The purpose of the thematic was to promote continuous improvement in the quality of the audit work performed over the accounting and disclosure of financial instruments, with a focus on the audit of expected credit losses (ECL) for larger banks, by providing auditors and audit committees with examples of good audit practice and common audit challenges.

The report focuses on:

• Classification and Measurement (C&M) of financial instruments
• ECL modelling
• ECL model assumptions
• Measuring Significant Increase in Credit Risk (SICR)
• Modelled Multiple Economic Scenarios (MES)
• Post Model Adjustments (PMAs)
• Completeness and accuracy of data inputs
• Individually assessed exposures
• IFRS 9 disclosures

The FRC performed the review by benchmarking key aspects of each firm’s methodology and assessing a sample of working papers for a recently completed audit by each firm to consider how the methodology was applied in practice. 

The FRC highlights that the Big 4 audit firms have made significant investment in their IFRS 9 audit methodologies and the review identifies a number of examples of good practice, including around the auditing of ECL models and assumptions.  Despite these good practices, the FRC also continues to observe instances of poorer application of methodology by some audit teams across a number of aspects of auditing IFRS 9, including ECL modelling, SICR, MES and individually assessed exposures.  

The thematic identifies a number of common features present in higher quality audits of IFRS 9-related balances:

• The audit team engaged the firm’s internal credit modelling specialists and economists to evaluate and challenge management around all critical assumptions and judgements which materially influenced the ECL estimates, and specifically considered the appropriateness of plausible alternative assumptions.
• A granular risk assessment was performed, identifying and assessing each constituent part of the ECL calculation and evaluating the impact of calculation methods, data inputs, model assumptions, and PMAs to determine which matters were of higher audit risk.
• An evolving audit approach that was reassessed throughout the audit, which considered and tested the design and operation of the bank’s controls around critical ECL elements. This ensured sufficient assurance was obtained as updated risk factors were identified during the course of the audit (for example, designing and performing additional substantive tests when management’s monitoring controls were found not to be operating as initially planned). 

The FRC expects this to be a useful resource for auditors, Audit Committees and stakeholders in the banking sector, highlighting the importance of consistent and appropriate application of IFRS 9 audit methodology, to ensure high quality auditing is performed over this critical and judgemental area.

A press release and the full thematic are available on the FRC website.