Can we evolve auditing standards to meet significant changes to accounting estimates?

As new accounting standards introduce radical changes to accounting estimates that will bring challenges for auditors, preparers, audit committees, prudential regulators and others, auditing standard-setters are moving to assist auditors with these challenges.

IFRS 9 Financial Instruments, issued by the International Accounting Standards Board (IASB), will require the use of an expected credit loss (ECL) model.

This new standard will affect certain industries, such as banks and financial institutions, which have credit risk exposures through holdings of loans and similar financial assets. The United States is developing similar standards.

In Canada, IFRS 9 will be effective for periods beginning January 1, 2018 (although there are some specific transition requirements). The Office of Superintendent of Financial Institutions is requiring Domestic Systemically Important Banks to adopt IFRS 9 for their annual period beginning November 1, 2017.

The IAASB’s response: The ISA 540 project

Because of the significant challenges brought by IFRS 9, the International Auditing and Assurance Standards Board (IAASB) issued a project publication to encourage auditors to understand the nature of changes needed to effectively implement an ECL model. It also provides a brief summary of audit challenges and how they might be addressed under existing ISA 540, including:

  • Use of an ECL model may require an entity to bring together data and assumptions from systems that may not be part of the traditional accounting systems. Data from outside of the entity may also be needed; for example, economic forecasts and loss statistics from the credit bureau. It will be a challenge for auditors to determine how to address such systems and data in the audit.
  • ECL will likely occur in a complex data environment involving many processes and controls, and perhaps bespoke models. These models may be subject to significant management judgment and will likely be complex. The auditor may need access to specific skills in order to perform the audit, including understanding the model and responding to the assessed risks of material misstatement.

Due to the complexity, estimation uncertainty, materiality of the ECL provision and the need for judgment, the use of an ECL model will likely give rise to significant risks of material misstatement. In acknowledgement of these impending audit challenges due to the adoption of the ECL model, the IAASB plans to address them in a project to revise ISA 540, which deals with audits of accounting estimates.

Reflecting an appropriate balance

While it is important that the IAASB consider ISA 540 in the context of complex accounting estimates like ECL, it is also critical that ISA 540 be capable of being applied to less complex accounting estimates. Auditing accounting estimates is a key element of most audits, large and small, and so a nuanced approach should allow for professional judgment, while emphasizing the appropriate response to significant risks.

Reflecting the importance of this project to Canadian stakeholders, the Auditing and Assurance Standards Board (AASB) is forming an advisory group. The advisory group will assist the AASB in considering the issues, provide input to the IAASB and identify specific challenges in a Canadian context. This reinforces the AASB’s efforts to obtain more evidence-based input as it sets auditing standards under its new strategic plan.

Keep the conversation going

How are Canadian companies preparing for IFRS 9? Where are the biggest challenges emerging? Are auditors responding?

Post a comment below; or email me directly.

Conversations about Audit Quality is designed to create an exchange of ideas on global audit quality developments and issues and their impact in Canada.

About the Author

Eric Turner, CPA, CA

Director, Auditing and Assurance Standards, CPA Canada