Auditing and assurance: Specialized industry QUIZ 1 (UPDATED: MIDTERMS)

Specialized industry

-Is not necessarily rare or even unusual
- They are likely either to have SPECIFIC FINANCIAL REPORTING STANDARDS applicable to them
- Have DISTINCT ACCOUNTING POLICIES which have been developed to account for specialized transactions and balances which are based on the normally-applied financial reporting standards

PAS 41

Agricultural sector

PFRS 6

Mining sector

PFRS 7

Banking sector

PAS 16

PPE

PFRS 17

Insurance company

High risk
Strict and several compliances with laws and government agencies and regulations
Complex accounting

Characteristics of specialized industry

Competence
Audit planning considerations
Reliance on experts

Audit considerations

Competence

the quality of being adequately or well qualified physically and intellectually

Requires the audit firm to consider whether the firm is competent to perform the engagement capabilities, including time and resources, to do so.

Knowledge of relevant industries
Experience w/ relevant regulatory or reporting requirements
The ability to gain the necessary skills and knowledge effectively

Audit planning

Identification of the risk material misstatement in a specialized industry should be approached in the same way as in any other audit -- by obtaining appropriate understanding of the business and its environment.

To assist the audit team members assigned to a specialized industry client, the audit firm is likely to have additional resources available, there may be:
- Briefing notes
- Internal technical guidances on how financial reporting standards should be applied within the sector

Reliance on expert

The auditor may plan to use an auditor's expert to obtain audit evidence

This is quite likely in a specialized industry as despite being competent to perform the engagement, the audit firm may not have the necessary specific expertise in some areas

IMPORTANT NOTE!
- Evaluate the relevance and adequacy of the expert's findings and conclusions
-Danger of over-reliance on the expert's work
- Any inconsistencies must be investigated

Bangko Sentral ng Pilipinas

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 Republic Act No. 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;

Its primary objective is to maintain price stability
conducive to a balanced and sustainable growth
of the economy and employment.

Category A

Universal banks/ Commercial banks;

Foreign banks and branches or subsidiaries of foreign banks regardless of unimpaired capital; and

Banks, trust department of qualifies 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 qualifies banks and other trust entities ;
National cooperative banks; and,
Non-banking financial institutions with quasi banking functions

Category C

Rural banks;
Non-stock saving and loan associations;
Local cooperative banks; and,
Pawnshops.

BOA accreditation & PIC
Auditor's independence
Category A auditors - established adequate quality assurance procedures

Accreditation of external auditors for banks (General req)

Auditor should not have immediate family or affiliated with any financial interest with the entity

Auditor does not have outstanding loans or any credit accommodations from the entity during the engagement

The CEO, CFO, Chief accounting officer shall not be previously employed by the auditor within 1 year preceding the audit initiation

Independence requirements

5 year experience in external audit
Experience required for the auditors

Must have the following track record:
A - at least 5 corporate clients with total assets of 50m each
B - at least 3 corporate clients with total assets of 25m each
C - at least 3 corporate clients with total assets of 5m each

Accreditation of external auditors for banks (Specific req)

Must report to BSP within 30 days:
Material finding involving fraud or dishonesty
Any potential losses with an aggregate amount of 1% of capital
Going concern assumption is no longer adequate
Material internal control weakness

Must report to BSP within 15 days
Termination or resignation as external auditor and reason
Material breach of laws or BSP rules
Even if there is none to report, report that there is none to report

Reportorial requirements

Bank

is defined as 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 bank by the BSP (PAPS 1006)

refer 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)

Universal bank

are financial service conglomerates that combine investment banking, commercial banking, development banking, and insurance to encompass a wider variety of services. They are also authorized to engage in other functions such as merchant banking, mutual funds, factoring, housing finance, and practically all types of functions typical in the banking business.

Commercial banks

are privately-owned institutions that accept deposits and lend money to projects to earn interest. They also offer personal, business, and mortgage loans, checking account services, and basic financial products like savings accounts and certificate of deposit to individuals and businesses. They are primarily owned by shareholders and are profit-based.

Thrift bank

composed of savings and mortgage banks, private development banks, stock savings and loan associations and microfinance thrift banks. Thrift banks are engaged in accumulating savings of depositors and investing them

Rural banks

government-sponsored/assisted banks which are privately managed and largely privately owned that provide credit facilities to farmers and merchants, or to cooperatives of such farmers or merchants at reasonable terms and in general, to the people of the rural community.

Cooperative bank

one which is organized, owned and controlled by cooperative organizations, for the purpose of providing financial and credit services to cooperatives and their members. Its members are either regular or associate

Islamic banks

refers to financial activities that adhere to Shariah (Islamic law). Two fundamental principles of Islamic banking are the sharing of profit and loss and the prohibition of the collection and payment of interest by lenders and investors.

Deposit taking
Borrowing
Lending
Settlement
Trading and treasury operations

Basic activities of banks

Characteristics of banks

Custody of large amounts of monetary items and other liquid assets
Engaged in transaction that transcends multiple place or jurisdictions

Holding of assets that can rapidly change in value or whose value is often difficulty to determine
Derive significant amount of funding from short term deposits

Fiduciary duties in respect of assets they hold on behalf of other persons or entities.

Engaged in a large volume and variety of transactions with significant values, complex accounting &
internal control system, and dependence on IT

Operate though networks of branches and departments that are geographically dispersed
Transactions that can often be directly initiated and completed by the customer without
intervention of the bank

Assume significant commitments without any initial transfer of resources
Stringent government regulations (BSP)

Customer relationships that the auditor may have with the bank might affect auditor;s
independence

Assume significant commitments without any initial transfer of resources
Stringent government regulations (BSP)

Customer relationships that the auditor may have with the bank might affect auditor's
independence

Exclusive access to clearing and settlement systems
Linked to national and international settlement system
Issue and trade in complex financial instruments

Nature of risk of transactions by bank
Scale of banking operations
Extensive dependence on IT process
Effect of laws and regulations
Development of new products and banking practices

Auditors consideration

Express opinion whether fairly stated in accordance to set standards
Conclude a description on the financial reporting framework of the bank

AUDITOR'S OBJECTIVES IN AUDIT OF FINANCIAL STATEMENTS OF BANKS

Audit plan

obtaining a sufficient knowledge of the entity's business and governance structure, accounting and internal control systems, including risk management and internal audit functions.
considering the expected assessments of inherit and control risks.
determining the nature, timing, and extent of the audit procedures to be performed.

Obtaining knowledge about the bank

The bank’s corporate governance structure;
The economic and regulatory environment in which the bank operates; and
The market conditions existing in each of the significant sectors in which the banks operates

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

Credit risk

the risk that a customer will not settle an obligation for full value, either when due or at any time thereafter.

Currency risk

the risk of loss arising from future movements in the exchange rate 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 negligence in the management of assets on behalf of other parties

Interest rate risk

risk that a movement in interest rates would have an adverse effect on the value of assets and liabilities or would affect interest cash flows

Legal and documentary risk

risk that contracts are documented incorrectly or are not legally enforceable in the relevant jurisdiction in which they are to be enforced or where the counterparties operate.

Liquidity risk

the risk of loss arising from the changes in the bank's ability to sell or dispose of an asset

Modeling risk

risk associated with the imperfections and subjectivity of evaluation models used to determine the values of assets and liabilities

Operational risk

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 the market prices, including interest rates, forex rates, equity and commodity prices and from movements in the market prices of investments

Regulatory risk

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 from regulatory.

Replacement risk

risk of failure of a customer to perform the terms of a contract.

Reputation risk

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 risk, or from involvement in improper or illegal activies by the bank or its senior management, such as money laundering or attempts to cover up losses

Settlement risk

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 full principal amount

Solvency risk

risk of loss arising from the possibility of the bank not having sufficient funds to its obligations, or from the bank's inability to access capital markets to raise required funds.

transfer risk

risk of loss arising when a counterparty's obligation cannot be converted in the counterparty's home currency.

A requirement to obtain customer identification

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

POLICIES AND PROCEDURES TO PREVENT MONEY
LAUNDERING

Understanding the 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

Development of an overall audit plan

The complexity of transactions undertaken.

The extent to which why any core activities are provided by service organizations
Contingent liabilities and off balance sheet items

Regulatory considerations

The extent of IT and other systems

Expected assessment of inherent and control risks.
The work of internal auditing

Audit risk
Materiality

Management's representations
Involvement of other auditors
Coordinating the work to be performed
Related party transactions

Going concern considerations

Internal control considerations

Transactions are executed in accordance with the 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 limitation of internal controls

The assessed level 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 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.
Results 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;
observation;

inquiry and
confirmation;
computation; and
analytical procedures.

Inspection

Physical existence of material negotiable assets.
Obtain understanding of terms

Inspect

Securities

Loan agreements

Collaterals

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 by the bank's customers and counterparties of
amounts, terms and conditions of certain transaction; and

Obtain information not directly available from the bank's accounting records.

Obtain information about off balance sheet commitments. Examples
of areas for which the auditor may use confirmations are:

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.

Computation

Check mathematical accuracy of schedules provided by client.
Checking consistent application of valuation models.

Use of computer assisted tools and techniques (CAATS).

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.

Contract of insurance

is an agreement whereby one undertakes for a consideration to indemnify another against loss, damage or liability arising from an unknown or contingent event.

Insurance contract

is a contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder.

Insurer
Insured
Cedant
Reinsurer

Parties to insurance contracts

Proprietary insurers

organized and operated by stockholders mainly for profit

Cooperative insurers

these are operated to provide insurance at cost to members. The insured are the owners.

Government

The government service insurance system (GSIS) which extends life insurance to government employees and the social security system (SSS) fall within this category.

Individual
Group
Industrial

Examples of life insurance

Fire
Marine
Casualty

Examples of non-life insurance

Suretyship

is a very specialized line of insurance that is created whenever one party guarantees performance of an obligation by another party. For example, when a student takes out a student loan, the bank will require the parent/s to sign as surety for repayment of the student loan, or when a private company applies for a loan, one or more of the directors usually sign as surety for payment should the company fail to pay.

Reinsurance

an insurance contract issued by one insurer (the reinsurer) to compensate another insurer (the cedant) for losses on one or more contracts issued by the cedant.

is a contract between a reinsurer and an insurer. In this contract, the insurance company—the cedent—transfers risk to the reinsurance company, and the latter assumes all or part of one or more insurance policies issued by the cedent.

Facultative reinsurance

Covers specific individual risk

Gives RI right to review each individual direct policy

Treaty reinsurance

provides automatic reinsurance of a defined book of business

Principle of insurable interest
Principle of utmost good faith
Principle of indemnity
Principle of subrogation
Principle of contribution
Principle of proximate cause

Basic insurance principles

Direct writings

an insurance contract that is not reinsurance contract
a. direct contact with the assured
b. agents
c. broker

Insurance commission
Securities and exchange commission
Bureau of internal revenue
Philippine stock exchange

Regulatory bodies governing insurance industry

Life insurance

a contract between the policy owner and the insurer

the insurer agrees to pay a designated beneficiary a sum of money upon the occurrence of the insured individual's or individual's death or other event, such as terminal illness or critical illness

In return, the policy owner agrees to pay a stipulated amount at regular intervals or in lump sum.

Term

period of coverage is specific; there is specific term

No cash value

Permanent

Coverage is usually until death of the insured

With cash value which can be accessed through policy loans

Whole life

Guaranteed death benefit, guaranteed cash value but not flexible

Universal

Guaranteed death benefit and cash value, but cash value is increase through interest or performance of investment chosen by insured.

Endowment

Cash value built up equals death benefit at a certain age, may be paid out to insured even if he lives or dies, after a specific period or age.

Cash surrender value

Is the sum of money an insurance company pays to the policyholder or annuity holder in the event his policy is voluntarily terminated before its maturity or the insured event occurs.

is the savings component of most permanent life insurance policies, particularly whole life insurance policies.

Discretionary participation feature

is a contractual right that gives policyholders the right to receive supplementary discretionary returns through participation in the surplus arising from participating business.

Unit-linked insurance contracts

is an insurance contract linking payments to units of an internal investment fund set up by the company with the consideration received from the policyholders. The investment support the linked policies are maintained in segragated accounts in conformity with Philippine laws and regulations.

example: VUL = portion is the premium for the insurance and portion is invested in for example a mutual fund

Net premiums due and uncollected

represents uncollected premiums on direct business including those by solicited general agents and insurance brokers.

Policy loans

pertains to loans issued to policyholders. The loans are issued with collateral of the cash surrender value of the policyholders insurance policy.

Automatic premium loans

if at the end of the grace period the premium due has not been paid, a policy loan will automatically be made from the policy's cash surrender value to pay the premium.

Gross premium on insurance contracts

premium arising from insurance contracts are initially recognized as income on the effective date of the insurance policies. Subsequent to initial recognition, gross earned premiums on life insurance contracts are recognized as revenue at the date when payments are due.

Reinsurance premium ceded

gross reinsurance premiums on traditional and variable contracts are recognized as an expense when the policy becomes effective

Premium refund

this pertains to the refunded amount by the company when after payment of premiums by the policyholder, the company cancels or declines the insurance application. This may also pertain to the refund of payments received in excess of the amount billed.

Premiums receivable

represents uncollected premiums on direct business including those by solicited general agents and insurance brokers

Deferred acquisition costs

cost that vary with and are primary related to the acquisition of new and renewal insurance contracts as such commissions are deferred and charged to expense in proportion to premium revenue recognized

Reserve for unearned premium

portion of the premium income of a nonlife insurance company which is not yet earned owing to the fact that the policy holders have not received the full term of protection for which the premium was collected

Return premiums payable

aggregate premiums to be refunded to the insured due to endorsement or cancellation of policies

Premiums revenue

Principal income of an insurance company directly from broker/agent/assured

Increase/decrease in RUP

charged/additional income based on the computation of reserve for unearned premiums

Returns and cancellations

premiums on policies cancelled or partially modified

Losses and claims payable

total amount of losses and claims due and payable to policyholders and other claimants

Losses and adjustment expense payable

adjustment expenses already incurred but not yet paid in connection with the settlement of losses and claims

Losses

Aggregate losses and claims the company has incurred during the period