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U.S. Securities and Exchange Commission

Office of the Chief Accountant:
Letter: Requesting the AICPA To Provide Industry Guidance on Models and Methodologies for Valuation

November 17, 2000

Ms. Arleen Thomas
Vice President - Professional Standards and Services
American Institute of Certified Public Accountants
1211 Avenue of the Americas
New York, NY 10036-8775

Dear Ms. Thomas:

I am writing to request that the AICPA continue and expand its leadership in addressing an important issue – providing guidance on valuation models and methodologies used to measure fair value and the auditing of those measurements. In today's dynamic economy, financial statement users have become increasingly interested in the fair values of a company's assets and liabilities, in addition to the historical cost information that also is provided in the financial statements. Further, many existing and proposed accounting standards require companies to measure more assets and liabilities at fair value. As a result, there is increasing need to improve the quality and comparability of fair value measurements and the auditing of those measurements. Therefore, I am encouraging the AICPA to take a larger leadership role, by developing detailed, broad-based guidance on valuation models and methodologies used (a) to measure fair value, under the oversight of the FASB, and (b) in auditing fair value estimates.

I believe that the AICPA is in a unique position to lead this effort because of its existing resources and expertise (including accounting, auditing, and valuation expertise), contacts inside and outside the accounting profession, and relationship with the FASB. I believe that the AICPA has the ability to bring together a world-class team of valuation experts, preparers, auditors, analysts, and other users to further develop this guidance in coordination with the FASB. Therefore, I am challenging the AICPA to make this effort a top priority.

The Time is Now

Numerous conditions exist that have created an urgent need for better guidance on estimating fair values and auditing those estimates, including:

  • The economy has become more dynamic than when many of the core accounting standards were developed and, thus, the need for reliable fair value amounts is becoming increasingly important.

  • The SEC staff has seen and continues to see problems that are attributable to unreliable estimates of fair value. Certain other regulators also have expressed similar concerns.

  • Over the years, accounting standards have included the requirement of measuring assets and liabilities at fair value without providing "how to" guidance for estimating those values. And, in some cases, guidance has not been issued on auditing those estimates. For example, APB Opinion Nos. 16, Business Combinations, and 25, Accounting for Stock Issued to Employees, and FASB Statements Nos. 107, Disclosures about Fair Value of Financial Instruments; 114, Accounting by Creditors for Impairment of a Loan; and 121, Accounting for the Impairment of Long-Lived Assets to Be Disposed Of; all fall in this category to some extent.

  • Various projects are underway that would require assets and liabilities to be measured at fair value including the FASB's and the Joint Working Group of Standard Setters' projects on measuring all financial instruments at fair value.

In light of these conditions, I believe there is no time like the present to move forward.

Leverage Past and Current Efforts

Various AICPA groups have undertaken projects to provide guidance on estimating fair values and auditing those estimates. I am encouraged by those initiatives but challenge the AICPA to engage in a broader-based effort in this area. In particular, I have been especially encouraged by the AICPA's efforts to develop a technical practice aid on IPR&D. In that project, valuation experts, accounting and auditing specialists, and industry representatives have worked together to develop comprehensive guidance that satisfies the requirements of existing accounting standards while providing meaningful information that is consistent with that recognized and used in the marketplace. That guidance includes the details (including examples) necessary to assist preparers, valuation experts, and auditors in "how to" do it. I encourage the AICPA to complete this project as soon as possible.

In addition, members of the SEC Regulations Committee began work on guidance for the valuation of stock approximately three years ago. The staff had high hopes this could lead to useful guidance addressing issues that preparers, auditors, and regulators face on a daily basis with respect to accounting for "cheap stock." Unfortunately, that project has lacked leadership and has not shown any progress in the last year.

The recent issuance on Statement on Auditing Standards 92, Auditing Derivative Instruments, Hedging Activities, and Investments in Securities, was helpful but lacks some of the necessary "how to" specifics that would lead to high quality audits. I understand that the AICPA is working on a separate audit guide on auditing derivatives and securities that will fill in those details. As most companies soon will be required to finally adopt FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, I believe it is imperative that the audit guide be finished as soon as possible.

Many large accounting firms already provide (and continue to develop) guidance on what are appropriate valuation models and methodologies under generally accepted accounting principles to their staff and clients. They also have (and continue to develop) guidance on how to audit fair value measurements. However, that guidance is not necessarily consistent. With that said, I believe the firms' guidance could be leveraged as the AICPA continues to develop its guidance.

Education is Needed

The development of valuation and auditing guidance is important but it is only one step in improving estimates of fair value. Efforts to educate are important too. Preparers, auditors, and even some users need to become more educated on fair value estimates – how they are calculated and what they mean. It is my hope that soon the AICPA's National Business Valuation Conference will be as well attended by preparers and auditors, as some of its other major conferences. In addition, educational curriculums need to be modified to more effectively teach valuation techniques, the meaning of fair value, and how financial instruments work. I believe that the AICPA, as a leader in the accounting profession, is in a unique position to promote the changes necessary to better educate those concerned.

In summary, again, let me commend the AICPA on its efforts to date in addressing fair value measurement issues and encourage the AICPA to continue its leadership by taking on a bigger role in the future. The staff looks forward to working with you on this important project.

If you have any questions or would like to discuss these issues further, please contact Jackson Day or Jenifer Minke-Girard at (202) 942-4400.


Lynn E. Turner
Chief Accountant

cc: Ed Jenkins, Chairman, Financial Accounting Standards Board, James Gerson, Chairman, Auditing Standards Board