How sensitive is the fair value estimate to changes in the discount rate? How much would the discount rate estimate have to change for it to have a material impact on the financial statements?

Question

estimation uncertainty. These additional evaluations include:
a) How management has considered alternative assumptions or outcomes and why it has rejected
them or how management has otherwise addressed estimation uncertainty in making the
accounting estimate.
b) Whether the significant assumptions used by management are reasonable.
c) When relevant to the reasonableness of the significant assumptions used by management or
the appropriate application of the applicable financial reporting framework, management’s
intent to carry out specific courses of action and its ability to do so.
If, in the auditor’s judgment, management has not addressed adequately the effects of estimation
uncertainty on the accounting estimates that give rise to significant risks, the auditor should, if
considered necessary, develop a range with which to evaluate the reasonableness of the accounting
estimate (AU-C 540:15-16).
With respect to developing a reasonable range, standards indicate that a range is useful and
effective if it is narrow enough for the auditor to conclude whether the accounting estimate is materially
misstated and that, “ordinarily, a range that has been narrowed to be equal to or less than performance
materiality is adequate for the purpose” (AU-C 540.A100).
Finally, the auditor may need to engage a specialist and use their work as evidential matter to
evaluate material financial statement assertions. In doing so, the auditor should consider the guidance
in AU-C 620, Using the Work of a Specialist.

Answer 1

The fair value estimate is fairly sensitive to changes in the discount rate. However, with performance
materiality of $10 million, the discount rate would have to decrease to 2.82 percent in order for the
difference in valuations to reach a level in excess of performance materiality, which seems unlikely.
Given the reasonable range in interest rate of 8-11 percent and the fact that the client’s choice of
10 percent falls at the tail of that range, there may be reason to question the client’s current choice.
However, given performance materiality of $10 million, small changes in the rate do not appear to
materially affect the fair value measurement.