Auditors are preparing for particularly careful scrutiny of
companies' assumptions about valuation and the risks posed to their
businesses in the light of current market volatility.
Two of the Big Four UK accountancy groups have issued internal memos
advising their audit teams on the issues that the current market
storm could throw up.
Concerns range from appropriately valuing illiquid and complex
financial instruments to the much larger, though as yet apparently
remote, danger that the potential balance sheet impact of recent
events poses a material risk to a company's survival.
The immediate focus will be on asset values but auditors have been
warned to question carefully "going concern" assumptions – in other
words, a company's ability to service its debt and stay afloat,
particularly if borrowing costs rise.
"Auditors would be careful anyway but now we will think more deeply
about the possibility of contagion effects. This means what may have
been a straightforward assumption last year may be more problematic
this time," said Martyn Jones, national audit technical partner at
Deloitte.
Mr Jones has warned staff to be sceptical about valuation and going
concern assumptions, and consider any potential impact on companies'
compliance with debt covenants.
Accounting experts face the same problems that have dogged the
financial world – accurately valuing complex derivatives.
Some will have been booked at their market price while others, such
as debt products with a fixed lifetime, which can include
collateralised debt obligations (CDOs), are accounted for over their
lifetime.
"Valuing mortgage-backed securities and CDOs has always been
challenging, " said Paul Sater, financial services partner at Ernst
&
Young. "In stable markets a fair value can be estimated using
models. In turbulent times valuations become highly judgmental."
A senior auditor said: "We have to ensure we consider all the risk
of a business. If we're auditing a pension fund, we're concerned
about how to value instruments such as CDOs. If it's a bank, we're
concerned about the contractual obligations of the loans they've
made. If it's the investment bank that bought those loans, then
we're concerned about reputational risk should something go wrong."
The bigger concern is that the liquidity squeeze turns into a wider
credit crunch, with banks and investors less willing to lend money,
driving interest rates higher.
"In a world of contagion, it could be we get a situation where the
possibility of material uncertainty [a real risk to the business]
for some companies increases," said Mr Jones.
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