FRB No. 19

June 9, 2016 SEC NOTICE Notice is hereby given that the Commission En Banc in its meeting on 03 May 2016 resolved to issue Financial Reporting Bulletin (FRB) No. 19, the details of which are as follows: Bulletin Date Subject Clarification/Details No. Matter 19 3 Expectations In line with the continuing effort to promote quality May for an control standards in external audit, the following 2016 Effective principles on the expectation for an effective Audit audit function are required to be observed by Function independent auditors. The FRB basically contains the responsibilities of the external auditor some of which are actually covered by the requirements under Philippine Standards on Auditing (PSA). The PSAs are the standards that the external auditors are required to apply when they conduct a financial statement audit. Consistent with the PSA, the principles herein highlight the responsibilities of the external auditor when conducting an audit of financial statements. They provide guidelines on how external auditors are expected to carry out audit engagements to obtain the overall objective of an audit of financial statement, i.e., expression of an opinion on the fairness of the financial statements. The member-agencies of the Financial Sector Forum, namely, the Securities and Exchange Commission, Bangko Sentral ng Pilipinas, Insurance Commission and Philippine Deposit Insurance Commission, had agreed that these principles for an effective external audit function be adopted in their respective supervisory jurisdictions. Expectations for an effective audit function: a) In forming an opinion, the external auditor shall identify and assess the risks of material misstatement in the company's financial statements, taking into consideration its operations, control environment and its components as well as the company's financial reporting systems. b) The assessment shall take into account qualitative aspects of the company's accounting practices, including indicators of possible biases in management's judgment. c) The external auditor should assess and communicate to the company's audit committee the results of its assessment on the capability of company's management to the extent possible, the strength of its control environment, and the adequacy of the company's accounting/information systems to comply with financial and prudential reporting responsibilities. d) The external auditor shall conclude whether it has obtained reasonable assurance that the financial statements, as a whole, are free from material misstatement, whether due to fraud or error. That conclusion shall include an evaluation of the following: 1) Whether sufficient appropriate audit evidence has been obtained; 2) Whether uncorrected misstatements are material, individually or in aggregate; and 3) Compliance with the applicable framework. e) If material error or fraud is discovered, the external auditor shall immediately bring such information to the attention of the audit committee or the board of directors. Moreover, the external auditor shall report to the SEC such material error or fraud and other matters as prescribed under existing regulations. f) In particular, the external auditor shall evaluate whether, in view of the requirements of the applicable financial reporting framework: 1) The financial statements adequately disclose the significant accounting policies selected and applied; 2) The accounting policies selected and applied are appropriate and consistent with the applicable financial reporting framework; 3) The accounting estimates made by management are reasonable; 4) The methodologies, assumptions and valuation practices including provisioning for loan losses are appropriate and consistent with the applicable financial reporting framework; 5) The information presented in the financial statements are relevant, reliable, comparable and understandable; 6) The financial statements provide adequate disclosures to enable the intended users to understand the effect of material transactions and events on the information conveyed in the financial statements; and 7) The terminologies used in the financial statements, including the title of each financial statement, are appropriate. g) In carrying out the audit of a company's financial statements, the external auditor recognizes that a particular company has characteristics that generally distinguish it from most other business enterprises, and which the external auditor takes into account in assessing the level of inherent risk. Examples of key audit areas and exposures that merit special audit consideration for a company include, but need not be limited to, impairment and loan loss provisioning, financial instruments measured at fair value, liabilities, related party transactions and disclosures. h) While the provisioning requirements under the prescribed financial reporting framework and regulatory rules and regulations may differ, external auditors are expected to look into the soundness of the assumptions and methodologies used under both regimes. In addition, external auditors should also look into the adequacy and propriety of documentation of significant differences between the valuations used for financial reporting purposes and for regulatory purposes. i) External auditors should also assess the adequacy and propriety of disclosures on related party transactions. The external auditors should exercise sound judgment on whether mere compliance with disclosure requirements prescribed under the applicable financial reporting framework already provides sufficient information to make a conclusion on whether the transactions are done at arm's length terms. j) While the external auditor has the sole responsibility for the audit report and for determining the nature, timing and extent of audit procedures, much of the work of internal auditing can be useful to the external auditor in the audit of the financial statements. The external auditor, therefore, as part of the audit assesses the internal audit function insofar as the external auditor believes that it will be relevant in determining the nature, timing and extent of the external audit procedures. k) The auditor is expected to exercise professional judgment in areas such as: 1) Assessing inherent and control risk and the risk of material misstatement due to fraud or error; 2) Deciding upon the nature, timing and extent of the audit procedures; 3) Evaluating the results of those procedures; and 4) Assessing the reasonableness of the judgments and estimates made by management in preparing the financial statements. l) While many areas of financial reporting require significant judgments (i.e., by management when implementing the standards and auditors when interpreting the standards during the audit process), it is expected that similar transactions will be accounted for in a manner that is consistent with the accounting standards and consistent across companies in the same industry. m) The external auditor should maintain an attitude of professional skepticism throughout the planning and performance of the audit, recognizing that circumstances may exist that cause the financial statements to be materially misstated. Specific areas where professional skepticism is particularly important include, among others, fair value measurements, related party relationships and transactions, going concern assessments, and in auditing significant unusual or highly complex transactions. n) The external auditor should promote a two- way communication with those charged with the governance. The subject of the communication may include the following: 1) The responsibilities of the external auditor in relation to the financial statement audit, and an overview of the planned scope and timing of the audit; 2) Information relevant to the external audit; and 3) Timely observations arising from the external audit that are significant and relevant to the companies' financial reporting process, including inappropriate accounting treatment that may result in tax violation. o) The external auditor should document its discussions with the company's board of directors and the audit committee. Where there are differences between regulations and the applicable financial reporting framework, as when there is more than one option allowed, discussions on the treatment adopted in the financial statements should be duly minuted. The external auditors are nonetheless, expected to recommend compliance with regulatory accounting treatment particularly when such is likewise acceptable under the applicable financial reporting framework. p) The external auditor is expected to charge only reasonable audit fees. In determining reasonable fees, the following may be considered: 1) Expected hours needed to complete the scope of work envisioned in the audit plan; 2) Complexity of the activities and structure of the company; 3) Level of internal audit assistance; 4) Level of fees being charged by other audit firms; and 5) Quality of audit services. In this respect, the external auditor is expected to ensure that the audit fees will be set at an amount that will not in any way compromise the quality of the audit. q) The external audit team is expected to be composed of members whose collective skills and competence are commensurate with the size and complexity of operations of the company. June 9, 2016, Mandaluyong City, Philippines. CAIHTE (SGD.) TERESITA J. HERBOSA Chairperson