CBA Financial Auditing and Reporting Questions and Answers 1 — Questions and Answers
Question 1: An auditor is reviewing a bank's implementation of the Current Expected Credit Losses (CECL) model under ASC 326. The bank's model incorporates historical loss data, current economic conditions, and management's reasonable and supportable forecasts. Which audit procedure is MOST critical for assessing the reasonableness of the Allowance for Credit Losses (ACL) calculation?
- Verifying that all loans from the general ledger are included in the ACL model's input data.
- Testing the mathematical accuracy of the model's calculations from input to output.
- Evaluating the reasonableness of management's economic forecasts by comparing them to external, independent economic data. (Correct answer)
- Reviewing the minutes from the Board of Directors meeting where the CECL accounting policy was approved.
Correct answer: Evaluating the reasonableness of management's economic forecasts by comparing them to external, independent economic data.
The CECL model's reliance on 'reasonable and supportable forecasts' of future economic conditions is a significant area of management judgment and estimation uncertainty. Therefore, the most critical audit procedure is to challenge and corroborate these forward-looking assumptions against independent, external sources. While completeness of data, mathematical accuracy, and governance are all important, the subjectivity of the economic forecast presents the highest risk of material misstatement.
Question 2: Under the Federal Deposit Insurance Corporation Improvement Act (FDICIA), for insured depository institutions with total assets exceeding a specified threshold, what is the external auditor required to issue an opinion on?
- The effectiveness of the bank's enterprise risk management program.
- Management's assessment of the effectiveness of internal control over financial reporting. (Correct answer)
- The bank's compliance with all applicable safety and soundness regulations.
- The accuracy of the bank's quarterly Consolidated Reports of Condition and Income (Call Reports).
Correct answer: Management's assessment of the effectiveness of internal control over financial reporting.
FDICIA Section 112 requires management of larger institutions to prepare an annual report assessing the effectiveness of the institution's internal control over financial reporting (ICFR). The institution's external auditor is then required to provide a direct examination and attestation report, issuing an opinion on management's assertion regarding ICFR.
Question 3: A bank holds a large portfolio of mortgage-servicing rights (MSRs), which it values using a discounted cash flow model. This model uses significant unobservable inputs, including assumptions about future mortgage prepayment speeds and default rates. According to ASC 820, Fair Value Measurement, these MSRs would be classified in which level of the fair value hierarchy?
- Level 1
- Level 4
- Level 2
- Level 3 (Correct answer)
Correct answer: Level 3
The fair value hierarchy under ASC 820 is based on the observability of inputs used in valuation. Level 1 uses quoted prices in active markets. Level 2 uses other observable inputs. Level 3 uses unobservable inputs, which are inputs developed by the entity using the best information available about assumptions market participants would use. Since the MSR valuation relies on significant unobservable inputs like prepayment speed assumptions, they are classified as Level 3 assets.
Question 4: For a large, publicly traded financial institution, which of the following is MOST likely to be identified by the external auditor as a Critical Audit Matter (CAM) in the auditor's report?
- The valuation of the allowance for credit losses on the loan portfolio. (Correct answer)
- The testing of controls over the reconciliation of correspondent bank accounts.
- The verification of interest income on U.S. Treasury securities classified as held-to-maturity.
- The review of the bank's compliance with physical security controls at branch locations.
Correct answer: The valuation of the allowance for credit losses on the loan portfolio.
A CAM is a matter that involved especially challenging, subjective, or complex auditor judgment. The valuation of the allowance for credit losses, particularly under CECL, fits this definition perfectly. It involves complex models, significant management judgment regarding economic forecasts, and requires extensive audit effort and scrutiny, making it a prime candidate for a CAM.
Question 5: An auditor is evaluating the internal controls over the preparation of the bank's Consolidated Report of Condition and Income (Call Report). Which of the following control activities is MOST fundamental to ensuring the accuracy of the data reported?
- A secondary review of the final report by a senior executive before submission.
- An automated system that provides an alert when the regulatory filing deadline is approaching.
- A formal, documented process for reconciling Call Report line items to the general ledger and supporting subsidiary systems. (Correct answer)
- A checklist used by the accounting department to ensure all required schedules are included in the filing.
Correct answer: A formal, documented process for reconciling Call Report line items to the general ledger and supporting subsidiary systems.
The most fundamental control for ensuring the accuracy of the Call Report is the direct reconciliation of the amounts within the report back to the bank's official books and records (the general ledger and sub-ledgers). This control provides foundational evidence that the report is a true reflection of the bank's financial position and results. Other controls like executive review, deadline alerts, and completeness checklists are important but secondary to this core data integrity control.
Question 6: During an audit of a bank's investment portfolio, an auditor is testing the valuation of U.S. Treasury bonds classified as 'Available-for-Sale' (AFS). Which audit procedure provides the MOST reliable evidence for the valuation of these securities?
- Recalculating the amortization of the premium or discount on the bonds.
- Reviewing the minutes from the Asset/Liability Committee (ALCO) meeting where the purchase was discussed.
- Analyzing the bank's internal model for projecting future interest rates.
- Comparing the bank's recorded fair value to a quoted price from an active, independent market source. (Correct answer)
Correct answer: Comparing the bank's recorded fair value to a quoted price from an active, independent market source.
AFS securities are carried at fair value. For an actively traded security like a U.S. Treasury bond, the most reliable audit evidence for its valuation is an external, independent source. Comparing the bank's carrying value to a quoted price from an active market (a Level 1 input) provides direct and highly reliable evidence of its fair value. The other procedures test different attributes but do not directly substantiate fair value.
CBA Financial Auditing and Reporting Questions and Answers 1
An auditor is reviewing a bank's implementation of the Current Expected Credit Losses (CECL) model under ASC 326.
The bank's model incorporates historical loss data, current economic conditions, and management's reasonable and supportable forecasts.
Which audit procedure is MOST critical for assessing the reasonableness of the Allowance for Credit Losses (ACL) calculation?