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Valuation Issues and the SEC: Observations on How Valuation ...

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  • 1. Valuation Professionals and Financial Reporting October 9, 2004 Scott A. Taub Deputy Chief Accountant Office of the Chief Accountant The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author’s colleagues upon the staff of the Commission.
  • 2. Financial Reporting Landscape Still responding to large reporting scandals Enron, Worldcom, Ahold, etc. Scandals exposed weaknesses in our system Audit committee oversight Accounting standards Auditing Integrity of preparers and advisers Ongoing and comprehensive changes 2
  • 3. Financial Reporting Landscape PCAOB establishment CEO and CFO certifications Non-GAAP financial measures guidance Codes of ethics for senior executives Financial experts on audit committees Principles-Based standards Disclosure of off-balance sheet transactions and contractual obligations Retention of audit records SEC review of all registrants every three years 3
  • 4. Financial Reporting Landscape Stronger auditor independence standards Prohibitions on improper influence of auditors Standards for listed company audit committees MD&A interpretive release International convergence Internal control reporting Critical accounting policies and estimates Current reporting of certain events Consideration of XBRL/tagged reporting 4
  • 5. Financial Reporting Landscape Certifications Management is taking reporting more seriously Certifications pushed-down to locations Auditors being asked to explain positions Internal Control Reporting Major efforts ongoing; more to come Problems already being identified and fixed Combined Effects Increased focus around anything requiring judgment 5
  • 6. Financial Reporting Landscape Objectives-Oriented Standards Standards grounded in conceptual framework with few alternatives or exceptions Guidance still to be provided, but principles/ objectives govern More professional judgment Expedite standard setting process Facilitate international convergence Emphasis on substance over form Fewer structuring possibilities 6
  • 7. Fair Value in Financial Reports Accounting standards require more and more use of fair value Balance sheet and footnotes Likely to continue Defined as willing buyer, willing seller, current transaction Considered more relevant in many cases Helps to prevent some transaction structuring Historical cost not really meaningful for certain items 7
  • 8. Where is Fair Value Used? Derivatives Financial assets Initial recognition in business combinations Asset retirement obligations Any exchange transaction Impairment tests for financial and non- financial assets Equity issuances Stock options (proposed) 8
  • 9. Concerns with Fair Value Relevance For assets to be used versus sold Own credit risk in liability measurement Reliability Too much judgment Not verifiable/repeatable Auditability May represent “hypothetical” transactions instead of real ones 9
  • 10. Concerns with Fair Value Abuse/Bias Can management be trusted? Who can check these estimates? Difficulty/Expense Internal expertise lacking Hiring valuation professionals expensive Second guessing Civil litigation Regulators Auditors Compounded by certifications 10
  • 11. Concerns with Fair Value Where can Valuation Professionals Help? Help companies identify appropriate inputs and methods Test and verify input data Models and methodologies to value hard to value items Help auditors to verify management estimates Add confidence, objectivity and reliability 11
  • 12. Perceived Problems with Valuations – An Accountants View Valuations “made as ordered” Valuations must be neutral and unbiased Value considering only partial information Inputs must be evaluated Excluding available information “Black-box” valuation models Valuation professionals must be more than just a complex calculator Need to take responsibility for use of reports “Alternative” valuations Expertizing in SEC filings 12
  • 13. For the Future Work with FASB on valuation methodologies Helps with reliability issues Work with PCAOB and large audit firms Auditability and verifiability is key High-quality valuation standards Need visibility Need to know what a valuation can accomplish and what it can’t 13