CBA Financial Auditing and Reporting 2 — Questions and Answers
Question 1: When auditing a bank's allowance for loan and lease losses (ALLL), which methodology is most consistent with GAAP?
- Specific identification only for non-performing loans
- Incurred loss model based on historical loss rates and qualitative factors (Correct answer)
- Expected loss model projecting lifetime credit losses at origination
- Mark-to-market valuation of all loans quarterly
Correct answer: Incurred loss model based on historical loss rates and qualitative factors
Under legacy GAAP (pre-CECL), the ALLL is estimated using the incurred loss model, incorporating historical loss experience and qualitative adjustments.
Question 2: A bank's auditor identifies that management consistently records loan loss provisions at the low end of an acceptable range. This pattern most likely indicates:
- Conservative accounting practices reducing earnings volatility
- Potential earnings management through manipulation of the provision (Correct answer)
- Compliance with regulatory minimum capital requirements
- Appropriate application of the materiality principle
Correct answer: Potential earnings management through manipulation of the provision
Consistently recording provisions at the low end of an acceptable range is a red flag for earnings management, as it inflates reported income.
Question 3: Which financial statement disclosure is required for banks under ASC 310-20 regarding loan origination fees and costs?
- Immediate recognition of all fees as revenue at loan closing
- Deferral and amortization over the loan's life using the effective interest method (Correct answer)
- Straight-line amortization over the contractual loan term
- Expensing of origination costs as incurred with fees deferred separately
Correct answer: Deferral and amortization over the loan's life using the effective interest method
ASC 310-20 requires that net loan origination fees and costs be deferred and amortized as a yield adjustment over the life of the loan using the effective interest method.
Question 4: During an audit of investment securities, an auditor finds that a bank reclassified securities from available-for-sale (AFS) to held-to-maturity (HTM). What is the primary audit concern?
- Whether the reclassification increases the bank's reported capital ratios
- Whether the bank has the positive intent and ability to hold the securities to maturity (Correct answer)
- Whether unrealized gains were appropriately recognized at reclassification
- Whether the reclassification was approved by the board of directors
Correct answer: Whether the bank has the positive intent and ability to hold the securities to maturity
Reclassification to HTM requires management to demonstrate genuine positive intent and ability to hold securities to maturity, which the auditor must evaluate.
Question 5: Which audit procedure is most effective for detecting unrecorded deposit liabilities at a bank?
- Confirming large deposit balances with customers directly
- Reviewing interest expense recorded for reasonableness relative to average deposits (Correct answer)
- Tracing deposits from the general ledger to supporting documentation
- Comparing current year deposit totals to prior year for unusual fluctuations
Correct answer: Reviewing interest expense recorded for reasonableness relative to average deposits
Analytical review of interest expense relative to average deposit balances can reveal if deposits are understated because understated liabilities produce lower-than-expected interest expense.
Question 6: Under FASB ASC 825, a bank elects the fair value option for certain financial instruments. Which statement is correct regarding audit implications?
- Fair value changes are recognized in other comprehensive income only
- The auditor must evaluate the bank's valuation techniques and key assumptions (Correct answer)
- The election is irrevocable and applies to all financial instruments in the same category
- Fair value option elections reduce the complexity of financial statement audits
Correct answer: The auditor must evaluate the bank's valuation techniques and key assumptions
When the fair value option is elected, the auditor must assess the appropriateness of valuation methodologies, inputs, and assumptions used to determine fair value.
Question 7: A bank's external auditor issues a qualified opinion due to a scope limitation. What does this mean for bank examiners reviewing the audit report?
- The bank's financial statements contain a material misstatement that management refuses to correct
- The auditor was unable to obtain sufficient evidence about a specific area of the financial statements (Correct answer)
- The bank failed to comply with all applicable banking regulations during the audit period
- Management disagreed with the auditor's proposed adjustments but the statements are otherwise fairly presented
Correct answer: The auditor was unable to obtain sufficient evidence about a specific area of the financial statements
A qualified opinion due to scope limitation means the auditor could not gather enough evidence to opine on a specific matter, leaving uncertainty about that area.
CBA Financial Auditing and Reporting 2
When auditing a bank's allowance for loan and lease losses (ALLL), which methodology is most consistent with GAAP?