In the United States, and the rest of the world, for that matter, we are moving towards a fair value basis of financial reporting and accounting.
As examples of the U.S. GAAP requirements for valuation, look at such areas as asset impairment, IPRD, stock options for compensation, lease residuals, financial instruments and many types of liabilities for which the exact amount may be a matter of valuation judgment.
Valuation principles are simple and easily understood. Determining which of many possible appraisal principles and methodologies is most appropriate in a particular situation is not so clear.
Should we use as the premise of value the assumption that the assets would be sold, or do we look at replacement value, assuming that the assets will continue in use? Do we accept management’s forecast and assumptions uncritically, or do we question them closely sometimes requiring changes in such management forecasts? Do we utilize the market comparable approach to value, or is itmore appropriate to utilize the cost approach?
Both for balance sheets and the determination of periodic income, the use of value information is becoming an increasingly important element
Answers to these fundamental valuation questions are often not explicitly spelled out in the final valuation report, and therefore a reader of the report may not realize what the truly key questions should be.
Quite frankly, many auditors, in terms of training and background, do not have the experience or expertise to understand fully the implications of the choice of appraisal assumptions. An accounting firm’s valuation professionals do have this expertise.
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So to sum up, then, we believe that valuation information is becoming an ever more important part of financial reporting. Valuation requires judgment. The judgment calls of an appraiser should be reviewed by those with valuation background.
If the same firm performs a valuation and then audits its own numbers, it is highly likely that the so-called review would be more for form than for substance. Self-review per se is not acceptable in this era when a single penny-per-share change in reported earnings can swing the price of a stock 10 percent or even 20 percent or more.
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When audit firms perform a valuation for their audit client, the valuation fee is usually non-competitive. Our experience suggests that in this instance the valuation fee tends to be higher than what the client might have paid to an independent appraisal firm or another Big 5 firm.
Offsetting this is that less audit time and fee is incurred in reviewing their own work. If audit firms are precluded from performing valuation work for their audit clients, they will most likely spend more audit review time on the valuations prepared by other firms.
It’s human nature if one knows that a peer is going to review one’s work one will try just that much harder to avoid undue criticism. Additional oversight by a second firm will challenge the appropriateness and supportability of the key assumptions that go into every appraisal and valuation report.
As ever more financial information is affected by requirements for fair value, it will become increasinglyimportant for valuations to be reviewed independently even at slight additional cost.
CHAIRMAN LEVITT: Thank you very much. Our final speaker this evening, final witness, is Nimish P. Patel, and I greatly appreciate your coming here from California. I’m interested that part of your background in securities has been the representation of so-called new economy type companies.
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