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    Extreme Estimation Uncertainty in Fair Value Estimates:...
    research summary posted February 19, 2015 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.03 Adequacy of Evidence, 12.0 Accountants’ Reports and Reporting, 12.05 Changes in Reporting Formats 
    Extreme Estimation Uncertainty in Fair Value Estimates: Implications for Audit Assurance
    Practical Implications:

    The increasing use of uncertain fair value measurements and other estimates in financial statements place an increasingly difficult burden on auditors, who are required to provide a high level of positive assurance that financial statements—including those containing items subject to enormous inherent estimation uncertainty such as those described above—are fairly stated in all material respects. The authors state that auditors are doing their best within the requirements imposed by standard setters and regulators, but also suggest that it is time for those who set and regulate standards to consider ways to more clearly convey where extreme estimation uncertainty exists within financial statements, and to reconsider auditors’ ability to provide positive, high level audit assurance on these inherently uncertain estimates.

    For more information on this study, please contact Steven M. Glover.


    Christensen, B. E., S. M. Glover, and D. A. Wood. 2012. Extreme Estimation Uncertainty in Fair Value Estimates: Implications for Audit Assurance. AUDITING: A Journal of Practice & Theory 31 (1):127-146.

    Financial statements, audit report, fair value, estimates, materiality, estimation uncertainty
    Purpose of the Study:

    The prevalence of fair value and other estimates in financial statements, as well as their inherent estimation uncertainty, has increased dramatically in recent years. Auditors are placed in a difficult position, as no amount of auditing can remove the underlying estimation uncertainty in reported values that are determined by management-derived estimation models that are hypersensitive to small changes in inputs. Despite the increase in uncertainty, the content of the audit report and the information conveyed on the face of the financial statements have changed relatively little. The study discusses how recent events have seemingly resulted in higher expectations and tighter constraints, thus placing a potentially unrealistic burden on auditors, essentially requiring them to provide a product that may be beyond their reach. Finally, the study questions whether auditing and financial reporting standards provide for effective conveyance of the uncertainty contained in financial statements.

    Design/Method/ Approach:

    The study uses estimates reported by Wells Fargo and General Motors to illustrate how changes in estimation model inputs impact fair value point estimates. The authors compare estimation uncertainty in the point estimates, as reported by management, to audit materiality for the financial statements taken as a whole.  The level of estimation uncertainty highlights potential challenges that auditors face in providing assurance on account balance estimates with uncertainty ranges that often are many times larger than materiality for the financial statements taken as a whole.


    Analysis of disclosures from Wells Fargo and GM show that:

    • Changes to the interest rate input as small as 3.70 and 27.04 basis points (bps) in 2008 and 2007, respectively, would yield material swings in the reported value of Wells Fargo’s mortgage-backed securities—changes that directly impact other comprehensive income. Such small changes are within a reasonable range of interest rates.
    • A 75 bps change to GM’s expected return on pension plan assets resulted in an overstatement of pretax earnings by $510 million and an understatement of the pension obligation by over 42 times audit materiality.

    The Wells Fargo and GM cases highlighted in the study demonstrate the extreme estimation uncertainty in some significant accounting estimates. Hypersensitivity to small changes in unobservable inputs, the large number of such inputs, the large number of estimates in the financial statements of complex entities that involve such inputs, and the level of management discretion involved in accounting estimates all add to the burden placed on auditors in providing assurance surrounding these estimates.

    Accountants' Reporting, Auditor Judgment
    Adequacy of Evidence, Changes in Reporting Formats