2008 seminar for the appointed actuary colloque pour l’actuaire désigné 2008 2008 seminar for...
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2008 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2008 Agenda Introduction to Auditing Auditing Standards Auditor Oversight The Audit Process Specific IssuesTRANSCRIPT
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2008 Seminar for the Appointed ActuaryColloque pour l’actuaire désigné 2008
Canadian Institute
of Actuaries
L’Institut canadien desactuaires
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Audits of Insurance Companies
26 September 2008
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Agenda• Introduction to Auditing• Auditing Standards• Auditor Oversight• The Audit Process• Specific Issues
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Introduction to Auditing
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8 Nature of Auditing• Accumulation of evidence about ‘information’ in a
systematic manner• Evaluation of the ‘information’ against suitable criteria• Expression of opinion in a written report to interested
users who were not involved in preparing the information
• Performed by a competent, independent person
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8 Need for Auditing• Decision makers in the financial
markets depend on reliable information– Auditing reduces information risk– Helps make capital markets efficient
• Stakeholders in an entity want to monitor management behaviour– An audit is a cost-effective way to achieve this
objective– An audit can serve as a deterrent against fraud
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8Accountability Relationship
in an AuditCICA Handbook Section 5025.07:
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8 Objective of an Audit of Financial Statements
CICA Handbook Section 5090.01:
The objective of an audit of financial statements is to express an opinion whether the financial statements present fairly, in all material respect, the financial position, results of operations and cash flows in accordance with generally accepted accounting principles (GAAP).
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8Types of Audit Opinions
• Unqualified• “Clean” opinion – No material misstatement
• Qualified • “Except for”• Either a departure from GAAP or scope
limitation• Adverse
• Financial statements are misleading• Departure from GAAP
• Denial• No opinion due to scope limitation (i.e. lack of
evidence)
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8Professional Scepticism
• Foundation of the auditor’s role• Understand possible conflict of interest
between the auditor and management• Objectively assess the risk of error• Objectively evaluate the type and
quality of evidence obtained• Obtain corroborative evidence for
management representations
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8 Use of Specialists in an Audit• Specialists are skilled in fields other than auditing
and accounting (e.g., actuaries)• Auditors may engage specialists to perform
additional audit work or assist in making audit decisions (e.g., assessing pension liabilities)
• In these situations, auditors must– Understand the specialist’s professional qualifications– Understand methods and assumptions used by the
specialist– Evaluate the information provided– Obtain corroborative evidence
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Auditing Standards
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8Canadian Generally Accepted Auditing Standards (GAAS)
• The Canadian Institute of Chartered Accountants (CICA) is given the authority to set accounting and auditing standards by the Canada Business Corporations Act
• Auditing standards are Recommendations to guide auditors in fulfilling their professional responsibilities
• Include guidelines on auditor qualifications, evidence examination and reporting
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8International Standards on
Auditing (ISA)• ISAs for financial statement audits will be adopted for
periods beginning on or after December 15, 2009 • Canadian ISAs will be renamed Canadian Auditing
Standards (CAS) and will constitute Canadian GAAS• Most are consistent with the current Canadian
standards
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8US GAAS
• In the US, the American Institute of Certified Public Accountants (AICPA) sets the generally accepted professional and technical standards for CPAs
• These apply to audits of US private companies, federal, state and local governments and non-profit organizations
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8PCAOB – Auditing Standards• The Sarbanes-Oxley Act (SOX) became law
in the US in 2002 after the fall of Enron• It created a five-member Public Company
Accounting Oversight Board (PCAOB) to oversee accounting firms that provide audit services for publicly traded companies
• The Board established auditing, quality control, ethics, and independence standards and rules to be used by registered public accounting firms
• Required by the SEC
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8PCAOB – Auditing Standards
• PCAOB adopted GAAS and ethical standards as developed by AICPA
• It also created more stringent rules in the area of auditor independence
• Developed detailed rules regarding audits on internal control over financial reporting integrated with an audit of financial statements
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Auditor Oversight
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8 PCAOB
• Conducts regular inspections of registered public accounting firms
• Portions of the report to the firm made public if firm does not address the Board’s criticisms/recommendations
• Can discipline firms that do not comply with its rules
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8CPAB
• The Canadian Public Accountability Board (CPAB) was created to oversee the auditors of public companies (similar to PCAOB)
• Tighten quality control of audit practice• Conduct annual inspections of accounting
firms – report to firms is confidential• Public report on the results of these
inspections is prepared discussing general issues
• Has the power to impose sanctions if fail to protect the public interest
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8Code of Professional Conduct
• Chartered Accountants are subject to the Rules of Professional Conduct
• Key Principles:– Independence– Confidentiality– Integrity and Due Care– Competence– Adherence to GAAP and GAAS
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8Legal Liability
• Sources of legal liability– Client - common law (negligence)– Third party – common law (negligence)– Provincial securities acts– Criminal liability – Fiduciary duty
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The Audit Process
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8 Planning• Understand the Business
– Business environment– Nature and composition of entity– Business and financial statement risks
• Understand the IT Environment– Complexity of the IT environment– Extent to which the entity uses IT
• Assess Internal Control at Entity Level– Components of internal control: control
environment, risk assessment, control activities, information and communication, and monitoring
• Evaluate Independence
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8Risk Assessment
• Identify fraud risks and determine response• Identify risks with implications on financial
statements:– Overall factors (e.g., factors affecting the
industry)– Account-specific factors (e.g., complexity of
transaction)• Use professional judgement• Affects nature, timing, and extent of audit
procedures to be performed
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8 MaterialityCICA Handbook Section 5142.04:
A misstatement or the aggregate of all misstatements in financial statements is considered to be material if, in the light of surrounding circumstances, it is probable that the decision of a person who is relying on the financial statements, and who has a reasonable knowledge of business and economic activities (the user), will be changed or influenced by such misstatement or the aggregate of all misstatements.
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8Materiality and Misstatements• Misstatements arise from departures from GAAP
and include inappropriate determination of estimates• Misstatements may arise from error or fraud, or
from the consequences of an illegal act• The audit is planned with the objective of detecting
misstatements that are quantitatively material to the financial statements
• Materiality is determined using professional judgement (unique to each client)
• AuG-41 suggests 5% of continuing income from operations
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8Understanding Significant
Processes• Identify significant processes that affect the
significant account– E.g., Actuarial Valuation process affects Policy
Liabilities • Identify sources and preparation of
information that is disclosed in the financial statements
• Consider the entire flow of transactions from initiation through reporting
• Identify where data errors could occur
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8Perform Walkthrough
• Follow the ‘critical path’ for the process, from transaction initiation to reporting in the general ledger
• Requires making inquiries of company personnel
• It also requires obtaining copies of documents (e.g., screen prints, schedules, system reports) to document the flow of the transaction
• Confirm that controls have been put in place
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8 Categories of Control
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8 Test of Controls• Select a combination of controls to test
whether they have been operating effectively throughout the year
• Test of controls include procedure such as – Inquiry of company personnel– Inspection of physical evidence resulting from
the performance of control (e.g., obtain reserve provision calculation schedule and look for evidence of review)
– Re-performance (e.g., recalculate reserve provision balance)
• Testing performed for selected samples
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8 Substantive Procedures• Procedures designed to obtain direct evidence on the
information contained in the financial statements, including:– Existence, completeness, accuracy and validity of data– Reasonableness of estimates
• Extent of testing depends on risk assessment and reliance placed on controls
• Combination of – Analytics (e.g., variance between current year and prior
year)– Detail testing (e.g., assess assumptions used in establishing
the reserve provision)
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8Difference between Test of Controls
and Substantive ProceduresTEST OF CONTROL:• Objective: to determine
whether control is operating effectively
• Nature: involves making inquiries and re-performance
• Extent: depends on frequency of control and involves sampling
• Timing: testing begins before year-end (balance sheet date)
• Example: re-perform quality check over system inputs re new business
SUBSTANTIVE PROCEDURE:
• Objective: to determine whether the information in the financial statements is reasonable
• Nature: analytics and detail testing
• Extent: depends on risk assessment and materiality
• Timing: may begin before year-end but completion after year-end
• Example: agree new business balance to source documents, such as contracts
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8Audit differences
• A difference between an amount in the financial statements and what the auditor believes should be the amount to be in accordance with GAAP
• An omission from the financial statements of an item required under GAAP
• Can arise as a result of an error, fraud, or judgemental difference (between auditor and management)
• The auditor will discuss the discovery of the difference with the appropriate company personnel
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8Difference between ERROR and Change in ESTIMATE
ERROR:• Unintentional • Mathematical mistake• Misapplication of GAAP• Oversight or misuse of facts• Example: Discount rate used
in the pension liability calculation was incorrectly inputted as 15% rather than the authorized 5%. Difference in outcomes represents an audit difference.
CHANGE IN ESTIMATE:• Estimates are based on
latest, most reliable information
• Change in estimate is a change related to new information or more experience
• Example: Long-term expected interest rate was estimated at 5%. However, change in economic conditions resulted in a revised estimate of 8%.
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8Communication of Results to
Audit Committee• Auditors are required to communicate
certain matters to the Audit Committee, including:– Fraud– Possible illegal acts– Identified material weaknesses in internal
control– Corrected and uncorrected non-trivial
errors– Other matters
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Specific Issues
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Specific Issues• System Change Controls• Sufficient and Appropriate Audit
Evidence• Documentation • AUG 43
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8 System Change Controls• IT is used by various departments in an organization
– E.g., actuarial departments use automated valuation models, or set-up models in Excel
• Auditors identify, understand, walk through, test and evaluate controls related to IT when they plan to rely on applications used by the client
• Examine two aspects:– Change Controls: only appropriately authorized, tested
and approved changes are made to applications, databases, etc.
– Logical Access: only authorized personnel have access to data and applications
• Otherwise, risk exists that inappropriate changes are made, resulting in inaccurate disclosures in the financial statements
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8Sufficient and Appropriate
Audit Evidence
• Quality and quantity of evidence allows the auditor to reach a conclusion:– Whether control is operating effectively– Whether the financial statement disclosure is reasonable
• Auditors are required to test the evidence obtained– Completeness of data– Accuracy of data
• When auditing estimates, need evidence on– Assumptions used– Methodology employed– Appropriateness of conclusions reached
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8 Appropriate “Support”• Is evidence that helps the auditor to:
– Re-perform the control– Perform analytical procedures – Perform detail testing
• Comes from a “reliable” source:– Reports generated by an application system tested by the
auditors– Prepared by an unbiased person, e.g., third party pricing
vendor– Reviewed by various people in the organization
• Examples:– Reserve trending calculation with documented analysis and
sign-off by reviewer– Detailed memo explaining assumption used in the model
and justification for the assumptions – Report from Bloomberg supporting model input
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8 Documentation• Auditors document procedures performed
and conclusions reached• Auditors also keep copies of evidence
obtained• To assist in the audit process,
– Document the control was performed (e.g., write comments and sign off on the reserve calculation to indicate you reviewed it)
– Where feasible, keep source documents on file (e.g. file download from Bloomberg, calculations performed)
– In memo format, explain your changes to the valuation model
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8AUG 43
Audit of Policy Liabilities of Insurance Companies
• Provides guidance on application of GAAS in the audit of policy liabilities
• Recognizes the complexity of this accounting estimate and need for specialized actuarial expertise
• Considers the following– Use of actuarial expert on the audit team– Role of appointed actuary – Need for corroborative evidence
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Questions?