Fair Value Measurements: Audit Consideration

This article highlights the audit considerations that must be taken to ensure fair value measurements are accurately conducted.

Auditing fair value measurements can be daunting due to the high level of uncertainty involved. Valuations necessitate significant professional judgments and other subjective inputs. This requires substantial and robust evidence to support the auditor's assertion that the assumptions used are reasonable and that the fair value measurements are presented fairly.

Fair value measurements are increasingly being used in financial reporting across various industries. This is, however, a critical area that, if not approached correctly in accordance with the relevant financial reporting framework, may impede audit quality.

Audit Consideration:

When auditing fair value measurements in accordance with the understanding derived from pertinent international auditing standards and in conjunction with ISA 545 guidance for auditors to support the entity's understanding and to determine the nature, timing, and extent of the audit procedures, the audit considerations include the following but are not limited to:

Professional Skepticism and Management Override of Controls

Professional scepticism is defined in ISA 200 as an attitude that includes a probing mind, being alert to conditions, events, or circumstances which may be indicate that a risk of material misstatement due to fraud or error exists, and a critical assessment of audit evidence.

According to ISA 315(Revised), paragraph A88, "the greater the extent to which a class of transactions, account balance, or disclosure is susceptible to misstatement due to complexity or subjectivity, the greater the necessity for the auditor to apply professional scepticism." Furthermore, when a class of transactions, account balance, or disclosure is susceptible to misstatement because of complexity, subjectivity, change, or uncertainty, these inherent risk factors may create an opportunity for management bias, whether unintentional or intentional and affect susceptibility to misstatement due to management bias. Auditors are expected to foster an environment conducive to the exercise of professional scepticism in the audit of fair value measurements by appropriately staffing and managing the engagement and providing sufficient evidence through detailed and precise documentation as to how professional scepticism was exercised at all stages of the audit.

Management provides the information to be used for the model’s inputs regardless of whether they or a valuation professional outside the audit profession prepares the model. ISA540 opines that when the model itself has an increased level of complexity or subjectivity, such as a fair value model using level 3 inputs, controls that address such complexity or subjectivity and controls over data integrity are more likely to be considered relevant to the audit. The standard recommends that auditors gain an understanding of the model and the relevant controls, consider how management determines the relevance and accuracy of the model, consider the model's validation or back-testing by evaluating the model's theoretical soundness, assessing the model's mathematical integrity and sensitivity, as well as the accuracy and completeness of the data, and the appropriateness of data and assumptions used in the model.

According to ISA540, the auditor must also evaluate whether the model has adequate change control procedures in place and how the model is altered or adjusted effectively and promptly in response to changes in the market or other factors.

Variability exists in fair value accounting estimates due to assumptions used regarding data sources and the basis for the judgments used to support them. The auditor should gain an understanding of assumptions that reflect what marketplace participants would use in pricing an asset or liability and those that reflect the entity's own judgments about what assumptions marketplace participants would use in pricing the asset or liability based on the best data available in the circumstances. [ISA 540: A41]

When markets are inactive or illiquid, the auditor is expected to obtain an understanding of how management selects assumptions, including an understanding of management’s implementation of appropriate policies for making model adjustments or developing new models, obtain an understanding of the rationale behind choosing the valuation technique, evaluate the resources used by management to determine the range of outcomes given the uncertainties involved, for example by performing sensitivity analysis, assess how and when applicable the decline in market conditions has affected the operations of an entity, its environment, the associated business risks and the implications for the entity’s accounting estimates and also obtain proper understanding of how the price data from external information sources may vary in the applicable circumstance.

The auditor must also consider how management evaluates the degree of estimation uncertainty. For fair value estimates, IFRS 13 suggests that if multiple valuation techniques are used to measure fair value, the results (i.e., respective indicators of fair value) must be evaluated in view of the reasonableness of the ranges of values indicated by those results. Management's judgments and decisions in making accounting estimates included in the financial statements, despite being individually reasonable, are indicators of possible management bias. The auditor must evaluate these indicators of potential management bias and consider the implications for the audit. Management bias is fraudulent when management's intent is to mislead.

Using the Work of An Auditor’s Expert

An auditor's expert is someone who specializes in a field other than accounting or auditing. Their expertise includes, but is not limited to, the valuation of complex financial instruments, land and buildings, plant and machinery, jewellery, works of art, antiques, intangible assets acquired, liabilities assumed in business combinations, potentially impaired assets, and the actuarial calculation of liabilities associated with insurance contracts or employee benefits.

The scope of the valuation and how the valuation professional's work will be used should be communicated between management, valuation professionals, and auditors. For efficiency, auditors should request that management require the valuation professional to communicate the preliminary valuation approach and techniques that will be used in the valuation, including key inputs and expected values, those charged with providing the necessary information, the required deliverables, and the timing of the fieldwork. The communication should also include information on potential valuation challenges and, if applicable, limitations imposed by the client in the valuation professional's analysis. For example, management may request a limited valuation analysis instead.

Regardless of whether the client or the auditor employs a third-party valuation professional to assist in evaluating management's fair value estimates, auditors are required by ISA 620, Using the Work of an Auditor's Expert, to consider whether the valuation professional possesses the necessary competence, capabilities, and objectivity. Auditors should also inquire about the relationship between the valuation professional and the client under review to ensure that the objectivity of the third-party valuation professional is not compromised. These considerations should be thoroughly documented in the auditor's engagement file.

Further Audit Consideration, ISA 545 Guidance:

The auditor should consider the control activities over the process used to determine fair value measurements and disclosures, the role of information technology, the classes of transactions, account balances, or disclosures that require fair value measurements, and the extent to which the entity depends on a service organization when trying to understand the entity's process for making this determination. Additionally, since management is accountable for any prospective financial information (PFI) it generates and since these PFIs are one of the main inputs into a fair value estimate, auditors should evaluate and examine any budgets and projections offered by management.


The underlying assumptions and management's justification for arriving at fair value should be sufficiently and adequately understood by auditors. This knowledge must be appropriately documented.

Audit procedures for determining the reasonableness of management's fair value measurements should also be included in the auditor's documentation. A few examples include comparing management's assumptions for reasonableness to third-party reports, market research, databases of third-party vendors, and financial statements of comparable companies.

Corporate bodies or organizations can always contact Mazars Nigeria's professional services to ensure the audit of fair value measurements is carried out according to the applicable financial reporting framework and that the appropriate documentation is done.