ANALYZING FAIR VALUE AUDITING IN CONTEMPORARY FINANCIAL REPORTING SCENARIO

Abstract

The importance of “audit” function in the corporate regulatory framework has been increasing monotonically in the last decade with the gradual adoption of Fair Value Measurement (FVM hereinafter) by accounting regulators across the world. FVM, as defined by IFRS 13, is “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”, has become an essential part of contemporary financial reporting scenario. In this revolutionized environment, the auditor’s functional domain, his approach, methodology, and the nature of his responsibilities are all undergoing a metamorphosis. The auditor’s role moves away from a conventional, mechanized attester of tangible evidence to one that exercises an exceedingly judgmental function in a holistic assessment of (sometimes highly subjective) substantiation of values ascribed to be fair by the entity’s management. The Public Company Accounting Oversight Board (PCAOB hereinafter) of the United States has gone on record stating that auditors are inadequately prepared to confront complicated issues in relation to evaluating FVMs (Bratten et al., 2013). Several other studies also highlight the fact that neither corporate accountants nor auditors have been able to keep pace with the progression and developments in this area resulting in a massive competency gap that poses serious challenges to the professional accounting bodies and regulators. Therefore, a comprehensive examination of auditors’ decision-making process in FVM auditing is required for effective and informed audit decisionmaking that may lead to improved audit quality. To achieve this objective, this study follows a confined approach to analyze the factors influencing auditors’ decision making process in FVM Auditing. Afterwards, this study aims to rank and prioritize the pre-identified factors of auditor decision-making process. In the end, we establish an interrelationship among top ranked factors (identified at earlier stage) and assess the driver and driving forces of FVM audit process. At first stage of analysis, this study performs a comprehensive analysis of factors affecting auditors’ decision-making process in FVM auditing from different stakeholders perspectives. The major findings of this study are as follows: In the first stage, we have carried out a principal component analysis on the collected data to extract the meaningful factors that may influence the auditors’ decision-making in FVM auditing. Factor analysis extracted the twelve factors namely: Estimation uncertainty, Regulators, Audit firm relationship with other firms, Presentation & format, FVM iv complexity , Standards ambiguity, Managerial bias, Audit fee, Cognitive limitations, Professional skepticism, Knowledge & understanding, and Valuation specialist. The results of the earlier section gives an insight that auditors follow a multi-criteria decision-making (MCDM) technique for FVM audit decision making. To organize our discussion and rank above identified factors, we adapted Bonner (2008) theoretical research framework, which discuss the auditor’s decision making progress through three critical factors the environment (Estimation uncertainty, Regulators, Audit firm relationship with other firms, and Presentation & formats), auditors specific (FVM complexity, Standards ambiguity, Managerial Bias and Audit fee) and the task related factors (Cognitive limitations, Professional skepticism, Knowledge & understanding and Valuation specialist). Results revealed that task related factors with global weightage of 0.557 are most significant factors in FVM audit process. Further, environmental factors with 0.3202 weightage and auditors specific factors with 0.1226 weightage are second and third in global ranking. This reveals that despite increasing environmental and auditor’s specific challenges, factors that specifically associated with “fair value measurement” task is still the most important factor in fair value environment. Further, Interpretive Structural Modeling (ISM) has been used to construct the inter-relationship grid between top ten factors of FVM audit process. The ISM output shows that Regulators and Standards ambiguity are the most significant of the ten identified key factors that have been input to the model as they are placed at the bottom. Audit fee on which cost efficiency of FVM audit depends appeared at the top of the hierarchy. Knowledge & understanding affects FVM complexity that plays a vital role in determining the requirement of Valuation specialist. High level of complexity and low level of knowledge enhances the need of Valuation specialist in the FVM audit process. Valuation specialist and estimation understanding mutually affect each other, as regular and judicious use of Valuation specialist helps in reducing the Estimation uncertainty in FVM audits. Further, high Estimation uncertainty elevates the level of Professional skepticism used by auditors. Similarly, Presentation & format also affects the level of Professional skepticism in financial statements. Our finding shows that Professional skepticism and Presentation & format are mutually interrelated to each other. Both of these factors collectively influence the level of Managerial bias in financial statements as skepticism and framing can enhance the opportunity for Managerial bias in financial statements. Contrary to literature (Cannon and Bedard, 2014). ISM indicated no direct relationship between Estimation uncertainty and FVM complexity reflecting the views of the panel that it was v the intrinsic nature of the FVM and the management inputs with regard thereto that leads to complexity rather than explicit uncertainties in estimations. The present study sets forward several implications for auditors’, academia, managers and regulators. This study extends the existing literature of FVM audit process and elaborates the hierarchical relevance of certain empirically identified factors in FVM audit process thereby assisting auditors’ to find anomalies in their FVM audit process and take corrective actions against it. This is the first study, which evaluated the FVM auditing process through any technique of multicriteria decision-making. Second, the prioritization of factors through numeric weightage may help auditors in determining the impact ratio of factors in FVM auditing process. Although factors with high weightage required additional efforts from auditors, but complete overlook of low weightage factors is also not advised as ranking may change in different economic context. Furthermore, regulatory bodies like the PCAOB and Financial Accounting Standards Board can use these findings to formulate new auditing standards and to restructure the existing FVM auditing framework. Finally, this study would help the managers for in-depth understanding of FVM audit process and thereby give them a perspective for providing precise inputs to the auditors wherever required.