Today’s Six Red Flags for Auditors

And two hot topics: Fair value and Impairment

February 9, 2009

Adapted from the new Audit Risk Alert: Current Economic Crisis: Accounting and
Auditing Considerations

In these difficult economic times, it’s more critical than ever for auditors to understand the rapidly changing business, economic, and regulatory environments in which their clients operate. Current Economic Crisis

The U.S. is experiencing great edconomic instability and the U.S. government is taking unprecedented actions in efforts to curtail the economic crisis. The National Bureau of Economic Research officially declared that the U.S. entered into a recession in December 2007. The U.S. government is facilitating sales of ailing financial institutions, has passed the Emergency Economic Stabilization Act of 2008, is rescuing U.S. automakers and dramatically increasing the monetary programs available from the
Federal Reserve.

In this environment, auditors must be aware of — among other risks — possible significant measurement uncertainty, including accounting estimates and fair value measurements.

Key risks may include:

  1. constraints on the availability of capital and credit,
  2. going concern and liquidity issues,
  3. marginally achieving explicitly stated strategic objectives,
  4. use of off-balance-sheet financings,
  5. special-purpose entities and other complex financing arrangements and
  6. volatile real estate markets.

While many of these risks are not new to business, auditors should be considering the many ways that clients could be affected by external forces. In addition, auditors may modify their audit procedures to ensure risks are still addressed adequately.

Hot Topics: Fair Value and Impairment

Among the causes that have been cited for the economic crisis, FASB Statement No. 157 on fair value has received a great deal of attention. FAS 157 defines fair value and establishes a framework for measuring fair value, but it does not dictate when an entity must measure something at fair value, nor does it expand the use of fair value in any way. It lacks guidance in applying fair value in an illiquid or distressed market, such as the current one. This lack of guidance has the potential to create inconsistencies in application by accountants and auditors. FASB and the SEC have jointly issued additional guidance to clarify for accountants and auditors in measuring fair value in an illiquid market.

Another important topic that has received increased attention in today’s economic environment is determining when an investment is other-than-temporarily impaired. It is important to note that other-than-temporary does not mean permanent. Determining whether an other-than-temporary impairment has occurred requires significant judgment based upon numerous considerations and U.S. GAAP (Generally Accepted Accounting Principles) does not provide any “bright lines” in making this conclusion.

Adapted from the new Audit Risk Alert: Current Economic Crisis: Accounting and Auditing Considerations. Available at www.cpa2biz.com, 1-888-777-7077.