This article is valuation commentary. It is not legal, tax, accounting, or investment advice. Specific engagements depend on facts and applicable professional standards.
This guide explains the rules. How LHM works with audit teams is described on the For CPAs and Audit Firms page.
Why the audit firm usually cannot prepare it
For audits of SEC issuers, Regulation S-X Rule 2-01(c)(4)(iii) says an accountant is not independent if it provides any appraisal or valuation service to an audit client, unless it is reasonable to conclude that the results will not be subject to audit procedures. The SEC’s 2003 adopting release chose that wording to narrow the exception and described a rebuttable presumption that the results will be audited. It says valuation services include valuing financial instruments, assets and liabilities acquired in a merger, and real estate. The SEC staff’s independence FAQ adds that materiality is not a basis for overcoming that presumption. PCAOB Rule 3520, Note 1, makes the SEC criteria a PCAOB obligation.
For non-issuer audits, such as private companies and employee benefit plans, the AICPA Code of Professional Conduct applies a two-part test. Under ET 1.295.110.02, independence is impaired, and no safeguard can fix it, when a valuation for an attest client involves a significant degree of subjectivity and its results are material to the financial statements, alone or combined with other valuation services. The Code’s examples of significantly subjective work are ESOPs, business combinations, and appraisals of assets or liabilities (ET 1.295.110.04). For these rules, “member” includes the member’s firm (ET 1.295.010.02), so a separate advisory group inside the same firm does not solve the problem.
The AICPA test leaves some room the SEC rule does not. A valuation that is immaterial, not significantly subjective, or prepared solely for a nonfinancial statement purpose such as estate and gift tax may be permitted. Each of those still requires the general nonattest requirements, including that management determines or approves all significant assumptions (ET 1.295.110.03, .05, .06). Where a stricter regulator’s rules also apply, such as the GAO, the Department of Labor, or a state board, the Code treats a breach of those rules as an impairment too (ET 1.295.010.07).
Timing matters under both regimes. The prohibition reaches the whole period covered by the financial statements under audit, not only the time after the engagement letter is signed (S-X 2-01(c)(4) and (f)(5); ET 1.295.010.01). The SEC staff’s FAQ puts it directly: “There is not a cure for prohibited services.” A narrow exception covers work a successor auditor did before it was engaged that relates only to earlier periods audited by another firm (ET 1.295.010.03; SEC staff FAQ, non-audit services question 4).
| SEC issuer audits (SEC and PCAOB) | Non-issuer audits (AICPA) | |
|---|---|---|
| Rule | S-X Rule 2-01(c)(4)(iii), carried into PCAOB Rule 3520 | AICPA Code, ET 1.295.110 |
| Test | Any valuation service, unless it is reasonable to conclude the results will not be audited | Significant subjectivity and materiality, both required |
| Materiality | Not a basis for the exception | An immaterial valuation may be permitted |
| Tax-only valuations | Not prohibited by the valuation rule; audit committee pre-approval still applies (S-X 2-01(c)(7); PCAOB Rule 3524 for tax services) | Permitted if solely for a nonfinancial statement purpose and the general requirements are met |
The AICPA’s nonauthoritative Q&A 220.01 says advice on methods and assumptions is acceptable when the general requirements are met, but supplying a firm-developed template, or entering the amounts into one, is in substance performing the valuation.
Two roles an outside valuation firm can play
An outside firm can then act in one of two capacities. In the AICPA auditing standards, AU-C 620.06 defines a management’s specialist as one whose work the entity uses to prepare its financial statements, and an auditor’s specialist as one whose work the auditor uses to obtain audit evidence. PCAOB standards use “company’s specialist” for the first and, for an outside firm the auditor hires, “auditor-engaged specialist” (AS 1210). The PCAOB staff’s February 2025 Spotlight on specialists (staff views, not a rule) calls them fundamentally distinct.
The SEC’s 2003 release explains why the split works for issuer audits: reviewing management’s valuation is part of the audit, while preparing it is a prohibited non-audit service.
| Management’s specialist | Auditor’s specialist | |
|---|---|---|
| Engaged by | The company | The audit firm |
| Paid by | The company | The audit firm; a direct contract with the company bears on objectivity (AS 1210.05) |
| Job | Prepares the valuation the company records | Evaluates the company’s valuation, or develops an independent estimate or range |
| Non-issuer standard | AU-C 501.27 | AU-C 620 |
| Issuer standard | AS 1105, Appendix A | AS 1210 |
| Who is responsible for the result | Management; the specialist’s assumptions become management’s once used (AU-C 540.A130) | The auditor, who keeps sole responsibility for the opinion (AU-C 620.03) |
What the standards ask of the auditor
When the company used a specialist. Under AU-C 501.27, the auditor evaluates the specialist’s competence, capabilities, and objectivity, obtains an understanding of the work, and evaluates whether it is appropriate as audit evidence. For issuers, AS 1105, Appendix A, requires the auditor to test the company data the specialist used, evaluate the significant assumptions, and evaluate whether the methods fit the reporting framework (AS 1105.A8). Under both regimes, more persuasive evidence is needed as the work becomes more significant, the risk rises, or the company’s ability to influence the specialist increases (AU-C 501.A72; AS 1105.A7). The note to AS 1105.A6 (see AS 2101.16 and .17) also asks whether an auditor’s specialist is needed to evaluate the company’s specialist.
When the auditor engages a specialist. AU-C 620.09 requires the auditor to evaluate the specialist’s competence, capabilities, and objectivity, including inquiry about interests and relationships with the client. AU-C 620.11 requires agreement, in writing when appropriate, on scope, roles, the form of communication, and confidentiality. AU-C 620.12 requires the auditor to evaluate the specialist’s findings, assumptions and methods, and source data. AS 1210.03 through .10 set parallel requirements for issuer audits, scaled to significance and risk. Under AU-C 620, an external specialist is not a member of the engagement team (.A14), and the auditor does not name the specialist in an unmodified report (.14).
PCAOB staff publications show where files fall short. The February 2025 Spotlight lists files where the company specialist’s report was placed in the file with no evaluation, and audits where no specialist was involved even though the team lacked the expertise. It also describes smaller firms engaging outside specialists to supplement the team as a good practice. The May 2025 Audit Focus, written for auditors of smaller companies, names failing to evaluate significant assumptions beyond vouching them to data as a common deficiency. Both are staff views, not rules.
What an independent valuation review covers
“Independent valuation review” is a practice term, not a defined one. In the standards, it is the auditor’s specialist evaluating management’s methods, significant assumptions, and data, or developing an independent estimate or range for comparison (AU-C 540.17; AS 2501.07). When LHM reviews a valuation for an audit team, the work covers:
- Method. Whether the approach fits the framework and the asset or instrument, and why the company chose it where methods give materially different answers (AS 2501.10 and .11; AU-C 540.22).
- Significant assumptions. Identifying the assumptions that are sensitive, unobservable, or open to bias, then testing them individually and in combination against history, strategy, market data, and the company’s other estimates (AS 2501.15 and .16; AU-C 540.23).
- Data. The relevance and reliability of external inputs, and a clear split with the audit team on who tests the company’s own data (AS 1105.A8; AU-C 620 appendix).
- The calculations. Mathematical accuracy, the allocation waterfall or simulation mechanics, and whether the inputs flow through as described, recalculated from the report and support where the model is not provided.
- An independent range, where useful. A range should contain only supportable outcomes (AU-C 540.28; AS 2501.25).
- The report itself. Restrictions or disclaimers in a specialist’s report can limit its use as audit evidence (AS 1210.12; AU-C 620.A43; AU-C 501.A88).
The review does not need to re-perform the company’s valuation. The PCAOB staff makes that point about evaluating a company’s specialist, and the work scales with significance and risk (AS 1210.10; AU-C 620.08). The deliverable is a memo describing the work performed, the results, and the findings (AS 1210.06d; AU-C 620.11c), written so the engagement team can file it. If the review finds the valuation unsupported, the findings go to the audit team and management decides how to respond. LHM’s review work centers on 409A and ASC 718 common stock valuations, purchase price allocations under ASC 805, and goodwill and long-lived asset impairment testing under ASC 350 and 360, along with the complex securities, warrants, and contingent consideration those engagements often include.
How to scope and time it so it does not hold up the audit
The standards do not set a schedule, so the points below are practice guidance tied to the paragraphs that support them.
- Decide in planning. The auditor determines whether specialized skills are needed (AU-C 540.14; AU-C 620.07).
- Write the agreement first. The AU-C 620 appendix (.A47) lists matters worth settling in the agreement: scope, completion date, prompt notice of delays, access to records and to management’s specialist, and who tests source data. Settle whether the specialist’s working papers enter the audit file; otherwise they stay its own (AU-C 620.A32). For issuer audits, AS 1210.06 requires a documented understanding with the specialist on its responsibilities, the work, and who tests the company’s data.
- Brief the specialist. Share the company’s estimation process, its use of a specialist, the framework requirements, and the accounting issues already identified (AS 1210.07; AU-C 620.A30).
- Get the support, not only the report. The forecast and the support for the significant assumptions should arrive with management’s draft. Preparers often do not release their working models, so plan the review around the report and its support.
- Talk before the memo. On significant-risk areas, oral updates during the work and a written report at the end may both be appropriate (AU-C 620.A33).
For CFOs and controllers, the same calendar runs in reverse. Engage management’s specialist early, choose a firm unrelated to the auditor’s specialist, and plan for the auditor to test the work. When LHM prepares the valuation for the company, the report states the standard of value, the methods, the significant assumptions and their sources, and the reconciliation, so the auditor can test the work rather than reconstruct it. Where management needs specialist expertise and does not obtain it, AU-C 501.A70 notes that the risk of material misstatement rises and the gap may be a significant deficiency or material weakness.