This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
• As used in FASB ASC 820, Fair Value Measurement, “fair value” is defined as:
The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
• FASB ASC 820 recognizes two distinct types of inputs:
– Observable inputs -- Developed using market data, such as publicly available information about actual events or transactions, reflecting assumptions market participants would use when pricing an asset or liability; and
– Unobservable inputs -- Market data is not available and are developed using the best information available about the assumptions that market participants would use when pricing an asset or liability.
• Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.
• Emphasis within Level 1 is on determining both:
– The principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability; and
– Whether the reporting entity can enter into a transaction for the asset or liability at the price in that market at the measurement date.
• Level 2 inputs are inputs that are observable, either directly or indirectly, other than quoted prices included within Level 1, for an asset or liability.
• Examples:
– Quoted prices for similar assets or liabilities in active markets.
– Quoted prices for identical or similar assets or liabilities in markets that are not active.
– Inputs other than quoted prices that are observable for an asset or liability.
• The greater the standard deviation, the flatter a bell-shaped curve and the more dispersed the data.
• Volatility is the standard deviation of the price of a specific stock:
– Statistically, approximately 68% of values in a normal distribution are within +/- 1 standards deviation of the mean, 95% are within +/- 2 standard deviations.
– Expressed as a percentage of the stock value -- e.g., a volatility of 10% means that over the course of a year the stock price is projected to be within 10% of its current price 68% of the time.
• Assess the assumed volatility for reasonableness, and consider the impact of multiple variations in calculating a range estimate.
• Present value model in which net settlements from the interest rate swap are estimated and discounted back to their current value.
• Variables include:
– Timing of cash flow, which is usually a contractual manner.
– Discount rate, which are the spot interest rates implied by the yield curve for hypothetical zero-coupon bonds due on the date of each future net settlement on the swap.
– Estimated net settlement cash flows, calculated using the net settlement value that would be required if future interest rates are equal to the rates implied by the current yield curve.
Auditor’s Responsibilities When Using the Work of an Auditor’s Specialist
• Sufficiently understand the specialist’s field of expertise to enable the auditor to determine the nature, scope, and objectives of the specialist’s work and evaluate the adequacy of that work for the auditor’s intended purposes.
• Has sole responsibility for the audit opinion expressed, and that responsibility is not reduced by the auditor’s use of the work of an auditor’s specialist.
• Should not refer to the work of an auditor’s specialist in an auditor’s report containing an unmodified opinion:
– If referenced in a modified report, must indicate that does not reduce the auditor’s responsibility for that opinion.
Pricing Service -- Evaluate Underlying Assumptions and Data
• Determine the nature of the information provided:
– E.g., what were the inputs and assumptions?
• If the price is not based on Level 1 or 2 inputs, the auditor should obtain an understanding of the model and evaluate whether the assumptions are reasonable.
• Evaluate whether the assumptions used by the pricing service reflect the price to sell the asset or paid to transfer the liability in the reporting entity’s principal/most advantageous market:
– Would traded or quoted prices be available to the entity?
– E.g., not listed on national exchanges or OTC markets, published data not available.
• Includes private investment funds meeting the definition of an investment company per ASC Topic 946-10-15-2:
– E.g., hedge funds, private equity funds, real estate funds, venture capital funds, commodity funds, offshore fund vehicles, funds of funds, common or collective trust funds, etc.
– May be structured as limited partnerships, limited liability corporations, trusts, or corporations.
Alternative Investments with Net Asset Value Per Share
• Practical expedient -- Allows use of the net asset value reported by the fund to estimate fair value.
• Apply to an investment that meets both of the following criteria as of the reporting entity’s measurement date:
– Investment does not have an otherwise readily determinable fair value; and
– The investment is in an entity that has all of the attributes specified in FASB ASC 946-10-15-2, Financial Services—Investment Companies (exceptions apply).
• If not as of same measurement date, may adjust most recent NAV.
• Must not be probable that will dispose of at different price.
• If cannot redeem at measurement date, but can in future, then consider length of time in FV measurement. Generally, redemptions only permitted with advance notice (e.g., 30-120 days).
• Level 2 if redemption notice not submitted effective on the measurement date; and reporting entity has the contractual and practical ability to redeem in the near term (typically 90 days or less).
• Level 3 if entity does not know when it will have the ability to redeem; and entity does not have the ability to redeem in the near term.
Possible Audit Procedures for Evaluating Alternative Investments
• Reconcile to audited F/S as of the same date:
– If as of different date, perform procedures over stub period, such as obtaining interim financial information or testing management’s tracking analysis.
• Review transactions at or near the balance sheet date:
– Investment in, or liquidation of, a portion of an alternative investment may support valuation.
– Consider settlement terms and timeliness for consistency with applicable financial reporting framework.
Alternative Investment -- Supporting Documentation Options
• Audited F/S as of the investor entity’s balance sheet date most persuasive audit evidence:
– Limited visibility into underlying investments detracts from evidence strength.
– Obtained detailed listing of underlying securities must be evaluated.
• Condensed schedule of investments or detailed listing as of a different date; supplement with alternate procedures, (e.g., sector data, indexes, and cash distributions).
– As explained in Note X, the financial statements include investments valued at $X (X% of net assets), whose fair values have been estimated by management in the absence of readily determinable fair values.
– Management’s estimates are based on information provided by the fund managers or the general partners.
• May qualify or disclaim opinion due to scope limitation in obtaining sufficient evidence.