The fair value measurement is an important aspect of financial reporting and is used to record the financial position of an entity on its balance sheet. The objective of fair value measurement is to provide a fair representation of the value of the assets and liabilities at the time of measurement.
Accounting Treatment:
Fair value measurement is an accounting principle that requires the measurement of an asset or liability based on its fair value, which 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. In other words, it is the market-based measurement of the value of an asset or liability.
In financial reporting, fair value measurement is applied to financial instruments, including investments in securities, financial derivatives, and liabilities. The measurement of fair value is based on the information that is available in the market, including market prices, yield curves, and credit spreads.
IFRS 13 Fair Value Measurement is the primary accounting standard that provides guidance on how to measure fair value in financial reporting. It sets out the definition of fair value, the requirements for determining fair value, and the disclosure requirements related to fair value measurements.
In order to comply with the requirements of IFRS 13, companies must have a robust system in place for measuring fair value, which should include the use of appropriate techniques and data sources. The system should also be subject to regular review and testing to ensure its reliability and accuracy.
In financial reporting, fair value measurement is used to report the value of financial instruments and to present the financial position of a company in the most transparent and accurate way possible. The use of fair value measurement enables companies to provide a better understanding of the value of their financial instruments, the risks associated with those instruments, and the impact of changes in market conditions on the value of those instruments.
Audit Risks:
- Misrepresentation of fair value measurements: This can occur when the entity provides incorrect or misleading information related to the measurement of fair values.
- Lack of documentation: This can occur when the entity does not maintain adequate documentation to support the fair value measurement.
- Inadequate internal controls: This can occur when the entity does not have sufficient internal controls in place to ensure accurate fair value measurements.
- Inaccurate calculations: This can occur when the entity uses incorrect calculations or assumptions to determine fair values.
- Lack of external data: This can occur when the entity does not use adequate external data to support fair value measurements.
- Reliance on Management Judgement: This can occur when the entity relies too heavily on management’s judgment to determine fair values.
- Valuation models: This can occur when the entity uses inadequate or incorrect valuation models to determine fair values.
- Inadequate testing: This can occur when the entity does not perform adequate testing to ensure the accuracy of fair value measurements.
- Misapplication of IFRS guidelines: This can occur when the entity does not follow the appropriate IFRS guidelines when recording fair value measurements.
- Conflicts of interest: This can occur when the entity has a conflict of interest that affects its ability to accurately measure fair values.
Audit Assertions:
- Existence: This assertion confirms the existence of the assets or liabilities measured at fair value.
- Valuation: This assertion confirms the fair value measurement of the assets or liabilities is accurate.
- Right of Use: This assertion confirms that the entity has the right to use the assets it has measured at fair value.
- Observability: This assertion confirms that the inputs used to determine fair values are observable.
- Accuracy: This assertion confirms that the calculations and assumptions used to determine fair values are accurate.
- Relevance: This assertion confirms that the fair value measurements are relevant to the financial statements.
- Reliability: This assertion confirms that the fair value measurements are reliable.
- Completeness: This assertion confirms that all necessary information has been included in the fair value measurements.
- Consistency: This assertion confirms that the fair value measurements are consistent with prior periods.
- Understandability: This assertion confirms that the fair value measurements are understandable and can be easily understood by users of the financial statements.
Walkthrough testing
Walkthrough testing is an important part of auditing the fairness of value measurement. This process is a part of substantive audit procedures that help the auditor to obtain evidence about the fairness of the client’s financial reporting. It involves evaluating the process used by the entity to determine the fair value of a financial instrument and to verify the accuracy of the recorded amount.
The following steps can be followed in a walkthrough testing of fair value measurement:
- Understanding the client’s process: The auditor should understand the process used by the entity to measure fair value and the relevant accounting principles. This understanding should be obtained through discussions with management, reading the relevant financial reports and other accounting documents.
- Evaluating the process: The auditor should evaluate the entity’s process for determining fair value to identify any potential weaknesses or areas of risk. This can include evaluating the input data used, the calculation methodology, and the accuracy of the recorded amounts.
- Obtaining evidence: The auditor should obtain evidence to support the entity’s fair value measurements. This can include reviewing documents such as pricing data, market data, and calculations used in the measurement process.
- Performing substantive testing: The auditor should perform substantive testing on a sample of the fair value measurements to ensure that they are accurate and properly recorded. This can include recalculating the measurements and comparing them to the client’s recorded amounts.
- Evaluating the results: The auditor should evaluate the results of the walkthrough testing and determine if the fair value measurements are accurate and the process used to measure them is appropriate. If the auditor finds any discrepancies or weaknesses, they should be reported and discussed with management.
Overall, the walkthrough testing process is an important part of auditing fair value measurement and helps the auditor to obtain sufficient evidence to support the fairness of the entity’s financial reporting.
Test of Control:
- Obtain an understanding of the client’s internal control relevant to fair value measurement and assess the risk of material misstatement.
- Review the client’s policies and procedures related to fair value measurement, including documentation of fair value calculations and disclosures.
- Evaluate the client’s documentation and evidence supporting fair value measurements, including external data sources used, calculations and assumptions, and methodologies applied.
- Test the accuracy and completeness of the client’s fair value calculations by performing sample-based substantive procedures, such as recalculations and comparisons to external data.
- Test the client’s processes for determining the most appropriate valuation method and assessing the impact of market conditions on fair value measurements.
- Test the completeness of the client’s disclosures related to fair value measurements in the financial statements, including significant assumptions and methodologies used.
- Test the client’s processes for assessing and re-measuring fair value in response to changes in market conditions and other relevant factors.
Substantive Audit Procedures:
- Obtain an understanding of the client’s industry and market conditions relevant to the fair value measurement.
- Test the accuracy and completeness of the client’s fair value measurements by performing sample-based substantive procedures, such as recalculations and comparisons to external data.
- Review the client’s documentation of fair value calculations and methodologies applied, including significant assumptions used.
- Test the accuracy of the client’s calculations of discount rates and other inputs used in fair value measurements.
- Test the client’s processes for obtaining and updating external data used to support fair value measurements.
- Evaluate the appropriateness of the client’s choice of valuation method and assess its impact on the fair value measurement.
- Test the completeness of the client’s disclosures related to fair value measurements in the financial statements, including significant assumptions and methodologies used.
- Test the client’s processes for assessing and re-measuring fair value in response to changes in market conditions and other relevant factors.
- Review the client’s processes for assessing and considering the impact of any financial or other instruments that might affect the fair value measurement.
- Test the accuracy of the client’s records of fair value measurements and changes in fair value over time.