Auditing and Assurance: Specialized Industries PDF

Saint Joseph College Accountancy Department Tunga-Tunga, Maasin City, Southern Leyte Aud 4 – Auditing and Assurance: Specialized Industries GROUP 1 BSA 3-A Members: Acsibar, Ashley Wela Cagna-an, Kimberly...

Saint Joseph College Accountancy Department Tunga-Tunga, Maasin City, Southern Leyte Aud 4 – Auditing and Assurance: Specialized Industries GROUP 1 BSA 3-A Members: Acsibar, Ashley Wela Cagna-an, Kimberly Codal, Merlyn Egido, Lorenzo Hadlocon, Kristene Jane Longhas, Jane Morata, Angel Lyca Rosal, Madelaine Tan, Johnn Clint A Written Report on Module 1: Auditing Banking and other Financial Institutions Overview The Philippine banking and finance sector play a crucial role in the national economy by mobilizing domestic savings and channeling them into productive investments, fostering economic growth and job creation. The sector encourages household savings to fund business expansion. Philippine banks are categorized into three types: universal and commercial banks (dominating the industry with approximately 12 trillion pesos in deposits), rural and cooperative banks, and thrift banks. Nature and Background of Specialized Industry The banking and finance sector are the lifeblood of economic development. It efficiently channels savings into investment, fueling business growth, job creation, and overall economic prosperity. A healthy financial sector fosters stability and facilitates the allocation of capital to its most productive uses. Banks perform core functions of accepting deposits (safeguarding funds for individuals and businesses), providing loans (financing various activities), and facilitating payment services  Saint Joseph College Accountancy Department Tunga-Tunga, Maasin City, Southern Leyte Aud 4 – Auditing and Assurance: Specialized Industries (transfers, checks, cards). Larger banks, particularly universal and commercial banks, expand beyond these core functions into investment banking (underwriting securities, advising on mergers and acquisitions), wealth management, and offering a wider array of financial products like insurance and investment vehicles. This diversification allows them to cater to a broader range of clients and participate more extensively in capital markets. Banks and Non-Bank Financial Institutions (NBFIs) both contribute to the financial system by facilitating the flow of funds, but they differ significantly in their primary methods of attracting capital. Banks are deposit-taking institutions; their core business model relies on attracting funds through customer deposits, which are then lent out to borrowers. NBFIs, on the other hand, do not typically accept traditional deposits. They raise capital through issuing securities (bonds, stocks), selling insurance products, managing investment funds, or other specialized financial instruments. Both contribute to financial intermediation, but banks primarily act as intermediaries for deposits, while NBFIs specialize in other forms of financial intermediation, often focusing on specific market segments or investment strategies.  Saint Joseph College Accountancy Department Tunga-Tunga, Maasin City, Southern Leyte Aud 4 – Auditing and Assurance: Specialized Industries Universal Banks: These are the largest and most diversified banks, offering a full range of banking services, including deposit-taking, lending, investment banking, and trust services. Their target market is broad, encompassing individuals, corporations, and government entities. Commercial Banks: These banks primarily focus on deposit-taking and lending to businesses and individuals. They offer a wide array of services but typically don't engage extensively in investment banking activities. Their target market is primarily businesses and individuals needing commercial loans and transactional banking services. Thrift Banks: These banks concentrate on accumulating savings and providing mortgage loans and financing for small and medium-sized enterprises (SMEs). They often cater to specific sectors like housing or SMEs, offering specialized lending products. Their target market includes individuals seeking mortgages and SMEs needing financing.  Saint Joseph College Accountancy Department Tunga-Tunga, Maasin City, Southern Leyte Aud 4 – Auditing and Assurance: Specialized Industries Rural/Cooperative Banks: These banks serve rural communities, mobilizing savings and extending credit to farmers, small businesses, and individuals in underserved areas. Their focus is on promoting rural development and financial inclusion. Their target market is the rural population, including farmers and small businesses in agricultural and related sectors. Non-bank financial institutions (NBFIs) include investment banks, investment companies, securities firms, venture capital, insurance companies, finance companies, pawnshops, credit card companies, and pension funds. They raise capital through various means, such as selling securities or insurance products, rather than accepting deposits like banks. They provide a wide range of financial services to individuals and businesses. Banks and NBFIs are interconnected parts of a healthy financial system. Banks provide core deposit-taking and lending services, while NBFIs offer specialized financial products and services. This diversity ensures a wide range of financial options for individuals and businesses, promoting investment, economic growth, and stability. A well-regulated and diverse financial system mitigates risk, fosters competition, and enhances the efficiency of capital allocation, ultimately contributing to a stronger and more resilient economy. Bank’s Basic Operational Model  Saint Joseph College Accountancy Department Tunga-Tunga, Maasin City, Southern Leyte Aud 4 – Auditing and Assurance: Specialized Industries The diagram illustrates a bank's basic operational model. Banks act as intermediaries, taking in funds from customers with excess capital (depositors, investors) and lending them to customers needing funds (borrowers, government, other banks). The difference between the cost of funds and the return on funds generates the bank's profit margin. The model also shows the regulatory oversight (BSP, SEC, BIR) and interactions with other banks and financial institutions. Overview, Updates, Statistics of the Specialized Industry Bangko Sentral ng Pilipinas (BSP) the independent central monetary authority of the Philippines that has regulatory and supervisory power over banks and non-bank financial institutions (NBFIs). supervises the nation’s banking system. However, certain NBFIs are regulated by other governing bodies. Insurance companies are overseen by the Insurance Commission while investment houses are overseen by the Securities and Exchange Commission. In the Philippines, financial intermediation continues to expand the economy and is expected to create greater prospects of employment over the next several years. As of October 2020, the value of loans granted by universal and commercial banks in the Philippines amounted to nearly 9.7 trillion Philippine pesos. Of these loans: approximately 364 billion pesos - granted for motor vehicle loans and for household consumption. approximately 1.6 trillion pesos - granted for production of real estate business in the country.  Saint Joseph College Accountancy Department Tunga-Tunga, Maasin City, Southern Leyte Aud 4 – Auditing and Assurance: Specialized Industries While granting loans for customers seeking financial help for a business venture or providing loans for household consumption have been increasing, a sound and healthy banking sector is essential to sustain this growing pattern. Bank loans that have nonperforming loans are generally considered bad debts and can affect a bank’s cash flows. A low ratio of nonperforming loans to total gross loans meant a healthy banking sector. As of 2019, the ratio of bank nonperforming loans to total gross loans in the Philippines was almost 2% and has significantly decreased over the past years. Among other industries in the Philippines, the banking industry has also been affected during the pandemic. The Bangko Sentral issued the implementing of rules and regulations and made changes to effectively cater the needs of the people during such time. Bayanihan Act (Republic Act No. 11469) - also known as the Bayanihan to Heal as One Act. - an act declaring a state of national emergency over the entire country to control the spread of the disease. - The law requires all lenders under BSP supervision to grant a 30-day grace period or extension for the payment of loans due within the enhanced community quarantine (ECQ) period, without imposing additional interest, penalties or charges on their borrowers. The BSP also relaxed the Know-Your-Customer (KYC) requirements for both over-the- counter and electronic or online transactions, to ensure that Filipinos still have access to basic government and financial services amidst the COVID-19 situation.  Saint Joseph College Accountancy Department Tunga-Tunga, Maasin City, Southern Leyte Aud 4 – Auditing and Assurance: Specialized Industries Top 10 Universal and Commercial Banks in the Philippines (https://www.bsp.gov.ph/Statistics/Financial%20Statements/Commercial/assets.aspx) (https://www.bsp.gov.ph/Statistics/Financial%20Statements/Commercial/deposits.aspx)  Saint Joseph College Accountancy Department Tunga-Tunga, Maasin City, Southern Leyte Aud 4 – Auditing and Assurance: Specialized Industries Recent Issuances BSP Circulars No. 1205 - Lifting of the Moratorium on the Establishment of Digital Banks No. 1206 No. 1202 No. 1204 No. 1201 No. 1203 No. 1200 BSP Memoranda Memorandum No. M- 2025-001 - Securities and Exchange Commission (SEC) Notice on Corporations in Danger of Being Suspended for Failure to Submit Annual Reports Memorandum No. M-2024-045 - Extension of the Transitory Period for Compliance with BSP Circular No. 1195 Memorandum No. M-2024-043 - Updated Guidelines on the Implementation of the Enhanced Comprehensive Credit and Equity Exposures Report (COCREE) of 2023 SEC Memorandum Circulars SEC Memorandum Circular No. 18, s. 2020 - Procedures in the filing of Audited Financial Statements and General Information Sheet to SEC after the Enhanced Community Quarantine  Saint Joseph College Accountancy Department Tunga-Tunga, Maasin City, Southern Leyte Aud 4 – Auditing and Assurance: Specialized Industries Audit Considerations  Saint Joseph College Accountancy Department Tunga-Tunga, Maasin City, Southern Leyte Aud 4 – Auditing and Assurance: Specialized Industries 1. Acceptance - Auditors must consider their experience with banking audits, the resources they have available (staff, technology, expertise), and whether they possess the specialized knowledge needed to handle the complexities of bank accounting and regulations. 2. Highly Regulated - Banks operate under a strict regulatory framework. Auditors must be familiar with and comply with numerous reporting requirements and accreditation standards specific to the banking industry. This adds significant complexity and time to the audit process 3. Peculiar Transactions - Banks engage in transactions that are far more intricate than those found in many other businesses. These include complex financial instruments, estimations (like loan loss provisions), and assets whose value can fluctuate rapidly (e.g., securities). Auditing these requires specialized skills and techniques. 4. Extensive Use of PFRS 9 - The adoption of PFRS 9 (Philippine Financial Reporting Standards 9) introduces complexities related to accounting for financial instruments. 5. Fraud Consideration - Banks are particularly vulnerable to fraud due to their high-value transactions and the digital nature of much of their operations. Auditors must be aware of the inherent risk of fraud in a highly digitized environment and the pressure to meet compliance standards. This necessitates robust fraud detection and prevention measures within the audit. 6. Remote Auditing and COVID-19 Limitations - The pandemic highlighted the challenges of conducting audits remotely. This includes concerns about the authenticity of documents and the inherent limitations of virtual audits compared to on- site examinations. Auditors need to adapt their methodologies to address these limitations.  Saint Joseph College Accountancy Department Tunga-Tunga, Maasin City, Southern Leyte Aud 4 – Auditing and Assurance: Specialized Industries Key Risks Considerations Credit Risk leading to Liquidity Risk - If a significant number of borrowers default (credit risk), the bank may face a shortage of funds to meet its obligations (liquidity risk). Operational Risk increasing Reputational Risk - A major operational failure (like a system outage or data breach) can severely damage the bank's reputation. Country Risk impacting Currency Risk - Political or economic instability in a country (country risk) can lead to fluctuations in its currency, creating currency risk for the bank's international sanctions. Interest Rate Risk and Price Risk - Changes in interest rates can impact the value of assets and liabilities (price risk), especially for banks holding interest-rate-sensitive securities. This also relates to Solvency Risk, as unexpected changes can threaten a bank's financial stability. Regulatory Risk and almost all other risks - Non-compliance with regulations can lead to fines, penalties, and reputational damage, which can then affect creditworthiness, liquidity, and solvency.  Saint Joseph College Accountancy Department Tunga-Tunga, Maasin City, Southern Leyte Aud 4 – Auditing and Assurance: Specialized Industries Fiduciary Risk and Reputational Risk - A breach of trust (fiduciary risk) will almost certainly damage the bank's reputation. Legal and Documentary Risk - Inadequate documentation or legal non-compliance can lead to many other problems, including regulatory issues, disputes, and financial losses. Concentration Risk and Credit Risk/Liquidity Risk - Over-reliance on a single client or industry sector increases the bank's vulnerability to losses if that client or sector experiences difficulties. Reporting on the Financial Statements Expressing an opinion on the bank’s financial statements, the auditor: adheres to any specific formats and terminology specified by the law, the regulatory authorities, professional bodies and industry practice. determines whether adjustments have been made to the accounts of foreign branches and subsidiaries that are included in the consolidated financial statements of the bank to bring them into conformity with generally accepted accounting principles in the Philippines. This is particularly relevant in the case of banks with foreign branches and subsidiaries because most countries local regulations prescribe specialized accounting principles applicable primarily to banks. This may lead to a greater divergence in the accounting principles followed by branches and subsidiaries, than is the case in respect of other commercial entities. The financial statements of banks are prepared in the context of the legal and regulatory requirements and accounting policies are influenced by such regulations. The BSP regulatory accounting principles for banks (RAP) may differ materially from generally accepted accounting principles (GAAP). When the bank is required to prepare a single set of financial statements that comply with both frameworks (i.e., RAP and GAAP), the auditor may express a totally unqualified opinion only if the financial statements have been prepared in accordance with both frameworks.  Saint Joseph College Accountancy Department Tunga-Tunga, Maasin City, Southern Leyte Aud 4 – Auditing and Assurance: Specialized Industries If the financial statements are in accordance with only one of the frameworks, the auditor expresses an unqualified opinion in respect of compliance with that framework and a qualified or adverse opinion in respect of compliance with the other framework. When the bank is required to comply with RAP instead of GAAP, the auditor considers the need to refer to this fact in an emphasis of matter paragraph. By assessing key risks, it is evident that there are challenges on all sides. Banks are under attack, being subject to enforcement actions, fines, penalties, and expensive remediation action. Regulators and politicians are under pressure from the public, and sometimes each other, to deal more firmly with the banking sector, the banks, and bankers involved in breaches of regulations, criminal law, public trust, and confidence. Auditors have perhaps been too accommodating in allowing bank management and directors to somehow “manage” the audit relationship to their advantage, and in order to mitigate their reputation and regulatory risk. Throughout history, in moments of crisis and challenge, there are great opportunities. As stated in the new Basel Committee “Corporate Governance Principles for Banks”, internal audit provides independent assurance in promoting an effective governance process and the long-term soundness of the bank.