Other Relevant Audit Considerations
ASA 540 requires the auditor to obtain written representations from management and, where appropriate, those charged with governance whether they believe significant assumptions used in making accounting estimates are reasonable. ASA 580 requires that if, in addition to such required representations, the auditor determines that it is necessary to obtain one or more written representations to support other audit evidence relevant to the financial report or one or more specific assertions in the financial report, the auditor shall request such other written representations. Depending on the volume and degree of complexity of financial instrument activities, written representations to support other evidence obtained about financial instruments may also include:
- Management’s objectives with respect to financial instruments, for example, whether they are used for hedging, asset/liability management or investment purposes;
- Representations about the appropriateness of presentation of the financial report, for example the recording of financial instrument transactions as sales or financing transactions;
- Representations about the financial statements and note disclosures concerning financial instruments, for example that:
- The records reflect all financial instrument transactions; and
- All embedded derivative instruments have been identified;
- Whether all transactions have been conducted at arm’s length and at market value;
- The terms of transactions;
- The appropriateness of the valuations of financial instruments;
- Whether there are any side agreements associated with any financial instruments;
- Whether the entity has entered into any written options;
- Management’s intent and ability to carry out certain actions; and
- Whether subsequent events require adjustment to the valuations and disclosures included in the financial report.
Communication with Those Charged with Governance and Others
Because of the uncertainties associated with the valuation of financial instruments, the potential effects on the financial report of any significant risks are likely to be of governance interest. The auditor may communicate the nature and consequences of significant assumptions used in fair value measurements, the degree of subjectivity involved in the development of the assumptions, and the relative materiality of the items being measured at fair value to the financial report as a whole. In addition, the need for appropriate controls over commitments to enter into financial instrument contracts and over the subsequent measurement processes are matters that may give rise to the need for communication with those charged with governance.
ASA 260 deals with the auditor’s responsibility to communicate with those charged with governance in an audit of a financial report. With respect to financial instruments, matters to be communicated to those charged with governance may include:
- A lack of management understanding of the nature or extent of the financial instrument activities or the risks associated with such activities;
- Significant deficiencies in the design or operation of the systems of internal control or risk management relating to the entity’s financial instrument activities that the auditor has identified during the audit;
- Significant difficulties encountered when obtaining sufficient appropriate audit evidence relating to valuations performed by management or a management’s expert, for example, where management is unable to obtain an understanding of the valuation methodology, assumptions and data used by the management’s experts, and such information is not made available to the auditor by management’ s expert;
- Significant differences in judgements between the auditor and management or a management’s expert regarding valuations;
- The potential effects on the entity’s financial report of material risks and exposures required to be disclosed in the financial report, including the measurement uncertainty associated with financial instruments;
- The auditor’s views about the appropriateness of the selection of accounting policies and presentation of financial instrument transactions in the financial report;
- The auditor’s views about the qualitative aspects of the entity’s accounting practices and financial reporting for financial instruments; or
- A lack of comprehensive and clearly stated policies for the purchase, sale and holding of financial instruments, including operational controls, procedures for designating financial instruments as hedges, and monitoring exposures.
The appropriate timing for communications will vary with the circumstances of the engagement; however, it may be appropriate to communicate significant difficulties encountered during the audit as soon as practicable if those charged with governance are able to assist the auditor to overcome the difficulty, or if it is likely to lead to a modified opinion.
Communications with Regulators and Others
In some cases, auditors may be required, or may consider it appropriate, to communicate directly with regulators or prudential supervisors, in addition to those charged with governance, regarding matters relating to financial instruments. Such communication may be useful throughout the audit. For example, in some jurisdictions, banking regulators seek to cooperate with auditors to share information about the operation and application of controls over financial instrument activities, challenges in valuing financial instruments in inactive markets, and compliance with regulations. This coordination may be helpful to the auditor in identifying risks of material misstatement.
The prudential supervisor in Australia for financial institutions is the Australian Prudential Regulation Authority (APRA). Prudential standards issued by APRA cover communications between the auditor and APRA. See, for example, APS 310 Audit and Related Matters, GPS 310 Audit and Actuarial Reporting and Valuation and LPS 310 Audit and Actuarial Requirements.
See ASA 540, paragraph 22. Paragraph 4 of ASA 580 Written Representations states that written representations from management do not provide sufficient appropriate audit evidence on their own about any of the matters with which they deal. If the auditor is otherwise unable to obtain sufficient appropriate audit evidence, this may constitute a limitation on the scope of the audit that may have implications for the auditor’s report (see ASA 705).
Paragraph A80 of ASA 540 provides examples of procedures that may be appropriate in the circumstances.
ASA 265 Communicating Deficiencies in Internal Control to Those Charged with Governance and Management establishes requirements and provides guidance on communicating deficiencies in internal control to management and communicating significant deficiencies in internal control to those charged with governance. It explains that deficiencies in internal control may be identified during the auditor’s risk assessment procedures in accordance with ASA 315 or at any other stage of the audit.
For example, ASA 250 Consideration of Laws and Regulations in an Audit of a Financial Report requires auditors to determine whether there is a responsibility to report identified or suspected non-compliance with laws and regulations to parties outside the entity. In addition, requirements concerning the auditor’s communication to banking supervisors and others may be established in many countries either by law, by supervisory requirement or by formal agreement or protocol.