How expected credit loss standards will challenge auditors

Auditors and others that deal with a company’s financial statement will experience new challenges as a result of implementation of new financial reporting standards requiring reporting of expected credit losses related to financial instruments.

IFRS 9, Financial Instruments, which will take effect January 1st 2018, contains a new expected credit loss (ECL) model. FASB also is working on a financial instruments standard that has not yet been issued but is expected to include requirements to report expected credit losses.

The International Auditing and Assurance Standards Board (IAASB) has issued a new publication to highlight the challenges IFRS 9 will create for auditors, management, governance bodies such as audit committees, and users.

“Auditors need to be aware of the changes related to ECL and the implications for audits,” IAASB Chairman Arnold Schilder said in a news release. “Auditors will need to be actively engaged in 2016 and 2017, in particular to understanding how an entity is planning for the adoption and implementation of its ECL models.”

The IAASB’s publication explains the board’s project to revise International Standard on Auditing 540, Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures, to help auditors handle the changes related to expected credit losses. The publication, prepared by an IAASB task force, provides a detailed summary of the initial thinking on special audit considerations related to ECL provisions, including related estimation uncertainty.

Broadly, the publication advises auditors, management, and those charged with governance to act now to understand how an ECL model can be implemented. Auditors also are advised to:

• Prepare for the challenges that may arise in an audit as a result of the new standards.
• Communicate effectively on audits of entities that will be significantly affected by these changes. Auditors are advised to have robust, active, and ongoing communication with management, those charged with governance, and regulators as appropriate. Communication will be important because entities may need to develop or change systems and models to obtain the necessary data and expertise.
• Be aware that the ECL provision’s complexity, estimation uncertainty, and materiality thresholds may lead to complex or difficult judgements regarding key data and assumptions, creating significant risks of material misstatement.
• Be aware that disclosures related to expected credit losses, including transitional disclosures, are likely to require significant attention from auditors because high estimation uncertainty is likely.

—Ken Tysiac (ktysiac@aicpa.org) is a CGMA Magazine editorial director.