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John Selwood's Q&As

This month, John follows up on some questions about valuations and ethical considerations from his recent webinar on auditing financial statements prepared under FRS 102.

Q) The Auditing Practices Board's Ethical Standard (ES) 5, para 77 says that auditors are not permitted to provide valuation services to an unlisted entity "where the valuation would both involve a significant degree of subjective judgement and have a material effect on the financial statements either separately or in aggregate with other valuations provided." Other than para 34 of that ES, can you suggest any practical guidance as to where a line could be drawn between what would and what would not be considered a significant degree of subjective judgement?

A) This continues to be a big issue for auditors because FRS 102 often requires assets and liabilities to be measured at fair value and the management of many audited entities do not possess the ability to undertake these valuations themselves.

As a result, they look first to the auditor for help, but ethically, the auditor cannot always provide it. As stated above, auditors cannot provide valuations that are both subjective and material to unlisted entities.

The question specifically stated, "other than para 34" where is there guidance on what is subjective. However, for those of you who are less well read than our questioner, para 34 states: "Where a significant degree of judgement relating to the financial statements is involved in a non-audit service engagement, the auditor may be inhibited from questioning that judgement in the course of the audit. Whether a significant degree of subjective judgement is involved will depend upon whether the non-audit service involves the application of well-established principles and procedures, and whether reliable information is available. If such circumstances do not exist because the non-audit service is based on concepts, methodologies or assumptions that require judgement and are not established by the audited entity or by authoritative guidance, the auditor's objectivity and the appearance of its independence may be adversely affected. Where the provision of a proposed non-audit service would also have a material effect on the financial statements, it is unlikely that any safeguard can eliminate or reduce to an acceptable level the self-review threat."

I am sorry to say that I cannot put it much better than that. Although, I would add that a return to basic ethical principles is useful here. As ES1 puts it: "Independence is freedom from situations and relationships which make it probable that a reasonable and informed third party would conclude that objectivity either is impaired or could be impaired."

An important element of this is the third-party element. What would the metaphorical man (or woman) on the metaphorical Clapham Omnibus think? Whether or not the auditor feels comfortable providing a particular valuation is obviously a key consideration. However, professional judgement has to extend to considering whether the fact that the auditor had provided a particular valuation would look right to an unrelated third party.

This is an extract from an article in the June 2015 edition of Audit & Beyond, the magazine of the Audit and Assurance Faculty.

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