Earlier this year, I was part of a group of auditors and accountants who worked on a paper on IFRS 9 that will support banks as they implement processes and systems to meet the new accounting standard. Contributing to this paper gave me a sense of professional pride and accomplishment.
It is not every day that six competitors work together to provide clients with ideas about how banks should engage with their own auditors. But we did - because this time is different: The changes are the biggest in accounting rules since IFRS was implemented in its entirety in 2005, and they will generally lead to banks setting aside more capital to cover expected credit losses (“ECL”).
Companies are being asked to do what sounds impossible – to peer into the future and estimate losses they have not yet incurred on particular loans. They must also adjust (both up and down) for future economic conditions and black swan events. Because of the forward-looking nature of the calculations, banks need an auditable, well-controlled and high-quality process for estimating ECL, and in our paper, we aim to help them get that.
In some ways, it is understandable what regulators want regarding ECL. They are trying to make the financial system more stable after the 2008 financial crisis. And since lenders know from experience that there will always be losses on books of business, such as large portfolios of similar items, why not go ahead and account for them as soon as possible?
Banks appear to be delayed given the challenge of the implementation of IFRS 9: There was an expectation in the market that they would be able to provide interim feedback in June of 2017 on how the standard will quantitatively impact their financial reports, but regulators, analysts, investors, and auditors are still waiting.
Our paper is the second about IFRS 9, written by the world’s six largest international accounting networks under the auspices of the GPPC, the Global Public Policy Committee. The GPPC comprises BDO, Deloitte, EY, Grant Thornton, KPMG and PwC and its public interest objective is to enhance quality in auditing and financial reporting. Our intent is to be helpful to those charged with governance (e.g. audit committees) in their oversight of auditors with regard to ECL. (The first paper was also addressed to those charged with governance and its purpose was to provide them with considerations that will help them oversee management’s progress during the implementation and transition phase.).
For audit committees, we suggested 9 questions to discuss with your auditors. In my opinion, some of the most interesting are:
- What is the auditor’s assessment of the bank’s controls over the key sources of complexity, judgement and uncertainty in the bank’s estimate of ECL under IFRS 9, and how has that assessment informed the auditor’s approach?
- How has the auditor exercised professional skepticism in testing the bank’s key judgements and assumptions (such as the selection of multiple, probability-weighted forward-looking economic scenarios and the determination of significant increases in credit risk) in the estimation of ECLs?
- What are the auditor’s views regarding the neutrality, clarity and comprehensibility of the disclosures regarding the bank’s estimate of ECLs?
From my perspective, these and the other questions are good ones for banks to start with, and it is my hope that our paper is just that - a starting point for discussions with clients. For me, it is not a one-size-fits-all audit manual, but a collection of best-practice thinking that should lead to a high-quality audit and more confidence in the financial results of banks.
As Christmas approaches, I am feeling ready for what is to come in the next months in the run up to IFRS 9 going live.
You can view the full paper here.