Plausibility review of valuation reports in the audit

A property company carries its assets at fair value on the balance sheet. A market value report is on file, prepared by a publicly appointed and sworn valuer, methodologically sound under the German Valuation Ordinance (ImmoWertV). And yet the auditor calls for the plausibility review of valuation reports by a further expert.

For the reporting entity – and at times for the original appraiser as well – this regularly causes irritation. Is the colleague's qualification being called into question? Is a publicly certified report not enough?

The report is the subject of the audit, not audit evidence

The carrying amount of a property in the financial statements is an accounting estimate made by management. The fact that management engages an external expert for this purpose changes nothing: in the terminology of the auditing standards this is a management's expert – commissioned, instructed and remunerated by the reporting entity. Its report is therefore part of the financial reporting subject to audit, not evidence obtained by the auditor.

The standards draw a clear conclusion from this. Under ISA 500 the auditor must, where information has been prepared using the work of a management's expert, evaluate that expert's competence and objectivity, assess the appropriateness of the methodology applied and examine the source data used. For estimates including fair values, ISA 540 and IDW PS 314 (revised) require independent audit procedures on method, assumptions and data. For companies audited under US standards, AS 1105, AS 2501 and AS 1210 impose comparable requirements.

An audit opinion that merely adopted a figure determined by an appraiser would not be defensible under any of these frameworks.

Why property values in particular attract attention

Property valuations combine several characteristics that make them demanding from an audit perspective. Under IFRS 13, fair value is regularly assigned to Level 3 of the fair value hierarchy because there are no observable market prices for the specific property; the value arises almost entirely from assumptions. Where the fair value model under IAS 40 is applied as well, all changes in value flow through profit or loss. The valuation therefore determines the reported result directly.

In addition there is the leverage of the input parameters. A change in the property interest rate of half a percentage point, a sustainable market rent that is ten per cent higher or lower, or a differently assessed remaining useful life often shift the income value by amounts that are material in themselves. At property companies and funds, the balance sheet item is frequently the largest of all. Where materiality, judgement and profit-or-loss impact coincide, the auditor regularly classifies the matter as a significant risk – with correspondingly intensive audit procedures.

What the plausibility review of valuation reports covers in practice

A plausibility review is not a blanket second opinion but a structured examination along the elements that drive value. It typically covers:

• the suitability and consistency of the methods selected, including the rationale for any deviations from the prior year,
• the appropriateness of the significant assumptions – sustainable market rent, vacancy and rent-loss risk, non-recoverable operating costs, remaining useful life, land value and the property interest rate,
• the relevance, currency and provenance of the external market data used, in particular data from the valuation committees, market reports and comparable transactions,
• the arithmetical accuracy and traceability of the valuation,
• the treatment of property-specific circumstances such as suspected contamination, encumbrances in section II of the land register, structural defects or leases with related parties,
• the sensitivity of the result to reasonably possible changes in the assumptions, and the estimation uncertainty that follows from it.

Particular attention goes to how current the data basis is. Where comparable rents or yield benchmarks are derived from market reports dating from several years before the valuation date, that is a classic starting point for queries – regardless of how carefully the report has been prepared in all other respects.

A market value under ImmoWertV is not automatically an IFRS fair value

The market value under section 194 of the German Building Code and fair value under IFRS 13 are close in substance: both aim at the price achievable in ordinary business dealings. They are not identical, however. IFRS 13 expressly requires measurement from the perspective of market participants and – for non-financial assets – consideration of the highest and best use. For the notes, the classification within the fair value hierarchy, the significant unobservable inputs and sensitivity disclosures are also required.

A German market value report does not provide this reconciliation on its own, because it was not prepared for that purpose. The requirements that financial reporting places on a valuation report are covered in the article on real estate valuation for financial statements in detail. Assessing whether valuation premises and documentation meet the requirements of international financial reporting is a separate technical task – and a frequent reason for engaging an expert on the auditor's side.

The role of the auditor-engaged expert

Auditors are specialists in financial reporting and auditing, not in property interest rates and adjustments to standard land values. Where their own expertise ends, they engage an expert whose work they use in accordance with IDW PS 322 and AS 1210 respectively.

That remit is narrowly defined and differs markedly from a fresh valuation. What is produced is neither a second full report nor an audit opinion, but an expert statement: on the appropriateness of methods and assumptions, on the reliability of the market data and on arithmetical accuracy – supplemented by an independently derived range for the significant value parameters and a list of open items. The audit strategy, the evaluation of these findings and the audit opinion remain with the auditor.

What preparers should take from this

Knowing where the auditor starts helps to avoid friction. A valuation report intended for financial statements subject to audit should not merely state its assumptions but derive and substantiate them, use current market data, show the effects of reasonably possible deviations and address the property's particular features transparently. Where contracts are concluded with related parties, the arm's length nature of the terms must be addressed explicitly.

Particular care is called for by anyone facing a change of auditor in the near future. A newly appointed auditor cannot build on findings from prior-year audits and evaluates valuation methodology and assumptions entirely independently for the first time – with a correspondingly high need for information. Anyone seeking certainty before the report goes into the audit can obtain a Second opinion in advance.

Conclusion

The plausibility review of valuation reports is the rule, not the exception. It follows from the fact that the property value is a judgemental estimate made by the reporting entity, and that a report commissioned by that same entity therefore cannot be sufficient audit evidence. Public certification and swearing-in attest to the qualification of the author – they do not replace the audit assurance the auditor must obtain independently.

In practice this means: the more transparently a report derives its assumptions, substantiates market data and discloses estimation uncertainty, the leaner the audit will be. And the more clearly the remit of the auditor-engaged expert is defined, the sooner a reliable conclusion is available.

The complete derivation, verifiable by third parties, is provided by the market value report.