PCAOB Staff Alert Advises Auditors on Impact of FASB Guidance on Fair Value Accounting
A recent PCAOB staff practice alert instructs auditors to evaluate whether a firm’s financial statement disclosures are in conformity with recent FASB guidance on mark-to-market fair value accounting. Also, depending upon the circumstances, the implementation of the guidance may present matters that the auditor should communicate to the audit committee. (Staff Audit Practice Alert No. 4).
New FAS 157-e affirmed that the objective of fair value when the market for an asset is not active is the price that would be received to sell the asset in an orderly transaction, not a forced liquidation or distressed sale, between market participants at the measurement date under current inactive market conditions. FASB also adopted guidance providing a clearer benchmark for when an other-than-temporary impairment exists and needs to be recorded on securities held outside of a firm’s trading book, and to transparently disclose the amount of the impairment directly associated with probable cash flow declines.
The practice alert advised auditors to evaluate whether disclosures in the financial statements being audited are in conformity with the disclosures required by the FASB guidance. FAS 157-4 requires the disclosure of changes in valuation techniques and related inputs for fair value measurements in interim and annual periods. FAS 115-2 requires disclosure enabling users to understand the reasons that a portion of other than temporary impairment was not recognized in earnings and the methodology and significant inputs used to calculate the portion recognized in earnings.
In addition, the Board staff advised auditors to read the MD&A accompanying the interim financial statements filed with the SEC since the MD&A and other filings might include discussions regarding fair value measurements and other than temporary impairment. Auditors should consider whether that information or the manner of its presentation is materially inconsistent with the financial statements. If the auditors conclude that there is a material inconsistency, or become aware of information they believe is a material misstatement of fact, the auditors should determine if the financial statements, the audit report, or both require revision.
Under FAS 157-4, revisions resulting from a change in the valuation technique are to be accounted for as a change in accounting estimate in the period of adoption. Firms are required to disclose a change, if any, in valuation technique and related inputs and quantify the total effect, if practicable, by major category. In addition, FAS 115-2 requires the company to recognize the cumulative effect of initially applying the guidance as an adjustment to the opening balance of retained earnings, as of the beginning of the period in which FAS 115-2 is adopted, with a corresponding adjustment to accumulated other comprehensive income.
The PCAOB staff advised auditors to evaluate whether the company's accounting for and disclosure of the changes are in accordance with the FASB guidance. To identify consistency matters that might affect the audit report, continued the alert, auditors should evaluate whether the comparability of the financial statements between periods has been materially affected by changes in accounting principles. The staff indicated that a change in accounting principle that has a material effect on the financial statements should be recognized in the audit report through the addition of an explanatory paragraph following the opinion paragraph.
More broadly, the staff alert advised that, in considering the effects of the FASB guidance on their audits and reviews, auditors should be aware that some PCAOB standards include descriptions of accounting requirements that are no longer current. The accounting standards set by the FASB are recognized by the SEC as generally accepted, continued the Board staff, and auditors should look to those standards and to the requirements of the SEC, rather than the standards of the PCAOB, for current accounting requirements and disregard descriptions of accounting requirements in PCAOB standards that are inconsistent with the recent FASB guidance.
It is axiomatic that the PCAOB has no authority to prescribe the form or content of an issuer's financial statements. Thus, while the staff audit practice alert describes applicable GAAP, it neither establishes nor interprets GAAP. The staff also noted that the PCAOB has a project on its standards-setting agenda to address the auditing standards related to auditing accounting estimates and auditing fair value measurements. In connection with this project, the PCAOB is planning to remove descriptions of accounting requirements from these standards.