United States: New PCAOB Audit Standards – How Will Your Level 2 Valuation Process Change?

In December 2018, after years of study and public input, the Public Company Accounting Oversight Board (PCAOB) adopted amendments and revisions to audit standards that apply when auditing accounting estimates, including fair value measurements.

A single updated standard (AS 2501 (Revised)), replaces three existing audit standards (AS 2501, replaced and retitled; AS 2502 and 2503 rescinded). The new standard establishes a uniform risk-based approach and emphasizes that auditors need to apply professional skepticism, including addressing potential management bias, when auditing accounting estimates. Additionally, the new standard provides more specific direction on auditing the fair value of financial instruments that are based on information from third-party pricing sources.

Amendments to other audit standards were also adopted, including AS 1105, [Audit Evidence, and AS 1210, Using the Work of a Specialist.] The amended AS 1210 is now titled Using the Work of an Auditor-Engaged Specialist, as it focuses primarily on auditor employed or auditor engaged specialists. Auditing the results of company employed specialists or company engaged specialists (such as Duff & Phelps) is now addressed in a revised appendix to AS 1105.

While many auditors are already implementing the new standards, they are required to do so for audits of financial statements for fiscal years ending on or after December 15, 2020.

Impact on Audits of Level 2 Financial Instruments

When determining the fair value of certain financial instruments that are not actively traded, but where pricing information is available from broker/dealers or pricing vendors, reliance has been historically placed on the "level 2" pricing data obtained from such sources. However, the new audit standard raises questions as to the sufficiency of such pricing data to support a relevant and reliable fair value estimate.

The new audit standards (AS 2501-A4) state that the following factors affect the relevance of pricing information provided by a pricing service:

  • The experience and expertise of the pricing service relative to the types of financial instruments being valued, including whether the types of financial instruments being valued are routinely priced by the pricing service;
  • Whether the methodology used by the pricing service in determining fair value of the types of financial instruments being valued is in conformity with the applicable financial reporting framework (compliant with ASC Topic 820); and
  • Whether the pricing service has a relationship with the company by which company management has the ability to directly or indirectly control or significantly influence the pricing service.

Further, transparency must be obtained from the pricing service such that the following factors are evaluated (AS 2501-A5):

  • Whether the fair values are based on quoted prices in active markets for identical financial instruments;
  • When the fair values are based on transactions of similar financial instruments, how those transactions are identified and considered comparable to the financial instrument being valued; and
  • When no recent transactions have occurred for either the financial instrument being valued or similar financial instruments, or the price was developed using a quote from a broker or dealer, how the fair value was developed, including whether the inputs used represent the assumptions that market participants would use when pricing the financial instruments.

When the fair values are based on transactions of similar financial instruments, the auditor should perform additional audit procedures to evaluate the process used by the pricing service, including evaluating how transactions are identified, considered comparable and used to value the types of financial instruments selected for testing (AS 2501-A6).

When the company's fair value measurement is based on a quote from a broker or dealer (broker quote), the relevance and reliability of the evidence provided by the broker quote depend on whether (AS 2501-A9):

  • The broker or dealer is free of relationships with the company whereby company management cannot directly or indirectly control or significantly influence the broker or dealer;
  • The broker or dealer making the quote is a market maker that transacts in the same type of financial instrument;
  • The broker quote reflects market conditions as of the financial statement date;
  • The broker quote is binding on the broker or dealer; and
  • There are any restrictions, limitations or disclaimers in the broker quote and, if so, their nature.

Note: Broker quotes generally provide more relevant and reliable evidence when they are timely; have binding quotes without any restrictions, limitations or disclaimers; and are from unaffiliated market makers transacting in the same type of financial instrument. If the broker quote does not provide sufficient appropriate audit evidence, the auditor should perform procedures to obtain relevant and reliable pricing information from another pricing source pursuant to the requirements of AS 2501.


If broker quotes are not actionable without restriction, or pricing vendor data is not transparent, contemporaneous and reflective f orderly transactions, for the size of position being valued, the auditor will be required to perform additional audit procedures. Management will then need to provide additional evidence, such as a validated model, which supports the fair value estimate. Over time, this may mean that models receive more emphasis in estimating fair value with pricing vendors or brokers providing supplementary support.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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