Auditing expected credit losses (ECL): Procedures, Risks, and Assertions:

Procedures:

The audit procedure for reviewing expected credit losses (ECL) typically involves the following steps:

  1. Review the Entity’s Accounting Policies: The auditor should review the entity’s accounting policies related to expected credit losses, including the basis for calculating and recording ECLs in the financial statements.
  2. Evaluate the ECL Methodology: The auditor should evaluate the entity’s methodology for calculating expected credit losses, including the assumptions and models used. This includes considering the data sources, the methodology’s accuracy and consistency, and the reasonableness of the assumptions.
  3. Review Supporting Documentation: The auditor should review the documentation used to support the calculation of expected credit losses, including loan data, loan agreements, and any other relevant documentation.
  4. Test the Reasonableness of the Calculations: The auditor should perform substantive procedures to test the expected credit loss calculations, including comparing them to historical trends, industry benchmarks, and other relevant data.
  5. Evaluate Management’s Assessment of Credit Quality: The auditor should evaluate the entity’s credit quality assessment, including its process for monitoring and reporting on loan performance and any changes to its credit risk profile.
  6. Evaluate the Accuracy of ECL Disclosures: The auditor should evaluate the accuracy and completeness of the entity’s disclosures related to expected credit losses in the financial statements.
  7. Document the Audit Work: The auditor should document the audit work performed, including the results of the tests and procedures and any findings or conclusions.

By following these steps, auditors can provide reasonable assurance that the entity’s expected credit losses are calculated accurately and recorded appropriately in the financial statements.

This helps to ensure that the financial statements provide a fair representation of the entity’s financial position and performance.

How to Evaluate the ECL Methodology? Please write it in detail

The evaluation of the expected credit loss (ECL) methodology is a crucial part of the audit process. The following steps outline a detailed process for evaluating the ECL methodology:

  1. Review Accounting Policies: Review the entity’s accounting policies and procedures related to expected credit losses to ensure they are in accordance with the relevant accounting standards. This includes understanding the basis for calculating and recording ECLs in the financial statements.
  2. Assess Data Sources: Evaluate the data sources used in the calculation of ECLs, including loan data, loan agreements, and any other relevant documentation. Ensure that the data used is accurate, complete, and reliable.
  3. Evaluate the Model: Assess the methodology used by the entity to calculate ECLs, including the models and assumptions used. Evaluate the reasonableness of the assumptions, the methodology’s consistency and accuracy, and the completeness of the data used.
  4. Evaluate the Reasonableness of the Calculations: Test the reasonableness of the ECL calculations by comparing them to historical trends, industry benchmarks, and other relevant data. Ensure that the calculations are reasonable and consistent with the entity’s experience and historical data.
  5. Consider the Timeliness of the Calculations: Evaluate the frequency and timeliness of the ECL calculations. Ensure that the calculations are performed in a timely manner and are updated regularly to reflect changes in the loan portfolio and the credit risk profile of the entity.
  6. Evaluate the Documentation: Review the documentation used to support the calculation of ECLs, including the loan data, loan agreements, and any other relevant documentation. Ensure that the documentation is complete and accurate, and that it supports the ECL calculations.
  7. Evaluate Management’s Assessment of Credit Quality: Evaluate the entity’s assessment of credit quality, including its process for monitoring and reporting on loan performance and any changes to its credit risk profile. Ensure that the assessment is reasonable and consistent with the entity’s experience and historical data.
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By following these steps, auditors can provide reasonable assurance that the entity’s expected credit loss methodology is reliable and accurate, and that the ECLs are calculated appropriately and recorded in the financial statements. This helps to ensure that the financial statements provide a fair representation of the entity’s financial position and performance.

What are the audit risks when auditing expected credit losses

When auditing expected credit losses (ECLs), auditors face several audit risks that must be considered in the audit process. These risks include:

  1. Inadequate Data: ECL calculations rely heavily on data inputs, and the accuracy of these inputs is critical to the reliability of the calculations. There is a risk that the data used by the entity may need to be more accurate and complete.
  2. Unreliable Methodology: The methodology used by the entity to calculate ECLs is critical to the accuracy of the calculations. There is a risk that the methodology may not be reliable or may not be applied consistently.
  3. Inadequate Assessment of Credit Quality: Credit quality assessment is a key factor in calculating ECLs. There is a risk that the entity may need an adequate process in place for monitoring and reporting on loan performance or may not have appropriately considered changes in the credit risk profile of its portfolio.
  4. Incorrect Calculation of ECLs: There is a risk that the entity may need to correct errors in calculating ECLs, leading to incorrect amounts being recorded in the financial statements.
  5. Incomplete Disclosures: The financial statements must include appropriate disclosures related to ECLs, including the methodology used, the assumptions made, and any significant changes in the calculations. There is a risk that these disclosures may not be complete or accurate.
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By understanding these audit risks, auditors can design audit procedures tailored to the entity’s specific circumstances and provide reasonable assurance that the ECLs are calculated accurately and recorded appropriately in the financial statements.

Key Audit Assertions for Auditing Expected Credit Losses

When auditing expected credit losses (ECLs), the auditor should consider the following key audit assertions:

  • Existence: The auditor should assert that the entity’s loans and other financial assets exist and are accurately recorded in the financial statements.
  • Valuation: The auditor should assert that the entity has accurately valued its loans and other financial assets, including calculating expected credit losses.
  • Rights and Obligations: The auditor should assert that the entity has the rights to the loans and other financial assets and must perform under the terms of the loan agreements.
  • Completeness: The auditor should assert that the entity has accurately recorded all of its loans and other financial assets in the financial statements, including any that may be impaired.
  • Classification: The auditor should assert that the entity has accurately classified its loans and other financial assets, including any that may be impaired, in accordance with the applicable accounting standards.
  • Presentation and Disclosure: The auditor should assert that the entity has appropriately presented and disclosed its loans and other financial assets in the financial statements, including calculating and presenting expected credit losses.

Considering these key audit assertions, the auditor can design procedures that reasonably ensure that the entity’s expected credit losses are calculated accurately and recorded appropriately in the financial statements.

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This helps to ensure that the financial statements provide a fair representation of the entity’s financial position and performance.

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