Valuation in the Fair Value Era: Focus on Quality, Risk
BY GREG FORSYTHE
INTRODUCTION
Regulators, standard-setting bodies, and accounting and valuation professionals share a
concern whether financial statement preparers, their valuation
advisers, and auditors are equipped and qualified to engage in the
various aspects of estimating and auditing fair value measurements.
Amid a rapidly changing climate and increasing complexity in the
financial marketplace, that concern is only growing.
How companies establish the fair value of
EDUCATION AND ENHANCING QUALITY
assets, liabilities and equity for financial
Regulators,
reporting purposes is a rapidly evolving
valuation specialists share the desire and
area. The speed and breadth of this
need for greater clarity and understanding
evolution are compelling public companies
of fair value requirements and processes;
to
interests often expressed as a call for
provide
higher
measurements
than
quality
fair
in
past,
the
value
and
accountants,
standards.
But
auditors
standards
are
and
not
a
measurements and disclosures that are
panacea. Unless those who perform, review
more
and use valuations are properly educated,
consistent,
supportable
and
auditable.
the process will remain vulnerable to error
and misapplication.
But meeting these demands isn’t easy. Fair
value measurements can be complex and
Accountants
confounding, particularly when no market
understand valuation and fair value. Many
analogue exists that can be used to help
valuation providers can be more qualified
estimate the fair value of an entity’s assets,
for
liabilities, or equity. Moreover, regulators
valuation techniques more consistently.
are scrutinizing financial statements for fair
And government authorities can recognize
value issues. This attention is creating
the
pressure
the
unintended consequences — potentially
corporate financial structure to an entity’s
resulting from the rules they impose on
management, board of directors, valuation
businesses. This convergence of interests
specialists and external auditors.
offers significant common ground for these
that
pushes
throughout
their
and
roles
potential
auditors
and
can
apply
stresses
better
established
—
including
groups to strive for higher quality fair value
measurement in financial reporting through
appropriate
standard-setting
and
Produced by Greg Forsythe, CFA, ASA, director, Financial Advisory Services LLP and leader of the Deloitte Center of
Valuation Excellence.
1
Valuation in the Fair Value Era: Focus on Quality, Risk
regulatory
actions,
particularly
in
the
following areas:
additional
stresses.
For
example,
consider the goodwill impairment test.*
In
 Conceptual
underpinnings:
this
analysis,
assume
that
the
For
carrying value of an entity’s reporting
various reasons, when developing the
unit, which is not publicly traded, is $100
concepts
million. Fair value measurements can
underpinning
fair
value
measurements for financial reporting
often
purposes,
standard-
reasonable range, and sometimes the
setters focused primarily on frequently
reasonable range for the fair value of the
traded financial instruments. These fair
reporting unit can straddle the $100
value measurements can be developed
million carrying value. The need for a
using “Level 1” inputs developed from
point estimate in such a situation to
quoted prices in active markets. “Level
comply with the accounting standard can
2” measurements leverage market data
create
from
reverberate throughout an organization,
the
similar
observable
accounting
assets
data.
and
Some
indirectly
assets
and
only
be
estimated
additional
stresses
within
that
a
can
from auditors to valuation providers to
liabilities, however, involve “Level 3”
executives
who
ultimately
inputs because they aren’t bought or
accountable for the conclusions.
stand
sold in the marketplace and have no
direct market analogues. Consequently,
demonstrating
that
Level
conform
inputs
concern for regulators, investors and
the
inputs
“market
other users of financial statements is the
participants” would use relies heavily on
potential for management bias in fair
analogy and indirect evidence. Methods
value
to value some of these assets, liabilities
Level 3. With the heightened focus on
and equity instruments are also still
fraudulent activity in recent years and
evolving in
the gradual understanding that many
to
3
 Management bias: Another increasing
many instances as the
measurements,
variables
the marketplace values such assets and
measurement—variables that are often
liabilities when there is no market for
provided by company management or
them. It is easy to see why significant
based on “professional judgment” of the
measurement
valuation professional employed by the
and
into
a
fair
in
valuation profession tries to mimic how
uncertainty
go
particularly
value
inconsistency can arise in fair value
company—heightened
measurements in this category, and why
scepticism
stresses can build up in the financial
auditors and their fair value specialists
reporting system due to the difficulty in
when auditing fair value measurements.
should
be
professional
employed
by
auditing such measurements.
TRYING YEARS
 The
accounting
accounting
framework:
framework
has
The
Scandals, crises and growing accountability
caused
demands have triggered a demand for
Produced by Greg Forsythe, CFA, ASA, director, Financial Advisory Services LLP and leader of the Deloitte Center of
Valuation Excellence.
2
Valuation in the Fair Value Era: Focus on Quality, Risk
higher quality fair value measurements,
value
provided
required in the coming years.
by
better
qualified
valuation
measurements,
much
more
is
practitioners. The consistent application of
valuation
standards
foundation
for
However,
fully
is
an
achieving
important
this
By focusing attention on these issues,
goal.
publicly listed companies with significant
the
fair value requirements in their financial
expectations of the environment within
reporting can address audit and regulatory
which fair value measurements are used is
risks,
crucial for those wishing to be involved.
investment community, and, ultimately,
While much has been achieved in the last
increase their enterprises’ value in the
decade toward improving the quality of fair
market place.
understanding
enhance
their
credibility
in
the
Produced by Greg Forsythe, CFA, ASA, director, Financial Advisory Services LLP and leader of the Deloitte Center of
Valuation Excellence.
3