In-House Asset Valuation and the Auditor's Reliance
An SMSF holds a 40% interest in a private company that operates a child care centre. The trustee, who is also the company's managing director, valued the interest at $2.4 million using a capitalisation of earnings method with a 12% discount rate and forecast earnings of $480,000. The previous year's valuation was $1.9 million. No independent valuation was obtained. The fund's total assets are $4.1 million, so the interest is 58.5% of the fund. The auditor has a prior-year working paper showing the same method produced a valuation that was later written down by $300,000 after the company lost a major tenant. The trustee has provided a one-page memo supporting the $2.4 million figure but no sensitivity analysis.
1. What level of evidence should the auditor obtain for the $2.4 million valuation, and can the trustee's memo be relied on?
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The auditor cannot rely on the trustee's one-page memo as sufficient appropriate evidence for a 58.5% asset. Auditing standards require the auditor to obtain sufficient appropriate evidence about valuation, and a related-party valuation prepared by the person who benefits from a higher figure is inherently lower in reliability. The memo lacks a sensitivity analysis, does not explain the 12% discount rate, and does not reconcile the forecast earnings to historical results.
The auditor should obtain the company's financial statements, management accounts, tenant agreements, and evidence supporting the $480,000 forecast. The auditor should test the discount rate against market evidence for comparable child care businesses and consider whether a market-based approach or an independent valuation is needed given the size of the holding.
The prior-year write-down is a significant red flag. The auditor should document why the same method is expected to produce a reliable result this year and should consider whether the forecast earnings are achievable given the loss of the major tenant. If the auditor cannot obtain sufficient evidence, the auditor should qualify the audit report or report the matter as a significant breach of the trustee's duty to value assets at market value.
2. If the auditor concludes the valuation is overstated by $400,000, what are the consequences for the fund's compliance and the audit report?
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An overstatement of $400,000 reduces fund assets from $4.1 million to $3.7 million and changes the member's reported benefits. The trustee has a duty under s 52 of the SIS Act and regulation 4.09 to value assets at market value, so an unsupported valuation is a breach of that duty. The auditor should report the breach to the trustee and consider whether it is significant enough to report to the ATO.
The audit report should identify the valuation as a qualification or emphasis of matter, depending on the auditor's judgement about materiality. A $400,000 error against $4.1 million is roughly 9.8%, which is likely material. The auditor should state the nature of the error, the evidence obtained, and the effect on the fund's financial position.
The auditor should also consider whether the overvaluation affected the member's ability to satisfy the minimum pension standards or the contribution caps, and whether it affected any related-party acquisition rules. If the interest was acquired from a related party at the higher value, the auditor should examine whether the acquisition was at market value and whether the in-house asset rules were breached.
3. How should the auditor document the judgement about whether to obtain an independent valuation?
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The auditor should document the factors considered, the evidence obtained, and the reasoning for the conclusion. This includes the size of the holding relative to total assets, the related-party nature of the trustee and the valuation, the availability of independent evidence, the prior-year write-down, and the cost and feasibility of an independent valuation.
The documentation should record the auditor's assessment of the risk of material misstatement, the procedures performed, and the reasons why those procedures were sufficient or not. If the auditor decided an independent valuation was not required, the documentation should explain what alternative evidence was obtained and why it was adequate.
The auditor should also record the discussion with the trustee, any representations obtained, and the effect on the audit opinion. Good documentation protects the auditor if the valuation is later challenged and demonstrates that the judgement was made on the evidence available at the time, not on hindsight.