One example involved a hypothetical regional bank that in the most recent period added a

new loan product – a 9-year auto loan in addition to their 3 and 5-year products. The
principal considerations identified by the auditor (i.e., #2, above) were that it was a new
product, the historical data on defaults of existing products would be of limited use, and that
loan impairment on these products “involved complex and subjective judgment” (language
straight out of the standard no less!).

Regarding #3, how the audit of the loan loss reserve was addressed, the first thing the
example states is that the auditor tested controls and the historical data that was used by
management as inputs. For every CAM communication I have seen (which admittedly is
limited at this point), they all start that way. But after that, things get to a point where we can
understand why the Accounting Establishment is squirming. The auditor reports that it
evaluated the qualitative adjustment to the historical loss rate, including the basis and
significant assumptions. No matter who is doing that — management, the auditor, or a
“specialist” — this is a highly speculative exercise. It could well be that the auditor’s best
protection here is to communicate as little as possible beyond tried and tested boilerplate.
Loan loss reserves should be a fairly common CAM disclosure, but there is no way to put a
good face on them. The subjectivity of the accruals raise questions like whether audits of loan
loss reserves based on current GAAP can provide reasonable assurance under any
circumstances beyond plain vanilla. It would seem that the PCAOB sensed this, because the
example communication mentioned that a “specialist” was involved in the estimate of the loan
loss reserve. But, I wonder what kind of specialist they were envisioning? If the standard
called for measurement of the loan portfolio at fair value, then I could imagine a specialist
contributing in a substantive way, but for me, I don’t know whether a specialist’s crystal ball is
any better for predicting future default rates than anyone else’s, without actually trying
to value the portfolio, which is not required by GAAP.