AUDSPEC Lecture Note 7 PDF 2024

Course: AUDSPEC Course Description: Auditing and Assurance: Specialized Industries Period: Final Date: 26 October 2024 Reference: 001-006 Preparer: Gilbert T. Tri...

Course: AUDSPEC Course Description: Auditing and Assurance: Specialized Industries Period: Final Date: 26 October 2024 Reference: 001-006 Preparer: Gilbert T. Trinchera, CPA, CISA, CrFA, CDTP, MTM, MPM Topic No. 7: Auditing Mining and Forestry, and Financial Services Industries Note: This handout provides an overview and essential guidance for students learning about auditing schools and academic organizations and should NOT BE UPLOADED IN SITES OR SHARED with other students or classes without the permission of the preparer. Module Objectives: Understand the nature and background of the specific specialized industry. Learn about the overview, statistics, and latest developments of the specialized industry in the Philippine context. Identify the various audit considerations and trends relevant to the industry MINING AND FORESTRY INDUSTRY 1.1 Introduction to Mining Industry Global Context The mining industry plays a pivotal role in the global economy, providing essential materials for construction, manufacturing, and technology sectors. The International Council on Mining and Metals (ICMM) estimates that mining contributes approximately $1.2 trillion to global GDP. Key minerals include gold, copper, coal, and rare earth elements. Increasing demand for clean energy technologies is driving the demand for lithium, cobalt, and other critical minerals. Philippine Context The Philippines has abundant mineral resources, ranking among the top producers of nickel, copper, and gold. In 2022, the mining industry contributed approximately 1.3% to the national GDP. Recent policy shifts have aimed to attract foreign investments while balancing environmental sustainability. The government, through the Department of Environment and Natural Resources (DENR), is actively involved in regulating mining operations. Auditing and Assurance: Specialized Industries For internal use only 1  Key Stakeholders Understanding the stakeholders involved is crucial for auditors: Government Agencies: The DENR and Mines and Geosciences Bureau (MGB) regulate mining operations, enforce environmental laws, and grant mining permits. These agencies are responsible for ensuring compliance with environmental standards. Mining Companies: These can be local or multinational firms involved in various stages of mining—from exploration to processing. Major players often include corporations like Nickel Asia Corporation and Philex Mining Corporation. Environmental Groups: NGOs play a critical role in advocating for sustainable practices, monitoring compliance with environmental regulations, and holding companies accountable for their impact on ecosystems. Revenue Recognition and Key Operations in Mining Key Operations Exploration: Involves activities to identify mineral deposits. Costs incurred during this phase, including geological surveys and feasibility studies, are capitalized as exploration assets. Development: Includes constructing infrastructure necessary for mining operations, such as roads and processing plants. Development costs are also capitalized until the mine starts commercial production. Extraction: The physical removal of minerals from the earth, which can be either surface or underground mining. The choice of extraction method impacts cost structures and environmental considerations. Processing: The transformation of raw minerals into marketable products, which can significantly affect revenue recognition. Timing and Measurement: Revenue is recognized when the risks and rewards of ownership are transferred, typically upon delivery. The measurement of revenue is based on the fair value of consideration received or receivable, often linked to market prices. Accounting Issues and considerations Auditing and Assurance: Specialized Industries For internal use only 2  Depreciation: Mining assets, such as equipment and facilities, are depreciated over their useful lives. The choice of depreciation method (straight-line vs. declining balance) can impact financial statements. Depletion: Depletion accounts for the reduction in the quantity of natural resources due to extraction. It is similar to depreciation but specifically applies to mineral resources. Depletion is typically calculated using the unit-of-production method, which allocates the cost of natural resources based on the volume extracted. Amortization: Costs related to intangible assets, such as mineral rights or licenses, are amortized over their useful lives. Understanding how these costs are accounted for is critical for accurate financial reporting. 1.2 Introduction to Forestry Industry Overview Cultivation: Involves the planting and nurturing of trees. Sustainable practices are essential to ensure that forestry operations do not deplete resources. Logging: The process of cutting trees. Logging practices must comply with environmental regulations to prevent deforestation and habitat destruction. Processing: Includes converting logs into finished products (e.g., lumber, paper). The processing phase adds value to raw materials and impacts revenue streams. Sustainable Forestry and Environmental Concerns Sustainable forestry aims to balance economic benefits with ecological preservation. This includes practices such as selective logging, reforestation, and maintaining biodiversity. Environmental concerns include deforestation, soil erosion, and the carbon footprint of logging activities. Auditors must assess whether companies are adhering to sustainability standards and practices. Revenue Streams in Forestry Logging Operations: Revenue generated from the sale of timber. Accurate measurement and recognition of this revenue are crucial for financial reporting. Auditing and Assurance: Specialized Industries For internal use only 3  Wood Processing: Income from manufacturing products such as paper and furniture. Different products may have varying margins and production costs. Sales: Direct sales of forest products to consumers and businesses. Understanding market dynamics and pricing strategies is essential for revenue forecasting. Key Accounting Principles in Forestry Inventory The accounting for biological assets, particularly growing forests, is governed by IAS 41 (Agriculture). This standard requires measuring biological assets at fair value, reflecting the market price of timber. Proper inventory valuation is critical to ensure accurate reporting of asset values on the balance sheet. Depreciation Similar to mining, forestry operations involve the depreciation of machinery and equipment used for logging and processing. Understanding the useful life and depreciation methods is vital for accurate financial statements. Accounting Standards and Regulatory Frameworks Accounting standards and regulatory frameworks that govern the mining and forestry industries. These frameworks are essential for ensuring compliance, transparency, and sustainability in financial reporting. A. Mining Industry Accounting Standards 1. PFRS 6: Exploration for and Evaluation of Mineral Resources PFRS 6 provides guidance on the accounting for exploration and evaluation expenditures in the mining sector. It allows companies to capitalize costs associated with exploring for mineral resources, ensuring these costs are not immediately expensed. Capitalization of Costs: Costs incurred during exploration and evaluation phases can be capitalized until the technical feasibility and commercial viability of the mineral resource are demonstrable. Reporting: Companies must disclose their accounting policies for exploration and evaluation costs, including how they determine which costs to capitalize. Auditing and Assurance: Specialized Industries For internal use only 4  2. PAS 16: Property, Plant, and Equipment (PPE) PAS 16 outlines the accounting treatment for property, plant, and equipment used in mining operations. Recognition: Assets must be recognized at cost, including all expenditures necessary to bring the asset to its intended use. Depreciation: Assets are depreciated over their useful lives. In mining, depreciation methods can vary based on the asset type (e.g., machinery vs. buildings). Impairment: Mining assets must be reviewed for impairment regularly, especially if there are indicators that the carrying amount may not be recoverable. 3. PAS 36: Impairment of Assets This standard outlines how to identify and measure the impairment of assets, including those in the mining sector. Cash-Generating Units (CGUs): Mining companies often operate multiple mines; thus, they must identify CGUs to assess impairment. Recoverable Amount: An asset is impaired when its carrying amount exceeds its recoverable amount, which is the higher of fair value less costs of disposal or value in use. 4. PAS 37: Provisions, Contingent Liabilities, and Contingent Assets This standard is critical for accounting for liabilities that may arise in the mining sector due to environmental rehabilitation, legal disputes, or other contingencies. Provisions: A provision must be recognized when there is a present obligation resulting from a past event, and it is probable that an outflow of resources will be required to settle the obligation. Environmental Liabilities: Mining companies often have obligations to rehabilitate sites after mining operations cease, requiring provisions for these costs. 5. PAS 38: Intangible Assets PAS 38 covers intangible assets, which may include licenses and exploration rights relevant to mining companies. Recognition: Intangible assets are recognized at cost and can be amortized over their useful lives. Exploration Costs: Certain exploration costs may be capitalized as intangible assets if they meet specific criteria. Auditing and Assurance: Specialized Industries For internal use only 5  B. Forestry Industry Accounting Standards 1. PAS 41: Agriculture (Biological Assets – Growing Forests) PAS 41 deals with the accounting for biological assets, such as growing forests, requiring them to be measured at fair value. Fair Value Measurement: Biological assets are assessed at their fair value, less estimated point-of-sale costs. Revenue Recognition: Revenue from the sale of timber is recognized when the risks and rewards of ownership are transferred. 2. PAS 2: Inventories PAS 2 is crucial for forestry operations, focusing on the accounting treatment of logs and processed wood. Inventory Valuation: Inventory must be valued at the lower of cost and net realizable value. Cost Flow Assumptions: Forestry companies must determine an appropriate cost flow assumption (FIFO, LIFO, etc.) for harvested logs and finished products. 3. PAS 16: Property, Plant, and Equipment Similar to mining, PAS 16 applies to forestry in accounting for equipment and facilities used in logging and processing. Depreciation: Depreciation methods must reflect the pattern in which the asset’s future economic benefits are expected to be consumed. C. Regulatory Bodies and Environment 1. Environmental Protection Laws DENR Regulations: In the Philippines, the Department of Environment and Natural Resources (DENR) is the principal regulatory body overseeing mining and forestry operations. Regulations include: Environmental Impact Assessments (EIA): Mandatory for new mining projects to assess potential environmental impacts. Rehabilitation Plans: Companies must submit plans for land rehabilitation post- mining. 2. Local Government Ordinances Local Regulations: Local governments often have ordinances governing the operations of mining and forestry within their jurisdictions, focusing on community rights and environmental protection. Auditing and Assurance: Specialized Industries For internal use only 6  3. Licensing and Permits for Mining Operations Licensing Requirements: Companies must obtain various licenses, including Exploration Permits, Mineral Production Sharing Agreements (MPSA), and Environmental Compliance Certificates (ECC) from DENR. 4. International Agreements Global Frameworks: International agreements, such as the Kyoto Protocol, affect forestry practices by promoting sustainable land use and reducing deforestation. Compliance with these agreements may require audits of environmental impacts and adherence to sustainable practices. Risk Assessment and Internal Controls in Mining and Forestry Industries I. Risks in the Mining Industry A. Environmental and Safety Risks 1. Environmental Degradation: - Pollution of water sources, land degradation, and biodiversity loss. - Long-term impacts of mining activities on local ecosystems. 2. Safety Hazards: - Occupational health risks to workers, such as exposure to hazardous materials and accidents. - Importance of compliance with safety regulations (e.g., OSHA in the U.S. or similar regulations in the Philippines). B. Asset Valuation and Impairment 1. Valuation Challenges: - Fluctuating commodity prices affect asset valuation. - Impairment assessments: when and how to recognize impairment losses. 2. Exploration Costs: - Accounting for exploration costs and the challenges in determining their recoverability. C. Fraud Risks 1. Underreporting of Extracted Minerals: - Manipulation of production data to evade taxes or regulatory scrutiny. 2. Corruption Risks: - Bribery and corruption in securing permits or contracts. - The role of anti-corruption policies and whistleblower protections. Auditing and Assurance: Specialized Industries For internal use only 7  D. Regulatory Compliance Risks 1. Licensing and Permits: - Importance of compliance with environmental and mining regulations. - Consequences of non-compliance (fines, loss of licenses). 2. Changes in Legislation: - Keeping abreast of changes in laws affecting the mining industry. II. Risks in the Forestry Industry A. Sustainability and Environmental Impact 1. Deforestation Risks: - The impact of logging on carbon emissions and biodiversity. - Importance of sustainable forestry practices. 2. Climate Change: - How climate change affects forest health and management practices. B. Inventory Management 1. Theft and Illegal Logging: - Risks associated with unauthorized logging operations. 2. Over-Logging: - Risks of depleting resources beyond sustainable limits. - Impact on long-term profitability and environmental health. C. Cost Controls in Large-Scale Operations 1. High Operating Costs: - Managing costs associated with large-scale forestry operations. - Importance of efficient resource allocation and budgeting. III. Internal Controls A. Mining Industry Controls 1. Controls over Exploration Costs: - Documentation and approval processes for exploration expenditures. 2. Equipment and Inventory Controls: - Physical controls over machinery and inventory. Auditing and Assurance: Specialized Industries For internal use only 8  - Use of tracking systems (e.g., RFID) to monitor equipment and inventory. 3. Safety and Compliance Controls: - Implementation of safety protocols and regular training for workers. - Auditing compliance with safety standards. B. Forestry Industry Controls 1. Inventory Tracking: - Importance of accurate logging inventories to prevent theft and over-logging. - Methods for tracking inventory (e.g., GIS systems). 2. Logging Permits: - Verification processes for logging permits to ensure legal compliance. 3. Conservation Efforts: - Internal controls to monitor compliance with sustainability practices. - Impact assessments for logging operations. IV. Implementation of Technology to Improve Controls 1. Geographic Information Systems (GIS): - Use of GIS for land management and environmental monitoring in mining and forestry. 2. Radio Frequency Identification (RFID): - Tracking inventory and equipment in real-time to prevent loss and ensure accountability. 3. Data Analytics: - Employing data analytics to identify patterns in risk and operational efficiency. - Use of predictive analytics for better risk management. Audit Procedures for Mining and Forestry Industries I. Audit Procedures in Mining A. Exploration and Development Costs 1. Capitalization: - Criteria for capitalizing exploration and development costs based on IFRS 6 (Exploration for and Evaluation of Mineral Resources). - Documentation required for cost capitalization: invoices, contracts, and geological reports. Auditing and Assurance: Specialized Industries For internal use only 9  2. Impairment Testing: - Procedures for testing the recoverability of capitalized costs. - Use of cash flow forecasts and market conditions in impairment assessments. - Case study: Analyzing the impairment of exploration assets in a declining commodity market. B. Valuation of Mining Reserves 1. Estimating Reserves: - Understanding the role of geological surveys and engineering reports in reserve estimation. - The importance of using the "proven" and "probable" reserve classifications for audit assessments. 2. Depletion Calculations: - Methodologies for calculating depletion (e.g., units of production method). - Documentation and records needed to support depletion calculations. C. Revenue Recognition from Mineral Sales 1. Recognizing Revenue: - PFRS 15 (Revenue from Contracts with Customers) principles applied to mining sales. - Conditions for revenue recognition: delivery, risk transfer, and payment terms. - The role of contracts and pricing mechanisms in revenue recognition. 2. Audit Focus Areas: - Sampling techniques for testing revenue transactions. - Verification of pricing and contracts with customers to ensure accuracy. D. Environmental Liabilities and Reclamation Costs 1. Estimating Environmental Liabilities: - Procedures for assessing the potential liabilities related to environmental remediation and reclamation obligations. - Compliance with PAS 37 (Provisions, Contingent Liabilities, and Contingent Assets) for recognizing environmental liabilities. 2. Audit Evidence: - Review of environmental assessments and reports. - Importance of evaluating the adequacy of provisions made for reclamation costs. Auditing and Assurance: Specialized Industries For internal use only 10  E. Licensing and Regulatory Compliance 1. Compliance with Regulations: - Review of compliance with mining regulations, permits, and licenses. - Procedures for evaluating the impact of regulatory changes on audit planning. 2. Audit Evidence Collection: - Inspecting documentation for mining licenses and regulatory filings. - Interviews with management regarding compliance controls and procedures. II. Audit Procedures in Forestry A. Valuation of Biological Assets (Growing Forests) 1. Valuation Techniques: - Methods for valuing biological assets under IAS 41 (Agriculture). - Assessing the fair value of growing forests and the importance of growth models. 2. Audit Focus Areas: - Review of growth assumptions and market pricing for timber. - Validating the methodologies used for fair value assessment. B. Inventory Valuation 1. Harvested Wood and Processed Products: - Procedures for inventory valuation based on IAS 2 (Inventories). - Importance of costing methods: FIFO, weighted average cost, and their impact on financial statements. 2. Audit Procedures: - Physical inventory counts and reconciliations. - Sampling methods for testing the valuation of harvested wood and processed products. C. Sustainable Practices and Regulatory Compliance 1. Assessing Sustainability Practices: - Importance of sustainable forestry certifications (e.g., FSC, PEFC) and their impact on audit procedures. - Reviewing sustainability reports and their alignment with financial statements. 2. Compliance Audits: - Procedures for verifying compliance with local forestry regulations and environmental laws. Auditing and Assurance: Specialized Industries For internal use only 11  - Evaluating the effectiveness of internal controls related to sustainability practices. D. Depreciation of Forest Machinery and Equipment 1. Depreciation Methods: - Review of depreciation policies for forest machinery and equipment. - Choosing appropriate depreciation methods (e.g., straight-line, declining balance). 2. Audit Procedures: - Testing the accuracy of depreciation calculations. - Ensuring proper documentation for acquisition costs and disposal of equipment. Ethical Considerations and Reporting in Mining and Forestry Audits I. Ethical Issues in Mining Audits A. Bribery and Corruption in Licensing Processes 1. Overview of Corruption Risks: - Statistics: Present data from Transparency International showing the mining sector as one of the most corrupt industries globally, particularly in developing countries. - Case Study: Panguna mine in Bougainville, Papua New Guinea, where bribery played a significant role in the licensing process. Discuss the socio-economic repercussions of this corruption. 2. Auditor's Role: - Independence: Emphasize the need for auditors to remain independent, including potential implications of accepting gifts or favors from clients. - Risk Assessment Procedures: - Conduct background checks on management and key stakeholders. - Review internal controls related to the licensing process. B. Environmental Destruction and Accountability 1. Impact on Communities and Ecosystems: - Environmental Issues: Discuss specific environmental impacts such as habitat destruction, water pollution, and soil degradation due to mining activities. - Case Study: Explore the Marinduque mining disaster in the Philippines, focusing on the environmental and health impacts on local communities. 2. Ethical Responsibility: - Role of Auditors: Auditors must assess the adequacy of environmental impact assessments (EIAs) and reclamation plans. Auditing and Assurance: Specialized Industries For internal use only 12  - Regulatory Compliance: Understanding relevant laws and regulations, such as the Philippine Mining Act, that require companies to adhere to sustainable practices. C. Conflicts of Interest (Auditor Independence) 1. Identifying Conflicts: - Examples: Discuss real-world examples where auditors faced conflicts of interest, such as being hired by companies they previously worked for or having financial interests in their clients. - Risks: Highlight the potential for compromised audit quality and loss of public trust. 2. Maintaining Independence: - Best Practices: Recommend practices such as establishing policies for rotation of audit partners, maintaining a distance from management during audits, and strict adherence to ethical guidelines. II. Ethical Issues in Forestry Audits A. Overlogging and Deforestation 1. Overview of Overlogging Practices: - Impact on Biodiversity: Discuss the role of forests in carbon sequestration and the negative effects of overlogging on biodiversity. - Statistics: Present statistics on deforestation rates in the Philippines and the impact on local communities. 2. Auditor's Ethical Responsibility: - Assessment of Practices: Auditors should evaluate compliance with sustainable forestry practices and whether companies adhere to guidelines set by organizations like the Forest Stewardship Council (FSC). B. Sustainability and Environmental Preservation 1. Importance of Sustainable Practices: - Sustainability Standards: Discuss certification schemes (e.g., FSC, PEFC) that promote sustainable forestry. - Case Study: Review companies that have successfully implemented sustainable practices and the benefits they have reaped (e.g., increased market access, improved public image). 2. Ethical Dilemmas: - Profit vs. Sustainability: Explore scenarios where companies prioritize profit over sustainability and the auditor's role in addressing this. Auditing and Assurance: Specialized Industries For internal use only 13  C. Auditor’s Responsibility in Ensuring Fair Reporting 1. Fair Representation of Financial Statements: - Key Principles: Discuss key accounting principles that must be applied in forestry audits, such as revenue recognition, asset valuation, and compliance with IAS 41. - Examples: Provide examples of how inadequate reporting can lead to misrepresentation of a company’s financial health. 2. Evaluating Internal Controls: - Control Assessment: Auditors should assess the effectiveness of internal controls related to environmental compliance and sustainability practices. III. Audit Reporting A. Reporting Audit Findings in Compliance with PSA 700 1. Understanding PSA 700: - Components of the Report: Explain the essential elements of an auditor's report, including the opinion, basis for opinion, and key audit matters. - Importance of Clarity: Emphasize the need for clarity in audit reporting, particularly for stakeholders with varying levels of financial literacy. 2. Crafting Clear and Concise Reports: - Techniques for Clarity: Recommend techniques such as using plain language, organizing information logically, and summarizing key findings for accessibility. B. Emphasizing Transparency in Environmental and Sustainability Reporting 1. Importance of Transparency: - Stakeholder Expectations: Discuss how stakeholders, including investors and communities, demand greater transparency in sustainability practices and reporting. - Impact on Reputation: Highlight cases where lack of transparency has harmed companies’ reputations (e.g., BP's Deepwater Horizon oil spill). 2. Frameworks for Reporting: - Global Reporting Initiative (GRI): Explain how GRI provides guidelines for sustainability reporting and the auditor's role in verifying these reports. C. Special Disclosures for Mining and Forestry in Financial Statements 1. Required Disclosures: - Specific Regulations: Discuss specific accounting standards and regulations that require disclosures related to environmental liabilities and sustainability practices. Auditing and Assurance: Specialized Industries For internal use only 14  -Examples: Review examples of disclosures for asset impairment related to environmental issues and sustainable forestry practices. 2. Auditor's Role in Assessing Disclosures: - Assessment Techniques: Explain techniques for evaluating the completeness and accuracy of disclosures. FINANCIAL SERVICES INDUSTRY Overview: The banking and finance sector performs a critical function in the Philippine economy as it is primarily responsible for the mobilization of domestic savings and the conversion of these funds into directly productive investments. Financing the needs of firms which desire to raise productive capacity by purchasing additional capital equipment, acquiring, or leasing idle property, building, and expanding factories, and increasing inventory are responsible for sustaining economic growth in the long term, alongside the creation of new jobs. It is very important for the banking and finance sector to continue finding ways to encourage households to save their unspent income in various financial assets so that these resources could be used and transformed into loans that will finance the expansion of directly productive business ventures. The Philippines' banks are classified into three types: universal and commercial banking, rural and cooperative banking, and thrift banking. Of these segments, universal and commercial banks that accepted domestic deposits and offered checking account services had dominated the Philippines' banking industry, with its total deposits valued at approximately 12 trillion Philippine pesos. Nature and Background of Specialized Industry The banking and finance sector is primarily responsible for mobilizing domestic savings and converting these funds into directly productive investments. Financing the needs of firms which desire to raise productive capacity by purchasing additional capital equipment, acquiring or leasing idle property, building and expanding factories, and increasing inventory are responsible for sustaining economic growth in the long term, alongside the creation of new jobs. Banks perform the function of safekeeping money and valuables and extending loans, credit and payment services in the form of checking accounts, money orders, cashier’s checks as well as the issuance of debit and credit cards. Large banks (particularly the universal and commercial banks) are also allowed to engage in other intermediation activities such as investment banking (underwriting debt instruments and or stocks for other firms) and may offer other forms of portfolio investment instruments and insurance products. Auditing and Assurance: Specialized Industries For internal use only 15  The financial system is composed of two general groups namely: banks and non-bank financial institutions. o Banking institutions include: universal banks, commercial banks, thrift or savings banks and the rural and cooperative banks. These institutions are allowed to collect savings and time deposits to fund loans and also perform the function of providing credit and payment services. Large banks, particularly the universal and commercial banks, can engage in other intermediation activities such as investment banking and may offer other forms of portfolio investment instruments and insurance products. o Non-bank financial institutions on the other hand, are composed of insurance companies, pension fund institutions, investment banks, financing companies, pawnshops and mutual fund institutions. These institutions are not allowed to collect deposits but may encourage the general public to invest household savings in various financial instruments. Premium payments for term insurance policies, regular contributions to pension funds, investment into mutual funds or purchases of shares of stock in financing companies and pawnshops are some of the ways by which non-bank financial institutions can source funds to finance lending and or investment operations. Universal and commercial banks have the largest resources and offer the widest variety of banking services outside of collecting deposits and providing loans. These other services include underwriting and other functions of investment houses, investing in equities and non-allied undertakings. Thrift banks include savings and mortgage banks, private development banks, stock savings and loan associations and microfinance thrift banks. They accumulate the savings of depositors and provide housing loans and financing for short-term working capital as well as medium- and long-term financing to small and medium scale enterprises engaged in agriculture, services, and industry. Rural and cooperative banks promote and expand the rural community by mobilizing savings and extending loans and other financial services to farmers to help with the purchase of seeds, livestock, fertilizers, and other farm inputs and the marketing of their produce. Non-bank financial institutions, on the other hand, are composed of insurance companies, pension fund institutions, investment banks, financing companies, pawnshops, and mutual fund institutions. There are several types of non-bank financial institutions offering a wide variety of services such as investment houses, financing companies, investment companies, securities dealers/brokers, lending investors, Auditing and Assurance: Specialized Industries For internal use only 16  government non-bank financial institutions, venture capital corporations, non-stock savings and loans associations, pawnshops and credit card companies. Overview, Updates, Statistics of the Specialized Industry in the Philippines The Bangko Sentral ng Pilipinas (BSP) is the independent central monetary authority of the Philippines that has regulatory and supervisory power over banks and non-bank financial institutions. The BSP supervises the nation’s banking system. Non-bank financial institutions such as insurance companies and investment houses are overseen by the Insurance Commission and Securities and Exchange Commission, respectively. The role of financial intermediation in the Philippine economy continues to expand and is expected to create greater prospects for employment over the next several years. The share of financial intermediation output to total service sector output as well as to gross domestic product has continually increased over the recent past. The main services of commercial banks in the Philippines are accepting deposits and offer checking account services, universal banking on the other hand provides all kinds of services of commercial banking and exercise the powers of an investment house and invest in non-allied enterprises. In the Philippines, these kinds of banks are the largest group of financial institutions and the most popular among customers with different financial needs because of its wide array of financial services. As of October 2023, 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 Philippine pesos have been granted for motor vehicle loans for household consumption and approximately 1.6 trillion Philippine pesos worth of loans granted for production of real estate businesses in the country. Auditing and Assurance: Specialized Industries For internal use only 17  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 2023, the ratio of bank nonperforming loans to total gross loans in the Philippines was almost two percent and has significantly decreased over the past years. The Philippine banking industry is not spared from the adverse impact of this pandemic. The Bangko Sentral ng Pilipinas (BSP) issued the implementing rules and regulation for the Bayanihan Act RA No. 11469. 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. Further, the BSP also relaxed the know-your-customer (KYC) requirements for both over the counter and electronic or online transactions. This is to make sure that Filipinos continue to have access to basic government and financial services amid the COVID-19 situation. Recent Issuances Auditing and Assurance: Specialized Industries For internal use only 18  Audit Considerations Auditing and Assurance: Specialized Industries For internal use only 19  Key Risks Considerations (PFRS 9) Reporting on the Financial Statements (see Philippine Auditing Practice Statement 1006 AUDITS OF THE FINANCIAL STATEMENTS OF BANKS for more details) In 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; and 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. 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 Auditing and Assurance: Specialized Industries For internal use only 20  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. The audit profession must rise to the challenge, embrace the key audit trends for 2015, and raise the standard of auditing to meet the higher level of Banking Governance now required. -END- Auditing and Assurance: Specialized Industries For internal use only 21