An auditor is assessing the risk of material misstatement for a nonissuer's complex financial instruments. The entity uses a third-party pricing service to value its portfolio of mortgage-backed securities. Which of the following procedures should the auditor perform to assess the reliability of the pricing service's data?

Answer options:

Obtain a written representation from management stating that the pricing service is reputable.

Confirm the year-end balances directly with the custodian holding the securities.

Evaluate the pricing service's controls over its valuation process or compare the prices to other independent pricing sources.

Recalculate the interest income received during the year to verify the effective yield.

How to approach this question

When using external data for valuation, you must validate the SOURCE. Is the source reliable? How do they get their numbers?

Full Answer

C.Evaluate the pricing service's controls over its valuation process or compare the prices to other independent pricing sources.✓ Correct

When an entity uses an external information source (like a pricing service) for fair value estimates, the auditor should evaluate the reliability of that data. This can be done by (1) testing the controls at the service (often via a SOC report), (2) comparing the prices to another independent source, or (3) understanding the proprietary models used.

Common mistakes

Confusing existence (confirmation) with valuation (pricing service).

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