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Auditors respond to the risks of material misstatement posed by estimates of expected credit losses under IFRS 9

10 August 2017

The introduction of IFRS 9 in January 2018, and with it the requirement to estimate expected credit losses (ECL), signals significant changes in reporting for financial institutions.

The Global Public Policy Committee (GPPC), of which BDO is one of six members, has released a paper to promote high quality audits of the accounting for ECLs by financial institutions.

Due to the introduction of potential new risks of material misstatement, the GPPC is looking to help the relevant parties to effectively evaluate the quality of the auditor’s response to the risks of material misstatement posed by estimates of ECLs by publishing this paper.

Given the importance of banks and financial institutions in the global capital markets and the wider economy, the quality of audits around their estimates of ECLs is key to building confidence in financial institutions’ high standard of implementation of IFRS 9. This is to ensure financial institutions are providing reliable estimates which users of financial statements can trust. As a result, financial institution management teams, audit committees and auditors have vital roles to play in the effective reporting of ECLs.

The GPPC recommends a robust system of internal controls be in place during and after the transition of IFRS 9 in order to guarantee that ECLs are estimated in a well-governed environment. The design and implementation of high quality policies, procedures, systems and models by financial institutions, in accordance with IFRS 9, will allow management to use appropriate judgements when estimating ECLs. Such judgements are based on certain foundational estimates, including:

  • Their accounting policies
  • Operational procedures and systems of internal control
  • Information systems and data
  • Estimation models.

The provision of transparent, neutral and informative disclosures by financial institutions on their financial statements will allow stakeholders to understand and evaluate the estimations of ECL made by the financial institutions.

The onus lies with Audit Committees to ensure the financial institution has clearly communicated the important matters regarding the estimates made on these financial statements. As such, Audit Committees play a unique and vital role in ensuring financial institutions have high quality estimates of ECLs under IFRS 9.

Audit Committees must govern the quality of the foundational elements upon which financial institutions base their estimates of ECLs, and ensure they are suitable. Consequently, the GPPC argues these will be key areas of focus for auditors when auditing the estimation of the ECL.

The responsibility of objectively evaluating and challenging accounting estimates with a risk of material misstatement at account level and in the broader context of the financial statement as a whole, lies with auditors. Their work will be of interest to many stakeholders, including investors, regulators and analysts. 

The GPPC examines the Audit Committee’s oversight of the auditor, and argues the risks of material misstatement related to the estimation of ECL under IFRS 9 are as a result of the:

  • Complexity of estimating credit losses
  • A higher number of inputs and assumptions, which are subject to judgement
  • Increased estimation uncertainty
  • Potential magnitude of the ECL estimate for systemically important banks (SIBs).

Overall, The GPPC recommends, when evaluating the auditor’s planned approach and the auditor’s findings, Audit Committees should take into account the auditor’s skills, knowledge and resources available to them and assess whether they are at an appropriate level to address the risks presented by the ECL estimate of a financial institution.

As financial institutions, regulators and auditors gain more experience with IFRS 9, new challenges and insights may come to light. The GPPC predicts the evolution of financial institution’s practices along with the expectations of regulators and auditors. Considerations must be given by all relevant parties on how the developments may affect their respective responsibilities regarding the estimate of ECL.

If you would like more information on the implementation of IFRS 9 please contact a BDO adviser.

Read the full GPPC paper or press release here.