Fair Value, Auditing and Internal Controls

Sergio Scandizzo

Accounting, along with its twin brother auditing, is one of the original governance tools that sheds light on what management is doing and the risks that the company is taking. However, both the techniques used in finance departments, and the abilities and incentives of the auditors, are far from straightforward and riddled with conflicts and inconsistencies. On the first point, this chapter will look at the issues of fair value and the procyclicality induced by “mark-to-market” valuation, and highlight the potential side-effects of accounting decisions. As auditors are one of the guardians of the reliability of accounting figures, we will then examine the issue of auditors’ independence compared to their ability to understand their clients’ business and the risks thereof. Finally, we will note that internal controls are also a key instrument of corporate governance, routinely taken into consideration within the auditors’ work. Failures in governance are often blamed on an inadequate control framework while effective controls facilitate the flow of information and transparency.

IS FAIR VALUE FAIR?

One of the criticisms of risk measurement techniques leading up to the 2008–09