I appreciate your guys’ opinions as well - hopefully i’m not coming off as being overly contrary.
Green - I would have to say that the auditing firm would have the ability to assess the value of goodwill. Goodwill can be tested at the CGU level, all we have to do is look at the cash flows being generated from the assets or business unit that was acquired to give rise to goodwill and perform a DCF anlaysis based on the company’s WAAC or another appropriate discount rate (industry average WAAC perhaps).
All the Big 4 firms (can only speak to these) have a valuations group in their office, or at least access to one if valuations are performed centrally. Valuations groups are comprised of CBVs, who have the competency to do these DCF’s if they are subjective beyond the technical abilities of a CA or CPA.
I often find passion most fervant when confusion and ignorance reign…and so I am taking points raised by folks that have not been directly engaged in audits (or otherwise have a true understanding of the process) with a grain of salt.
I would remind you that the financial statements are ultimately the responsibility of management - so that fact that the audit partner and client would discuss that status and assumptions underlying “intangible assets” (perhaps the greyest of grey anywhere on a financial statement) is certainly not surprising or alarming to me. The fact that clients will request some guidance in these areas is also hardly surprising. That “CFA vs MBA” is suggesting that the valuation was “Fait accompli” is inconclusive - god only knows what gave rise to the original intangible (business purchase, license, etc.) and whether an event of any significant occured during the year (or triggering a recast of assumptions) which would even call for a major rethinking. CFO’s get paid to talk “big” does not mean at all that the subject audit partner would not take issue with a real issue.
Its funny that people interpest financial statements like a golfing score card or adding machine tape…no room for assumptions and difference of opinion. Not true and one reason that f/s disclosures are so critical.
Meanwhile I can scan the current standing of opinions by analysts - citing a mixed bag of “Sell, Buy, Hold” and thats cool! …Or a weatherman simply cites a percent probability of rain…or a lawyer either wins or loses their case LOL. Why would anyone go into audit LOL.
As someone who has been on both sides of the ledger, I can say that how an audit is run is dependant upon the personalities of who is staffing it. On my particular audit we didn’t let our client get away with anything and risked losing the client a few times. If a company gets enough people involved in a fraud, it is going to be hard for any auditor to catch that fraud. It is not the auditor’s responsibility to detect all instances of potential fraud. It is easy to come in with the benefit of hindsight and act like fraud is so obvious to detect. The PCAOB is laying the smack down on accounting firms right now, so if anyone thinks nothing has changed in the industry, they are very misinformed.
And where do you get the CF’s to do your DCF analysis on for goodwill impairment? I doubt you’ll find an audit firm willing to say they confirm the forecast cash flows provided by management. All they do is verify the methodology is unlikely to cause a material misstatement, assuming the CFs are accurate (which they do not test).
Obviously there are a lot of assumptions and variables factoring into anything subject to a DCF based valuation, but I assure you that the amount of work performed over each variable would be sufficient to conclude that material misstatement is unlikely. Auditor’s don’t simply ‘verify the methodology’ - each input is tested for reasonability, and any variables subject to judgement are tested for sensitivity in the ultimate valuation
a delusional question… if frauds are committed by suppression or obfiscation of evidence, then unless you are on the ground to test these evidences you will have no clue. Reading annual reports alone won’t help.
How does one test forecasted cash flows? When I was in public accounting, we beat the crap out of the DCF model, but there is only so much you can do for a forecasted figure. We looked at historical actual results vs. budgeted results, economic outlook reports and the company’s near term business plans. There isn’t much else you can do. If you are able to tell a company that their 2017 projection is wrong, you are wasting your time in public accounting.
I think it’s basicaly about consistency. Things like these are red flags in my opinion:
8% perpetual growth is wrong (the company would eventually become bigger than the economy)
Even excess growth for a long time may be fishy (most IPOs fall back to the average growth rate of the sector in 5 years).
Higher growth with declining reinvestment rates is probably wrong (maybe it’s a high advertising company expecting better results from viral videos or something - red flag).
Perpetual efficiency growth on the already existing investments is wrong (nobody is infinitely efficient)
Long term ROC comfortably above WACC without strong sustainable competitive advantages is wrong (at least for a base case - show some humility) Using WACC for the parent when assessing riskier projects/acquisitions is wrong (every riskier project seems good until the company itself gets significantly riskier and gets its own cost of capital screwed). Counting non-recurring stuff as if it was recurring (or vice-versa) is wrong (the company can base growth rates on unrealistic current cash flows).
With todays technology, auditors are able to do manual journal entry testing through computer assisted audit techniques (CAAT’s). Any material manual journal entires would be flagged and substantively tested, so the risk of things like what happened at Enron is becoming increasingly remote as a result
I’m on Assigned Reading 33: FRA Red Flags. I wanted to know how Enron got away with these SPE’s.
It says that Enron was not obligated to report the SPE’s on their books according to the black letter law of GAAP. Well, how did Enron make it so that they owned less than 50% of the SPE? I can’t imagine them duping outsiders into buying out their shares when all these empty shells held was Enron’s hidden debt.
Yes, if the CFA charterholder is not biased towards the employer , He could have identified or researched the reports that led to the Enron scandal . But I think the CFA charterholder should have been the independent body unbiased from his employer.A closer look at financial statements by expert would have identified the wrongdoings in the system.
“If you are able to tell a company that their 2017 projection is wrong, you are wasting your time in public accounting”
Yes that heavy lifting should be left to CFA’s and other analyst professionals who have been known to do that so well lol…please they must bring to bear their opinion on the reasonableness of the methodology and the variables associated with it (projections, discount rates, probablilities, etc.) and it is well within the CPA’s skill set to do so.
Lets keep in mind that goodwill originates from a transaction price (be it a company, license, technology etc acquisition) which is itself a highly judgemental value (albeit executed through exchange of consideration).
Besides I thought savvy analysts pretty much ignore financial statement goodwill and instead reach their valuations based on adjusted pure cash flow measures