Prudential Regulation Authority Rulebook

3.1

The matters addressed form part of the agenda of the existing bilateral meetings between auditors and supervisors. The introduction of a written report requirement whose scope is agreed in advance instils more discipline and focus on sharing key audit findings with the PRA and should be seen as a part of the overall bilateral relationship between the PRA and auditors. The bilateral meeting will continue to focus on more firm-specific risks and issues, although building on information obtained from the written reports.

3.2

Auditors will use the audit work undertaken for the annual report and accounts to comply with the reporting requirements. The relevant annual report and accounts may be those produced by the ultimate parent company of a firm within scope of the policy (“group”), those of any individual firm within scope of the policy (“firm”) and, where relevant, those of a ring-fenced holding company.

3.2A

Typically, the PRA will be concerned with the group as a whole and will ask questions related to the group financial statements (or elements thereof). There may also be circumstances where the PRA wishes to ask questions about the audit of the financial statements of one or more firms within a group (eg a ring-fenced body) or of a ring-fenced holding company.^[2] In such circumstances, the PRA might require reporting on the audit of transactions between that entity and other parts of the group, which would be eliminated on consolidation by the ultimate parent company. In some cases the transactions the PRA requires reporting on might be material in the context of the individual accounts but not in the context of the consolidated accounts, which is another reason why the reporting might need to relate specifically to the audit of a firm’s own financial statements. Where the PRA asks questions relating to the audit of particular financial statements within a group, the PRA will make this clear to external auditors.

3.2B

Potentially there will be overarching questions about the adequacy of application of key accounting policies or controls and the auditors’ assessment of areas at risk of material misstatement. Other than these, all questions will be directed only at portfolios or, where appropriate, line items or account balances that in the auditor’s judgement are materially relevant to the circumstances of that firm or group (as defined by auditing standards’ reference to assessment of risk of material misstatement).

3.3

Some of the questions may nevertheless cause auditors to decide to undertake more work than originally envisaged in their audit planning. The initial dialogue with the PRA about the questions may lead auditors to reconsider their identification and assessment of risks of material misstatement and their planned responses to those risks. It is the choice of the auditors, however, if they decide to do more work than is necessary to respond to any such reconsideration of the risks of material misstatement in order to become comfortable about providing the report to the PRA.

3.4

The PRA will seek to avoid asking questions that could just as easily be answered by the firm. Usually, the questions the PRA asks will require a discursive response that describes audit processes, methodologies and judgements. Auditors should nevertheless consider whether it is necessary to include management information to allow for a clear and full response (eg to clarify the scope of testing or quantify judgements).

3.5

The PRA will endeavour to respect the fact that some issues are likely to be immaterial in relation to some firms. While the PRA understands that the auditor’s opinion is on the truth and fairness of the financial statements as a whole in the context of what is material, paragraph 10 of ISA (United Kingdom and Ireland) 320 Materiality in Planning and Performing an Audit,^[3] discusses the need to set materiality levels in relation to ‘particular classes of transactions, account balances or disclosures’ as well. Therefore there may be areas on which the PRA’s questions are directed to materiality at this level, depending on the significance of the particular issues, including disclosures, to users of the accounts.

3.6

When raising questions about note disclosures, the PRA will bear in mind that, in the context of bank reporting, some note disclosures are extremely important to users of the accounts in terms of giving necessary analysis of summarised figures in the main financial statements or providing additional insights into key financial statement assertions. Moreover, auditing standards make clear that note disclosures are important and should be part of the auditor’s consideration, including in relation to materiality.

3.7

The PRA will aim to keep the scope of questions both as clear and as tightly drawn as possible. Duplication to a degree with audit committee material and management letters is inevitable and, bearing in mind the different duties of care involved, will not be something that the PRA will actively seek to avoid. Having said that, the PRA’s purpose is to learn new things about the audit, not to make auditors repeat to the PRA things they are already putting in writing to their clients.

3.8

A question may be marked in the written report as not applicable in relation to any audit that is in scope for either of the following reasons (simply designate A or B as the reason):

3.9

Areas of focus on which questions might be asked of auditors arise from their knowledge of valuation matters, quality of earnings, key accounting judgements, and their observations on the quality of the systems and controls relevant to the preparation of the financial statements. Questions in relation to these revolve around specific issues, transactions and balances, as well as the overall picture presented in the financial statements. In each case auditors might be asked to provide their observations on the factors they have considered and challenges they made before forming their conclusion on the appropriateness of management judgements.

(a) Valuation matters relate to audit work on major asset and liability categories in the firm’s balance sheet. Auditors might be asked to report their findings from consideration of inappropriate valuations, testing controls over valuation procedures and methodologies, and substantive testing, including sensitivity and scenario analysis. Disclosures around key valuation matters are also included.

(b) Quality of earnings reporting by the auditors focuses on their consideration of aspects or components of a firm’s revenue and expenses, in order to provide insights into the trends in historical earnings and relationships between revenue and cost lines so as to aid identification of areas of risk. The auditors might be asked to discuss how they used any procedures to assess the reasonableness of relationships between major revenue and cost categories.

(c) Key accounting judgement areas typically address matters such as loan loss provisioning, customer redress provisions and level 2 and 3 fair values, but other questions may arise in any particular year, for example in relation to uncertain tax exposures, deferred tax assets, goodwill and other intangible assets. These areas typically involve a significant degree of management judgement in determining what should be recognised in the financial statements and how it should be measured. Disclosures around key judgement areas are also included. Where firms are part of groups that have insurance activities, questions may also arise in relation to that area.

(d) Questions on the quality of the systems and controls relevant to the preparation of financial statements include the design effectiveness of the key controls over these important financial reporting areas. This also covers any control operating weaknesses identified during audit testing together with recommendations for remediation and explanation of mitigating or compensatory tests the auditors have undertaken in order to be able to place reliance on the relevant systems.