Management and auditors may be impacted by AICPA proposal on valuation of financial instruments
The question of scope is a key consideration regarding the AICPA’s proposed valuation framework for financial instruments. CPAs in business and industry, management and audit committees should consider reviewing and commenting on the document and not assume it will only impact their auditors. Smaller audit firms should not ignore the proposal. .
Scope key issue Although dubbed a “disclosure framework,” the document establishes a minimum scope of work and related documentation needed to support the fair value of financial instruments.
The cover page of the framework states comment is sought from those who perform valuations for regulatory purposes. However, the scope is much broader than just for regulatory reporting purposes.
Indeed, the framework expressly applies to private companies reporting in conformity with U.S. generally accepted accounting principles or International Financial Reporting Standards, and public companies reporting in conformity with regulatory requirements such as those of the U.S. Securities and Exchange Commission or the U.K. Prudential Regulation Authority.
"Financial instruments," following the FASB's definition, include more than derivatives, but also many garden-variety components of the financial statements.
The AICPA, recognizing scope is a key issue, has expressly asked for comment on the scope of the proposed disclosure framework, and the accompanying application guidance.
Intended purpose Jeff Rockwell High, Senior Manager – Financial Instruments on the AICPA’s Fair Value Measurement team, describes the purpose of the framework. “The framework is designed for professionals – both internal or external - performing valuation engagements.”
He notes there is a distinction between audits and valuation engagements. “A valuation engagement results in a conclusion of value. An audit is an engagement to examine an organization’s financial records to determine if they are accurate, complete and follow required standards.”
The language used in the framework, however, may be interpreted more broadly than just engagements formally called ‘valuation engagements.” The Scope section of the framework states:
The term engagement or assignment to estimate value consistent with a specified measurement objective refers to any engagement, assignment, or part thereof that involves estimating the value of financial instruments… to serve as a basis for management’s preparation of financial statements or other reports ...
The framework aims to support high quality, reliable, auditable financial reporting by emphasizing professional skepticism, including "evidential skepticism" and "self-skepticism."
Potential broad implications for management, auditorsIn assessing the practical application of the framework's scope, the purpose of the framework (as stated in the preface and introduction) and key terms (as defined in the glossary) are summarized below.
What is the purpose of the framework?
to provide a framework for the valuation professional, regarding performance requirements when engaged (in the case of independent third-party professionals) or assigned (in the case of internal professionals employed by a reporting entity) to provide fair value and other measurements of financial instruments and components thereof...
[the framework] sets forth minimum scope of work and documentation requirements for valuation professionals.
Who is a “valuation professional”?
Within the context of this document, an individual who conducts valuation services for financial reporting purposes.
What are “valuation services”?
Valuations used to support management assertions made in financial statements issued for financial reporting purposes.
Mandatory for some, best practice for others The establishment of whether the framework is mandatory vs. best practice appears to follow the type of professional (Certified in Valuation of Financial Instruments (CVFI)-credentialed vs. non-credentialed) rather than the type of engagement. It is mandatory for CVFIs, and "best practice" for all other valuation professionals.
CVFI's are a subset of “valuation professionals,” and may work for a third-party valuation firm, an audit firm, or management. The framework also applies to “internal valuation professionals” (“IVP”): those who are assigned to perform valuations for their employers.
Defines "may," "must," "should"
The word "may" is defined in the framework's glossary, along with "must" and "should:"
may: required to consider...but the action itself is not required
should: best practice that is presumed mandatory; however, in rare circumstances, the valuation professional can elect an alternative option
Opting not to follow 'may' or 'should' may need to be documented.
Interaction with FASB, PCAOB standards The AICPA’s proposed framework also addresses reliance on third-party specialists. Separately, the PCAOB issued proposed standards on fair value and estimates, and on the auditor’s use of third-party specialists; comments are due to the PCAOB on August 30.
The framework acknowledges and differentiates itself from the various accounting and auditing standards.
“The Framework is not a standard, but a means for a valuation professional to demonstrate the work in the valuations they perform,” says the AICPA’s High. “The Framework provides guidance for how practitioners describe the instrument being valued and the rationale for the method(s) and/or model(s) used to perform the valuation, as well as the choice of inputs and summarization of outputs and results.”
Regarding interaction with GAAP or regulations, paragraph 1.13 of the framework states:
- If any part of this framework conflicts with a published governmental, judicial, or accounting authority, then the valuation professional should follow the applicable published authority or stated procedures with respect to the part applicable to the valuation in which the valuation professional is engaged or assigned. The other parts of this framework continue in full force and effect.
- If a published governmental, judicial, or accounting authority differs in that it simply requires less than this framework, then the requirements of this framework still must be met.
Comments are due to the AICPA by September 27. Further information is on the AICPA website.