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2010-12-31 11:58:00
Accouting estimates fair value

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  1. Accounting Estimates802.1 Preparation of financial statements normally requires making accounting estimates. SAS No. 57, Auditing Accounting Estimates (AU 342.01),
    defines an accounting estimate as “an approximation of a financial
    statement element, item, or account” in the absence of exact
    measurement. The following are examples of accounting estimates may be
    relevant to CIRAs:
    a. Net realizable values of assessments receivable.b. Valuation of common property contributed by the developer/sponsor.c. Valuation of securities.Accounting estimates may involve fair value measurements (see the discussion beginning at paragraph 802.8).
  2. 802.2 As discussed in paragraph 801.31, SAS No. 57 (AU 342.08)
    highlights the importance of evaluating whether management has
    identified all material accounting estimates. The “General Auditing and
    Completion Procedures” audit program (HOA-AP-2 or HOA-AP-2-S)
    includes a program step to document that the auditor considered whether
    all material estimates were identified. This step is included in the
    program step related to significant estimates and concentrations
    • (See section 801.) The “Significant Estimates Identification Checklist” at HOA-CX-16.2
    • can also be used by the auditor to identify significant estimates in
    • the financial statements. The representation letter drafting forms at HOA-CL-3.1 and HOA-CL-3.2
    • include optional language addressing material estimates in addition to
    • the specific representations for particular estimates, e.g., gain or
    • loss contingencies, etc., ordinarily included in representation letters
    • (see section 806)
  3. 802.3 SAS No. 57 does not prescribe specific audit procedures to substantiate specific accounting estimates; 3
    for example, specific audit procedures for substantiating the estimated
    allowance for uncollectible assessments. Instead, the SAS suggests a
    framework for designing audit procedures to evaluate the reasonableness
    of specific accounting estimates. An auditor must first understand
    • how management developed the estimate. Three approaches may then be used
    • to determine the reasonableness of the estimate: (a) make an
    • independent estimate for comparison with the client's, (b) review and
    • evaluate the client's estimation process for reasonableness, or (c)
    • review subsequent events or transactions in identifying and evaluating
    • estimates. In small CIRA engagements, estimates can often be calculated
    • by the auditor based on discussion with the client about factors that
    • usually affect the client's experience.
  4. 802.4 Whatever approach is used to
    audit an accounting estimate, the usual result is an acceptable range
    in the auditor's mind for the estimate, e.g., the member assessments
    that will become uncollectible will be somewhere between $12,000 and
    $15,000. If the client's accounting estimate falls within this range, it
    is acceptable.
    • SAS No. 107, Audit Risk and Materiality in Conducting an Audit (AU 312),
    • states that an accounting estimate may be evaluated by comparing it
    • with a range or a point estimate, if the point is a better estimate than
    • any other amount. However, accounting estimates are usually evaluated
    • based on a range of reasonableness because it is rarely possible to be
    • precise in estimating future events
  5. 802.5 If the CIRA's estimate falls
    outside the auditor's range of reasonableness, then the difference
    between the CIRA's estimate and the closest end of the auditor's range
    should be considered a misstatement. For example, if the auditor's range
    of reasonableness is $12,000 to $15,000 for uncollectible assessments,
    but the CIRA has chosen to estimate $10,000 for uncollectibles
    • , then there is a $2,000
    • misstatement that should be included with other audit differences. SAS
    • No. 107 on materiality and audit risk supports this position.
  6. 802.6 SAS No. 107 also states that
    the auditor should consider the possibility of management bias in the
    development of accounting estimates. In other words, an auditor should
    consider whether differences between estimates best supported by the
    audit evidence, and the estimates included in the financial statements
    that are individually reasonable,
    • indicate (in the aggregate) a
    • possible bias on the part of management. If management, for example,
    • always chooses estimated amounts for the valuation of assets that are at
    • the low end of the range the auditor considers reasonable, the combined
    • effect could result in a material misstatement of income. In that case,
    • the auditor should consider whether other recorded estimates reflect a
    • similar bias and perform additional procedures to address those
    • estimates. The auditor should also consider whether management's
    • estimates were at one end of the auditor's reasonable range in the prior
    • year and at the other end in the current year. That could indicate the
    • possibility that management is using accounting estimates to manage
    • earnings. If the auditor believes that is the case, he or she should
    • consider communicating the matter to those charged with governance as
    • discussed in section 812
  7. 802.7 SAS No. 99, Consideration of Fraud in a Financial Statement Audit (AU 316), requires the auditor to review accounting estimates for biases that could result in material misstatement due to fraud
    • In addition, it requires auditors to perform a retrospective review of
    • significant prior-year accounting estimates to determine whether the
    • underlying judgments and assumptions indicate possible bias. The review
    • may provide additional information about whether the current year's
    • estimates could be biased. If the auditor identifies possible bias, SAS
    • No. 99 requires the auditor to evaluate whether the circumstances
    • represent a risk of material misstatement due to fraud.
  8. Fair Value Measurements and Disclosures802.8

    GAAP requires some assets, liabilities, and components of equity to be measured or disclosed at fair value.
    • Examples of a CIRA's use of fair value measurements include (a)
    • abandoned or foreclosed units received by the CIRA for nonpayment of
    • delinquent assessments, (b) units received by the CIRA from the
    • developer in settlement of litigation, (c) securities classified as
    • available for sale, and (d) common property transferred to the CIRA by
    • the developer. SAS No. 101, Auditing Fair Value Measurements and Disclosures (AU 328),
    • establishes standards and provides guidance for testing fair values.
    • Because fair values are essentially estimates, the SAS primarily expands
    • the guidance in SAS No. 57 to apply to this specific topic.
  9. 802.9 Some fair values are readily
    determinable because there are relevant quoted market prices (such as
    for marketable securities classified as available for sale). For such
    items, published price quotations in an active market are the best
    evidence of fair value.
    • When there is no observable market
    • price or items have characteristics requiring an estimate to be made,
    • use of a valuation method, such as discounted cash flows, may provide
    • the best estimate of fair value.
  10. 802.10 When a valuation method is
    used, the auditor considers the appropriateness of the method, including
    management's rationale for selecting the method. Auditors may consider
    whether management has evaluated the range of values resulting from
    different methods and investigated the reasons for the differences.
    Changes in circumstances may require changes in the method used to determine fair value.
  11. 802.11 The following approaches
    may be used to obtain evidence supporting a fair value estimate
    determined using a valuation model:
    • • Test the client's valuation,
    • including management's assumptions (or those of a specialist), the
    • valuation model, and the underlying data.• Develop an independent estimate and compare it to the client's valuation.•
    • Review subsequent events and transactions to corroborate the client's
    • valuation. (However, the auditor should consider only those events or
    • transactions that reflect circumstances existing at the balance sheet
    • date.)
  12. 802.12 When testing the client's
    valuation or developing an independent estimate based on management's
    assumptions, the auditor should evaluate whether management's
    assumptions are reasonable and not inconsistent with market information.
    If management
    • retained a specialist to develop
    • the valuation, the auditor's responsibility to test the assumptions does
    • not change. The auditor considers the source and reliability of
    • evidence supporting the assumptions, pays special attention to
    • assumptions that are highly sensitive or uncertain and those susceptible
    • to misapplication or bias, and considers the sensitivity of the
    • valuation to changes in assumptions and market conditions
  13. To be reasonable, the assumptions, individually and taken as a whole, need to be realistic and consistent with the following:
    • • The general economic environment, the economic environment of the specific industry, and the entity's economic circumstances
    • .• Existing market information
    • .• The plans of the entity, including what management expects will be the outcome of specific objectives and strategies
    • .• Assumptions made in prior periods, if appropriate.
    • • Past experience of, or previous conditions experienced by, the entity to the extent currently applicable.
    • Other matters relating to the financial statements, for example,
    • assumptions used by management in accounting estimates for financial
    • statement accounts other than those relating to fair value measurements
    • and disclosures
    • .•
    • The risk associated with cash flows, if applicable, including the
    • potential variability in the amount and timing of the cash flows and the
    • related effect on the discount rate.
  14. 802.13 The accuracy, completeness,
    and relevancy of the underlying data should also be tested, and the
    auditor should ensure that the resulting valuation properly reflects
    both the assumptions and the data.
    Tests may include verifying the source of the data, recomputation, and review of information for internal consistency.
  15. 802.14 The auditor who
    independently develops assumptions for use in evaluating the client's
    estimate should still understand management's assumptions so he or she
    can assess whether any significant matters have been omitted and can
    evaluate any significant differences between management's and the
    auditor's estimates
    As noted in paragraph 802.12, this evaluation also should be performed if the fair value estimate is developed by a valuation specialist.
  16. 802.16 During summarization and
    evaluation procedures, the auditor should evaluate the sufficiency of
    the evidence obtained and its consistency with other evidence obtained
    during the audit
    • Regardless of the audit approach
    • used, the auditor should ordinarily obtain management representations
    • about the reasonableness of significant assumptions and consider certain
    • communications with those charged with governance. Management
    • representations are discussed in section 806 and communications with those charged with governance are discussed in section 812.
  17. Identifying Financial Instruments of Nonpublic Entities802.17 As discussed in section 303, financial instruments consist of the following:
    a. Cash.b. Evidence of an ownership interest in an entity.c. Contracts that require one entity to deliver cash or another financial instrument to another entity.d. Contracts that require two entities to exchange financial instruments on potentially unfavorable terms.
  18. Contracts that are financial instruments can be grouped into five categories:
    • unconditional receivable-payable contracts, receivable-payable contracts
    • conditional on the occurrence of an event outside the control of either
    • party, financial option contracts, financial guarantees or other
    • conditional exchanges, and financial forward contracts. Since contracts
    • are not financial instruments unless they are to be settled with cash or
    • other financial instruments, a number of common rights and obligations
    • are excluded, such as deferred revenue for membership assessments
    • received in advance that will be settled by providing services.
    • Similarly, executory contracts for future services to be provided by one
    • of the parties (such as an operating lease) are not financial
    • instruments.
  19. Disclosure Requirements802.18 FASB ASC 825 (formerly SFAS No. 107, Disclosures about Fair Value of Financial Instruments), primarily requires certain entities to disclose
    • (a) the fair values of financial instruments for which it is practical
    • to estimate fair values and (b) concentrations of credit risk.
    • Disclosures about market risk of financial instruments are encouraged,
    • but not required. Section 303
    • discusses and illustrates disclosures of concentrations of credit risk.
    • It is the authors' belief that most CIRAs are exempt from the
    • requirement to disclose the fair value of financial instruments. 5 Fair value disclosures are discussed in PPC's Guide to Preparing Financial Statements. The disclosure checklist at HOA-CX-13 includes the FASB ASC 825 (formerly SFAS No. 107) disclosures.
  20. Auditing Fair Value Disclosures802.19 SAS No. 101, Auditing Fair Value Measurements and Disclosures,
    provides guidance on auditing such measurements and disclosures
    contained in financial statements. SAS No. 101 supplements, rather than
    amends, SAS No. 57, Auditing Accounting Estimates. It is applicable to disclosure of the fair value of financial instruments required by FASB ASC 825 (formerly SFAS No. 107). According to SAS No. 101:
    • • Evaluation of whether fair value disclosures are in
    • conformity with GAAP ordinarily involves the same audit procedures used
    • to audit fair value measurements recognized in the financial statements.•
    • If fair value disclosure is omitted because it is not practical to
    • determine fair value with sufficient reliability, the adequacy of
    • disclosures required in such circumstances is evaluated.The requirements of SAS No. 101 are discussed further in connection with the discussion of accounting estimates in section 802.