AUDITSI (Overview)

Introductory Concepts: Introduction to Auditing & Assurance – Specialized Industries

Course Description

• Financial statements are the representation of the reporting entity’s management. To lend
credibility to the entity’s prepared financial statements, they have to be examined by an
independent CPA, who expresses an opinion as to the fairness by which such financial statements
are presented. De La Salle – College of Saint Benilde
• As CPAs performing engagement services, learners must be exposed to the transaction cycles of
specialized industries, so that they can formulate audit plans and audit procedures.
• This course covers detailed approaches to problems and situations normally encountered in the
independent examination of financial statements of entities engaged in specialized industries.

Nature of Financial Statement Audits

• An audit is a systematic process of objectively obtaining and evaluating evidence regarding

assertions about economic actions and events to ascertain the degree of correspondence between
these assertions and the established criteria and communicating the results thereof. De La Salle –
College of Saint Benilde
• Assurance is an engagement whereby a practitioner expresses a conclusion that enhances the
degree of confidence of the users on a subject matter prepared by a “responsible party” when the
subject matter is compared and measured against established criteria.

Recap of Audit Process

• Pre-engagement – To minimize the likelihood of being associated to a client whose management

lacks integrity.
• Audit Planning – To assess the different risks associated with the audit to determine the nature,
timing, and extent of further audit procedures necessary to be performed.
• Consideration of internal controls – To establish a basis for reliance on internal controls in
determining the nature, timing and extent of audit procedures to be performed.
• Evidence gathering (substantive testing) – To ascertain the degree of correspondence between the
financial statements prepared by client’s management and the financial reporting framework.
• Completing the audit – To assist the auditor in assessing whether the conclusion reached is
consistent with evidence gathered.
• Issuance of audit report – To communicate the results of the work of the auditor to various intended
users.
• Post –audit responsibilities – To assess and evaluate the quality of the audit services by the
engagement team.

Overview: Auditing & Assurance – Specialized Industries

• A specialized industry is a distinct market that has a unique way of accounting for transactions and
reporting its financial results. These differences are allowed under the applicable accounting
framework, such as IFRS or GAAP. Examples of specialized industries are airlines, banks, and
insurance.
• Other examples of specialized industries: real estate, business process outsourcing (BPO), health
maintenance organizations, agriculture, oil extraction, etc.
What makes an industry “Specialized”?

• Either the industry has specific financial reporting standards or the industry has distinct
accounting policies which have been developed for specialized transactions and balances which
are based on the normally applied financial reporting standards.

Examples:

• IAS 41, Agriculture is clearly relevant specifically to the agricultural sector.

• IFRS 7, Financial Instruments: Disclosure will need specific application by companies operating in
the banking sector
• Valuation of extracted oil in line with IAS 2 Inventories (Specific application of accounting
standards)
• Valuation of apple trees (an example of bearer plants) under IAS 16 Property, Plant and Equipment.
(Specific application of accounting standards)

What are the basic auditing considerations for specialized industries?

• International Code of Ethics for Professional Accountants requires that the auditor should have an
appropriate understanding of the nature and complexity of the client’s business , as well as
knowledge of relevant industrial regulatory or reporting requirements
• ISA 220 (Revised) Quality Management for an Audit of Financial Statements requires the auditor
to assess whether there are sufficient and appropriate resources to perform the engagement and
that there is the ‘appropriate competence and capabilities

Module 1: Banks

Importance of Auditing Banks

• Banks are important pillars of our economy. The general public placed their hard-earned money
(savings) in banks.
• Banks need the trust of the general public. It is of public interest. The role of external auditors is
crucial

Who Regulates banks?

• Bangko Sentral ng Pilipinas – Central bank of the Republic of the Philippines

• The BSP enjoys fiscal and administrative autonomy from the National Government in the pursuit
of its mandated responsibilities.

The BSP’s responsibilities are as follows:

• To provide policy directions in the areas of money, banking, and credit

• To supervise the operations of the banks and to exercise such regulatory and examination
powers as provided under RA 11211 (The New Central Bank Act, as amended) and other
pertinent laws over the quasi-banking operations of non-bank financial institutions
• To exercise regulatory and examination powers over money service businesses, credit
granting businesses, and payment system operators; and
• Its primary objective is to maintain price stability conducive to a balanced and sustainable
growth of the economy and employment.
What are Covered Entities under the BSP?

Category A

• Universal Banks / Commercial Banks

• Foreign banks and branches or subsidiaries of foreign banks, regardless of unimpaired capital;
• Banks, trust department of qualified banks and other trust entities with additional derivatives
authority, pursuant to Section 613 regardless of classification, category and capital position.

Category B

• Thrift Banks
• Quasi Banks
• Trust department of qualified banks and other trust entities
• National Coop Banks; and
• Non-Banking Financial Institutions with Quasi banking functions

Category C

• Rural Banks / Local Coop

• Nonstock savings and loan associations
• Local Coop Banks
• Pawnshops

Accreditation Requirements for External Auditor of Banks (General Requirements)

• BOA accreditation & PIC – at least five (5) years of audit experience
• Auditor’s independence
• Category A auditors – established adequate quality assurance (QA) procedures

Accreditation Requirements for External Auditor of Banks (Auditor’s Independence)

• The auditor or any of the auditor’s immediate family should not have or committed to acquire
any direct or indirect financial interest in the covered institution.
• The auditor does not have outstanding loans or any credit accommodations or arranged for the
extension of credit or to renew an extension of credit with the covered institution (except credit
card obligations and fully secured auto/housing loans which are not past due) at the time of
signing the engagement and during the engagement.
• The covered institution’s CEO, CFO, Chief Accounting Officer or comptroller shall not be
previously employed by the external auditor during the 1 year preceding the date of the initiation
of the audit.

Accreditation Requirements for External Auditor of Banks (Specific Requirements)

• At least five (5) years experience in external audits

• Experience required as an associate, partner, lead partner, concurring partner or auditor-in-
charge
• At the time of application, the auditor must have the following track record:
o Category A – at least 5 corporate clients with TA of at least P50M each
o Category B – at least 3 corporate clients with TA of at least P25M each
o Category C – at least 3 corporate clients with TA of at least P5M each
Specific Reportorial Requirements to BSP

The external auditor must report to BSP within 30 calendar days after discovery:

• Any material finding involving fraud or dishonesty (including cases that were resolved during the
period of audit)
• Any potential losses the aggregate of which amounts to at least one percent (1%) of the capital
• Any finding to the effect that the consolidated assets of the company, on a going concern basis,
are no longer adequate to cover the total claims of creditors; and
• Material internal control weaknesses which may lead to financial reporting problems.

The external auditor must report to BSP within 15 calendar days:

• Termination or resignation as external auditor and reason

• Discovery of material breach of laws or BSP rules and regulations such as but not limited to:
o Capital Adequacy Ratios
o Loans and other risk assets review and classifications.
• In case there are no matters to report (e.g., fraud, dishonesty, breach of laws, etc.) the external
auditor/auditing firm shall submit directly to BSP within fifteen (15) calendar days after the
closing of the audit engagement a notarized certification that there is none to report.

Nature of Banks and Banking Operations

• A bank is defined as a type of financial institution whose principal activity involves the taking of
deposits and borrowing for the purpose of lending and investing and that is recognized as a
bank by the BSP (Philippine Auditing Practice Statements 1006)
• Refers to entities licensed by the BSP that are engaged in the lending of funds obtained in the
form of deposits (General Banking Law of 2000)

Classification of Banks

Universal Banks (UBs)

• Banks in addition to the powers authorized for a commercial bank, the powers of an investment
house and the power to invest in non-allied enterprises.

Commercial Banks (KBs)

• Banks that have in addition to the gen powers incident to corporations, all such powers as may
be necessary to carry on the business of commercial banking subject to such rules as the MB
may promulgate.

Thrift Banks (TBs)

• comprised of (1) savings and mortgage banks and (2) stock savings and loan associations –
Banks that include savings and mortgage banks, private development banks, and stock savings
and loan.

Rural Banks (RBs)

• Banks that are created to make needed credit available and readily accessible in the rural areas
for purposes of promoting comprehensive rural development.
 Cooperative Banks (Coop Banks)

• Banks that primarily provide financial, banking and credit services to cooperative organizations
and their members.

Islamic Banks (IBs)

• “Shariah-compliant finance” refers to finance or banking activities that adhere to shariah

(Islamic Law).

Basic Activities of Banks

• Deposit Taking
• Borrowing
• Lending
• Settlement
• Trading and Treasury Operations
• Securities Underwriting, Brokerage, Asset Management (for Universal Banks)

Characteristics of Banks

• Custody of large amounts of monetary items and other liquid assets.

• Engaged in transactions that transcend multiple place or jurisdictions.
• Banks hold assets that can rapidly change in value or whose value is often difficult to determine.
• Derive significant amount of funding from ST deposits.
• Fiduciary duties in respect of the assets they hold on behalf of other persons or entities.
• Engaged in a large volume and variety of transactions with significant values, complex
accounting & IC systems, & dependence on IT
• Operates through a network of branches and departments that are geographically dispersed.
• Transactions that can often be directly initiated & completed by the customer without the
intervention of the bank. (ATM or online)
• Assume significant commitments without any initial transfer of resources.
• Subject to stringent government regulations (BSP)
• Customer relationships that the auditor may have with the bank might affect the auditor’s
independence.
• Exclusive access to clearing and settlement systems
• Linked to national and international settlement systems
• Issue and trade in complex financial instruments (reported at FV)

Auditor’s Considerations in Audits of Banks

• The particular nature of the risks associated with the transactions undertaken by banks.
• The scale of banking operations and the resultant significant exposures that may arise in a short
period.
• The extensive dependence on IT to process transactions
• The effect of the regulations in the various jurisdictions in which they operate.
• The continuing development of new products and banking practices that may not be matched by
the concurrent development of accounting principles or internal controls. (e.g., cryptocurrency)
Auditor’s Objectives in Audit of FS of Banks

• The auditor should express an opinion whether the bank’s FS are fairly stated, in all material
respects, in accordance with the applicable financial reporting framework.
• The auditor’s report will include a description on the applicable financial reporting framework
that the management used in preparing the bank’s financial statements.

Planning and Performing the Audit of Banks’s FS

• Plan – Obtain a sufficient knowledge of the entity’s business and governance structure,
accounting and internal control systems, including risk management and internal audit functions
• Consider the expected assessments of inherent and control risk
• Determining the nature, timing, and extent of the audit procedures to be performed

Obtaining the Knowledge of the Business

The auditor should consider the following areas:

• The bank’s corporate governance structure

• The economic and regulatory environment in which the bank operates; and
• The market conditions exist in each of the significant sectors in which the bank operates.

Risk Associated with Banking Activities

Country Risk

• The risk of foreign customers and counterparties failing to settle their obligations because of
economic, political and social factors of the counterparty’s home country and external to the
customer or counterparty. (Country Limit).

Credit Risk

• The risk that a customer or counterparty will not settle an obligation for full value, either when
due or at any time thereafter. Credit risk, particularly from commercial lending, may be
considered the most important risk in banking operations.
• Credit risk arises from lending to individuals, companies, banks, and governments. It also exists
in assets other than loans, such as investments, balances due from other banks and in off
balance sheet commitments. Credit risk also includes country risk, transfer risk, replacement risk
and settlement risk.

Currency Risk

• The risk of loss arising from future movements in the exchange rates applicable to foreign
currency assets, liabilities, rights, and obligations.

Fiduciary Risk

• The risk of loss arising from factors such as failure to maintain safe custody or negligence in the
management of assets on behalf of other parties

Interest Rate Risk

• The risk that a movement in interest rate would have an adverse effect on the value of assets and
liabilities or would affect interest cash flows.
Legal and Documentary Risk

• The risk that contracts are documented incorrectly and are not legally enforceable.

Liquidity Risk

• The risk of loss arising from the changes in the bank’s ability to sell or dispose of an asset.

Modeling Risk

• The risk associated with the imperfections and subjectivity of valuation models used to
determine the values of assets or liabilities

Operational Risk

• The risk of direct or indirect loss resulting from inadequate or failed internal processes, people
and systems or from external events.

Price Risk

• The risk of loss arising from adverse changes in market prices, including interest rates, foreign
exchange rates, equity and commodity prices and from movements in the market prices of
investments.

Regulatory Risk

• The risk of loss arising from failure to comply with regulatory or legal requirements in the
relevant jurisdiction in which the bank operates. It also includes any loss that could arise from
changes in regulatory requirements.

Replacement Risk

• Sometimes called as performance risk. The risk of failure of a customer to perform the terms of a
contract. The failure creates the need to replace the failed transaction with another at the current
market price. This may result in a loss to the bank equivalent to the difference between the
contract price and the current market price.

Reputational Risk

• The risk of losing business because of negative public opinion and consequential damage to the
bank’s reputation arising from failure to properly manage some of the above risks, or from
involvement in improper or illegal activities by the bank or its senior management, such as
money laundering or attempts to cover up losses.

Settlement Risk

• The risk that one side of a transaction will be settled without value being received from the
customer. This will generally result in the loss to the bank of the full principal amount.

Solvency Risk

• The risk of loss arising from the possibility of the bank not having sufficient funds to meet its
obligations, or from the bank’s inability to access capital markets to raise required funds.
Transfer Risk

• The risk of loss arising when a counterparty’s obligation is not denominated in counterparty’s
home currency. The counterparty may be unable to obtain the currency of the obligation
irrespective of the counterparty’s particular financial condition.

Factors that Contribute to Operational Risk

Considering the Risk of Fraud
Policies and Procedures to Prevent Money Laundering

• A requirement to obtain customer identification (KYC procedures)

• Staff screening
• A requirement to know the purpose for which an account is to be used
• The maintenance of transaction records
• The reporting to the authorities of suspicious transactions or of all transactions of a particular
type, for example cash transactions over a certain amount.
• The education of staff to assist them in identifying suspicious transactions

Understanding Bank’s Risk Management Process

• Oversight and involvement in the control process by those charged with governance
• Identification, measurement and monitoring of risks
• Control activities
• Monitoring activities
• Reliable information systems

Internal Control Considerations

Internal controls related to accounting system are concerned with achieving objectives such as the
following:

• Transactions are executed in accordance with management’s general or specific authorization

• All transactions and other events are promptly recorded at the correct amount, in the appropriate
accounts and in the proper accounting period so as to permit preparation of financial statements
in accordance with accepted principles generally accepted in the Philippines
• Access to assets is permitted only in accordance with management’s authorization
• Recorded assets are compared with the existing assets at reasonable intervals and appropriate
action is taken regarding any differences

Inherent Limitations of Internal Control

• The assessed levels of inherent and control risks cannot be sufficiently low to eliminate the need
for the auditor to perform any substantive procedures
• Irrespective of the assessed levels of inherent and control risk, the auditor performs some
substantive procedures for material account balances and classes of transactions

Environmental Factors

• The organizational structure of the bank and the manner in which it provides for the delegation of
authority and responsibilities
• The quality of management supervision
• The extent and effectiveness of internal auditing
• The extent and effectiveness of the risk management and compliance systems
• The skills, competence, and integrity of key personnel
• The nature and extent of inspection by supervisory authorities.

Performing Substantive Procedures

• The auditor determines the nature, timing, and extent of the substantive tests.
• Result of internal control considerations
 • Consider significant risks
• Emphasis on test of completeness

Audit Evidence and Procedures

To address the assertions of management, the auditor may perform the following procedures:

Inspection

• Physical existence of material negotiable assets.

• Obtain understanding of terms and conditions of agreements.
• Inspect : Securities, Loan Agreements, Collaterals, and Commitment Agreements
• Consider assets held on behalf of third parties.

Inquiry and Confirmation

• Obtain evidence of the operation of internal controls

• Obtain evidence of the recognition of the bank’s customers and counterparties of amounts, terms
and conditions of certain transactions
• Obtain information not directly available from the bank’s accounting records
• Obtain information about off balance sheet commitments.

Examples:

• Collateral
• Verifying or obtaining independent confirmation of the value of assets and liabilities that are
not traded or are traded only on over-the-counter markets
• Assets, liability and forward purchase and sale positions with customers and counterparties
• Legal opinions on the validity of bank’s claims

Computation

• Check mathematical accuracy of schedules provided by client

• Checking consistent application of valuation models
• Use of computer assisted tools and techniques (CAATs) (e.g., searching for duplicate transactions

Analytical Procedures

• Reasonableness of interest income and interest expense

• Reasonableness of processing of large volume of data
• Appropriateness of going concern assumption
• Checking against range of statistical and financial information available for regulatory & other
sources
Module 2: Auditing & Assurance – Specialized Industries: Insurance Companies

What is an Insurance?

• Insurance is a contract between two parties whereby one party agrees to undertake the risk of
another in exchange for consideration known as premium and promises to pay a fixed sum of
money to the other party on happening of an uncertain event (death) or after the expiry of a certain
period (in case of life insurance) or to indemnify the other party on happening of an uncertain
event (in case of general insurance). The party bearing the risk is known as the “insurer” or
“assurer” and the party whose risk is covered is known as the “insured” or “assured”.

What is an Insurance? (Simple Version)

• It is a non-bank financial institution

• Provides insurance policy to protect individuals or policy holders from the risk of financial losses
in exchange for insurance premiums;
• An insurance company operates to pool risk among a large number of policy holders;

How does insurance works?

• Insurance can help us financially recover if a risk should damage the things we value.
• In insurance parlance, “risk” is the chance that something harmful or damaging will occur and
leave you facing a loss.

Types of Insurance

Life Insurance

• promises specific financial compensation to the beneficiary in case of the demise of the insured
person. To avail the insurance benefits, the policyholder is liable to pay the premium amounts
regularly and timely, as per the policies of the chosen plan.

General insurance

• is a general term used for all the insurance plans that safeguard things other than life, such as your
health and valuables against theft, natural disasters, accidents, etc. Timely premiums are to be paid
 for the value of protection chosen by you. The insurance company is then liable to pay you the
assured sum if any damage or theft happens to the insured entity.

Types of Insurance (Summary)

Who Regulates Insurance Companies?

Insurance Commission (IC)

• IC is an attached agency of the Department of Finance (DOF). It is committed to protect the interest
and welfare of the insuring public and to develop and strengthen the insurance industry. As
regulator, they provide an opportunity for every Filipino to secure insurance protection and we
shall observe practices at par with regional and global standards.

Special Considerations that make Insurance Accounting Unique

• Insurers assume risk on return for a premium

• Statutory accounting principles apply to the insurance industry
• Insurance category impacts accounting process
• How assets, liabilities, revenues, expenses, etc. are classified and accounted for
• The purpose of financial statements to evaluate the business
Risky Accounts

• Premium Payments (IS)

• Claim Payments (IS)
• Agent Commissions (IS)
• Cash and Bank Balances (SFP)
• Reserves (SFP) – Needed for future claims. Should follow the IC rules.
• Investments (SFP)

Significant Classes of Transactions on a Risk-Based Audit

Underwriting

• is the method an insurance company uses to understand how much of a risk you are to insure.

Pitfalls:

• Policies may be processed twice

• Fictitious premiums are recorded
• The coding of premiums may be incorrect which may result in inaccurate computation of
premiums
• Premiums are written even if policies have not been renewed
• Not all approved policies may have been posted
• Premiums may be recorded in the wrong period

Audit procedures

• Verification of existence (is there really a premium recorded?)

• Premium cut-off (Validate in the premium register)
• Premium analytical procedures
• Premium register reconciliation (sub-ledger vs GL)
Critical Audit Procedures (Premium)

Significant Classes of Transactions on a Risk-Based Audit

Reinsurance

• It is an insurance contract issued by one entity (the reinsurer) to compensate another entity for
claims arising from one (1) or more insurance contracts issued by that other entity (underlying
insurance contracts).

Pitfalls

• Reinsurance offers from unauthorized companies may be processed

• The assumed policy may be processed twice or fictitious premiums may be recorded
• Not all approved policies and premium adjustments or cancellations are recorded
• The coding of premiums may be incorrect, resulting in inaccurate computation of premiums
• Premiums may be recorded in the wrong period and not all approved policies may have been
posted

Audit Procedures

• Check reinsurance premiums subsidiary ledger and GL control accounts

• Develop expected changes for reinsurance premiums
• Perform analytical procedures for the current reinsurance premiums and previous reinsurance
premiums
Claim Processing

• It refers to the insurance company’s procedure to check the claim requests for adequate
information, validation, justification, and authenticity. At the end of this process, the insurance
company may reimburse the money to the healthcare provider in whole or in part.

Pitfalls:

• An unauthorized claim may be processed

• Claims may be processed for cancelled or expired policies or outside of the policy coverage
• Claims may be processed for payment twice
• Loss reserves may not be as updated as needed
• Not all claims may be recorded and fictitious claims may be recorded
• Claim transactions may not be posted and its related reinsurer’s shares

Audit Procedures

• Secure outstanding claim register and perform reconciliation between subsidiary and general
ledger
• Select samples from subsidiary ledger and check from claims folder. Secure claim number, line of
insurance, amount, date, name of insured, and check if it is recorded in the correct period
• Compare recorded reserves and reconcile with report of insurance adjuster

Critical Audit Procedures (Claims)

Critical Audit Procedures (Commissions)

Special Considerations that makes Insurance Accounting Unique:

Statutory Accounting Principles:

• Consistency
• Recognition
• Conservatism

Implementation of IFRS 17

IFRS 17 is effective for annual reporting periods beginning on or before 01 January 2023 with earlier
application permitted as long as IFRS 9 is also applied

Insurance contracts combine features of both a financial instrument and a service contract. In addition,
many insurance contracts generate cash flows with substantial variability over a long period. To provide
useful information about these features, IFRS 17:

• Combines current measurement of the future cash flows with the recognition of profit over the
period that services are provided under the contract
• Present insurance service results (including presentation of insurance revenue) separately from
insurance finance income or expenses; and
• Requires an entity to make an accounting policy choice of whether to recognize all insurance
finance income or expense in profit or loss or to recognize some of that income or expense in
other comprehensive income.

Implementation of IFRS 17
IFRS 17

• Fundamental change to the income statement under IFRS 17

• Very different view and presentation
• Different concept of “Revenue” and Expense”
• Splits Income Statement into Sections:
o Insurance Service Results
o Investment Results
o Other Results/Income Taxes

IFRS 17 – Simplifying Assumptions for our Example:

• All business is non-participating, long-term life insurance

• All contracts are subject to the General Measurement Approach (GMA)
• All groups of contracts are profitable currently and have positive CSM balances
• No Other Comprehensive Income (OCI)

IFRS 17 – Income Statement

Insurance Revenue will consist of the following:

• Contractual Service Margin (CSM) recognized for services provided

• Risk adjustment released in the period
• Expected claims
• Expected expenses (Directly attributable)
• Recovery of Insurance acquisition expenses

Insurance Service Expense will consist of the following:

• Actual Claims
• Actual Expenses (Directly Attributable)
• Amortization of Insurance Acquisition Expenses
• Changes in Estimates in Liability for Incurred Claim (LIC) fulfillment cash flows
• Experience adjustments on the LIC

IFRS 17 – Income Statement (Investment Result):

Actual Investment Income:

• Interest Income, coupon/dividend income

• Change in market value of actual assets

Finance Income or Expense

• Expected interest accretion on the Best Estimate Liability (BEL), Risk Adjustment (RA) and CSM
• Change in Liabilities (BEL & RA) due to changes in IFRS 17 yield curve during the period
Insurance Commission Circular Letter Number 2021-65:

Insurance Commission Circular Letter Number 2021-65:

Insurance Commission Circular Letter Number 2018-52
Insurance Commission Circular Letter Number 2021-65:
Insurance Commission Circular Letter Number 2023-006: