Auditors are under orders from regulators to assure management takes ownership for the fair value measurements they outsource to pricing services rather than simply taking the third party's work at face value.

Jason Plourde, a professional accounting fellow at the Securities and Exchange Commission told accountants and auditors at a national conference of the American Institute of Certified Public Accountants that it's not enough for management to entrust valuation to a third-party pricing service, particularly for hard-to-value illiquid securities where pricing may be based on significant estimates and assumptions. Financial statement reviewers are asking management questions through the comment letter process about use of pricing service information to assure management is complying with accounting and disclosure requirements in financial statements, management discussion and analysis, assessments of internal controls, and the fundamental requirement to keep accurate books and records, he said.

Management would be wise to ask itself some important questions about its use of third-party pricing services, Plourde advised. “Do we have sufficient information about the values provided by pricing services to know that we're complying with GAAP?” he said. “Have we adequately considered the judgments that have been made by third parties in order to be comfortable with our responsibility for the reasonableness of such judgments? Do we have a sufficient understanding of the sources of information and the processes used to develop it to identify risks to reliable financial reporting? Have we identified, documented, and tested controls to adequately address the risks to reliable financial reporting?”

Auditors need to bone up on the valuation methods and assumptions as well, said Plourde, noting the Public Company Accounting Oversight Board made special mention of it in a September 2010 report on areas of concern arising from inspections. The report pointed out auditors too often failed to evaluate whether fair value measurements were determined using appropriate valuation methods and test controls over management's valuation processes. Auditors also failed too often to understand the methods or assumptions used by their own third-party providers who helped develop independent estimates of fair value.

Auditors would be wise to focus on the same questions posed to management about having adequate information to assure compliance with GAAP, adequate consideration of judgments used by third parties, and adequate assessment of risk and control over financial reporting, Plourde said. He advised auditors to pay close attention to the issues as they prepare for the upcoming audit cycle.