the
American Bankers
and a former assistant Treasury secretary, told Accountancy
in November that mark-to-market inflates prices for company assets in
an upswing.

‘People a year ago were saying why does the price of energy keep going up?
Because mark-to-market makes it look good,’ Abernathy said.

However, that PCAOB line just about saves fair value from its critics,
because it could be argued that it was not the principle that was faulty, but
its use. Guns don’t kill people, as they say, people kill people.

However, it could give critics the opportunity to ask what the point is in a
standard that is not properly enforced by auditors? More to the point, it will
fuel condemnation of auditors for their role in the credit crunch.

Of course, the PCAOB was not inspecting all audit firms, only eight. And the
comments will not apply to all of them. So it’s reasonable to assume some of the
auditing went perfectly well.

The Securities and Exchange Commission is currently reviewing the use of fair
value in the US
an examination triggered by the first rescue package pushed through Congress by
Treasury secretary Hank Paulson.

Many of those who have taken part in the SEC review have defended fair value.
The PCAOB report might just help those who want to see it go.

Firms subject to annual inspection 2004-2008

BDO Seidman LLP
Crowe Chizek and Company LLC
Deloitte & Touche LLP
Ernst & Young LLP
Grant Thornton LLP
McGladrey & Pullen LLP
PricewaterhouseCoopers LLP.

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