Extreme Estimation Uncertainty in Fair Value Estimates: Implications for Audit Assurance

Posted: 25 Aug 2011 Last revised: 10 Feb 2012

See all articles by Brant E. Christensen

Brant E. Christensen

University of Oklahoma

Steven M. Glover

Brigham Young University

David A. Wood

Brigham Young University - School of Accountancy

Date Written: January 9, 2012

Abstract

The overall complexity and estimation uncertainty inherent in financial statements have increased in recent decades; however, the related reports and services have changed very little, including the format of the balance sheet and income statement, the content in the auditor’s report, and the level and nature of assurance provided on estimates. We examine estimates reported by public companies and find that fair value and other estimates based on management’s subjective models and inputs contain estimation uncertainty or imprecision that is many times greater than materiality. Importantly, changes in the estimates often impact net income; consequently, the extreme estimation uncertainty also resides in measures such as earnings per share. We do not question the value audits provide to the marketplace, the importance of fair value reporting, or the ability of auditors to deploy up-to-date valuation and auditing techniques. Rather, we suggest that the convergence of relatively recent events is placing an increasingly difficult, and perhaps in some cases unrealistic, burden on auditors. We consider whether the convergence of events in regulation and standard setting may have outstripped auditors’ ability to provide the level and nature of assurance currently required on estimates with extreme estimation uncertainty by auditing standards and regulators. We discuss potential changes to financial reporting and auditing standards that may improve the information provided to users and also address the concerns we raise. Finally, we suggest avenues for future research that may be fruitful in addressing how changes to standards would influence the behavior of preparers, auditors, and users.

Keywords: Financial Statements, Audit Report, Fair Value, Estimates, Materiality, Estimation Uncertainty

JEL Classification: M4, M40, M49, G18, G1, G2, G3

Suggested Citation

Christensen, Brant E. and Glover, Steven M. and Wood, David A., Extreme Estimation Uncertainty in Fair Value Estimates: Implications for Audit Assurance (January 9, 2012). Auditing: A Journal of Practice & Theory, Vol. 31, No. 1, pp. 127-146, Available at SSRN: https://ssrn.com/abstract=1916336

Brant E. Christensen

University of Oklahoma ( email )

Norman, OK 73019-4004
United States

Steven M. Glover

Brigham Young University ( email )

Provo, UT 84602
United States
801-422-6080 (Phone)
801-422-0621 (Fax)

David A. Wood (Contact Author)

Brigham Young University - School of Accountancy ( email )

518 TNRB
Brigham Young University
Provo, UT 84602
United States
801-422-8642 (Phone)
801-422-0621 (Fax)

HOME PAGE: http://marriottschool.byu.edu/employee/employee.cfm?emp=daw44

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