CBA Financial Auditing and Reporting 3 — Questions and Answers
Question 1: When auditing a bank's interest rate risk (IRR) disclosures, which document most directly addresses management's IRR measurement methodology?
- The bank's annual report to shareholders
- The Asset/Liability Management (ALM) policy and committee minutes (Correct answer)
- The external auditor's management letter from the prior year
- The Federal Reserve's Regulation Y filings
Correct answer: The Asset/Liability Management (ALM) policy and committee minutes
The ALM policy documents the bank's IRR measurement models, risk limits, and governance, making it the primary source for auditing IRR methodology.
Question 2: A bank auditor is evaluating goodwill impairment testing under ASC 350. Which triggering event would require an interim impairment test between annual testing dates?
- A 5% decline in the bank's stock price during the quarter
- A significant regulatory action that negatively impacts the reporting unit's operations (Correct answer)
- Management's plan to restructure a minor administrative function
- A change in the external auditor assigned to the engagement
Correct answer: A significant regulatory action that negatively impacts the reporting unit's operations
A significant adverse regulatory action is a qualitative triggering event that makes it more likely than not that the fair value of a reporting unit has declined below its carrying amount.
Question 3: Which approach is required by U.S. GAAP under CECL (ASC 326) that differs most significantly from the prior incurred loss model?
- Losses are recognized only when they become probable and can be reasonably estimated
- Lifetime expected credit losses are estimated and recognized at the time of loan origination (Correct answer)
- Historical charge-off rates are the sole basis for estimating credit losses
- Qualitative factors are eliminated to improve comparability across institutions
Correct answer: Lifetime expected credit losses are estimated and recognized at the time of loan origination
CECL requires banks to estimate and record expected credit losses over the entire life of a financial instrument at origination, replacing the incurred loss trigger.
Question 4: An auditor is assessing the completeness assertion for off-balance-sheet exposures at a bank. Which procedure is most relevant?
- Confirming outstanding loan balances with borrowers at year-end
- Reviewing unfunded commitment records and comparing to loan origination documentation (Correct answer)
- Testing interest income recorded on funded loans for accuracy
- Recalculating the bank's risk-weighted assets under Basel III
Correct answer: Reviewing unfunded commitment records and comparing to loan origination documentation
Comparing unfunded commitment records to loan agreements ensures that all off-balance-sheet credit exposures are identified and properly disclosed.
Question 5: Under GAAS, when a bank auditor uses the work of an internal auditor, the external auditor must:
- Accept the internal auditor's findings without independent verification to avoid duplication
- Evaluate the competence, objectivity, and work quality of the internal audit function (Correct answer)
- Include the internal auditor as a co-signer on the audit report
- Reduce the audit fee proportionally to reflect reliance on internal audit work
Correct answer: Evaluate the competence, objectivity, and work quality of the internal audit function
AU-C Section 610 requires external auditors to assess internal auditors' competence and objectivity and evaluate the quality of their work before placing reliance on it.
Question 6: In auditing bank trading securities, which valuation level under ASC 820's fair value hierarchy typically requires the most auditor scrutiny?
- Level 1 — quoted prices in active markets for identical assets
- Level 3 — significant unobservable inputs based on management assumptions (Correct answer)
- Level 2 — inputs other than quoted prices that are observable for the asset
- Level 0 — regulatory book values assigned by banking regulators
Correct answer: Level 3 — significant unobservable inputs based on management assumptions
Level 3 fair values depend heavily on unobservable, management-derived assumptions, making them susceptible to bias and requiring the greatest auditor skepticism.
Question 7: A community bank's financial statements show significant growth in brokered deposits. From an audit perspective, this is most relevant to which risk area?
- Credit risk from increased loan demand funded by new depositors
- Liquidity risk and concentration risk from reliance on volatile, rate-sensitive funding (Correct answer)
- Operational risk from processing a higher volume of deposit transactions
- Compliance risk from potential violations of the Community Reinvestment Act
Correct answer: Liquidity risk and concentration risk from reliance on volatile, rate-sensitive funding
Brokered deposits are considered volatile funding sources that can be withdrawn quickly when rates change, creating significant liquidity and concentration risks.
CBA Financial Auditing and Reporting 3
When auditing a bank's interest rate risk (IRR) disclosures, which document most directly addresses management's IRR measurement methodology?