The number of audit deficiencies tied to fair value measurements is still high, but declined for the second year in a row, according to a new analysis of Public Company Accounting Oversight Board inspection reports on auditing firms.

The analysis, released Wednesday by the valuation and litigation consultancy firm Acuitas Inc., found the percentage of audit deficiencies has fallen this year since reaching a peak in 2013. However, it’s still a high proportion. The PCAOB considered 31.6 percent of the audits it looked at for annually inspected firms to be deficient in 2015. That was down from 39.2 percent in 2014 and 42.9 percent in 2013.

Audit deficiencies that could be attributed to fair value measurement and impairment engagements continued to be significant, accounting for approximately 31 percent of all audit deficiencies. Failures to assess audit risks, test internal controls and to test assumptions underlying prospective financial information were the root causes of most FVM and impairment audit deficiencies.

For 2009 to 2013, 75 percent of fair value measurement deficiencies could be attributed to financial instruments; however in 2014 the main source of FVM deficiencies shifted to business combinations. In 2014 56 percent of fair value deficiencies cited by the PCAOB related to business combinations. In 2014, the proportion increased to 68 percent.

The PCAOB has cited the high pace of merger and acquisition activity as a factor that introduces financial reporting risks related to the complexity of transactions and of fair value measurement of acquired assets and liabilities in business combinations, the report noted. The risk of material misstatement can come from the identification of all intangible assets, assignment of goodwill to reporting units and the measurement of contingent consideration can arise from business combinations. The PCAOB’s director of inspections has indicated that audit work on business transactions has been an area of PCAOB focus because of the complicated nature of fair value measurement for acquired assets.

Acuitas found that failure to assess audit risks and to test internal controls and assumptions underlying prospective financial information are the root causes of most fair value measurement and impairment audit deficiencies.

“It’s apparent that the number of audit deficiencies remains high, owing to a surge in deal-making activity,” said Acuitas managing director Mark Zyla in a statement. “But we are seeing industry and accounting firm leaders committing to more quality control measures and ensuring due professional care, hence the decline.”

The PCAOB attributes the improvements to factors such as greater responsiveness from management and the increased use of quality control aids.

In June, the PCAOB released a proposed auditing standard, Auditing Accounting Estimates, Including Fair Value Measurements, indicating the PCAOB’s intention to encourage improvements in these areas.

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Photo: PCAOB

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Michael Cohn

Michael Cohn

Michael Cohn, editor-in-chief of AccountingToday.com, has been covering business and technology for a variety of publications since 1985.