Applying the Provisions of SAS 81 to the Banking Industry

Article excerpt

By Brian Patrick Green, CPA, PhD. * and Alan Reinstein, CPA, D.B.A.**

ABSTRACT

All financial statement audits should now adhere to the American Institute of Certified Public Accountants' (AICPA's) new provisions of Statement on Auditing Standards (SAS) No. 81, Auditing Investments, which offers guidance for evidence accumulation consistent with the Financial Accounting Standards Board's (FASB) Statement of the Financial Accounting Standard (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. Under the new standard, bank management must prepare for at least three innovations: Auditors will request access to materials previously less relied upon as evidence; new people-specialists in their field-may accompany the auditors; and auditors will apply a different criterion for achieving "adequate evidence."

A primary focus of the new audit Standard is the auditor's assessment of management's "intent" to classify and value investments-an issue of much importance to investors, lenders, regulators, and other financial statement users. SAS No. 81 emphasizes gathering adequate and competent evidence for each management assertion to support a fair presentation of investments. The purpose of this paper is to review the provisions of SAS No. 81 as they affect the banking industry in order to prepare bank management for changed audit practices. Since 1994, the FASB has required all companies to change their accounting for marketable debt and equity securities-from primarily an historical cost to a market value approach. These changes significantly altered many companies' reported net income and financial position. Close auditor attention to the specific application within the banking industry is essential, given that financial instruments are the bulk of that industry's assets. Both increased industry risks from escalated competition and dramatic swings in Asian and American markets only magnify the need for industry-specific guidance to reduce the probability of material misstatement.

The AICPA recently issued SAS No. 81, Auditing Investments, which became effective in 1998 for all financial statement audits. The Standard offers guidance to audit management assertions of existence, ownership, completeness, presentation, and valuation and the need to corroborate assertions related to debt and equity securities investments. This focus arose from SFAS Standard No. 115, Accounting for Certain Investments in Debt and Equity Securities, requiring expanded scrutiny of management's intent and ability to hold financial instruments and the related measures of fair market value. A major catalyst for this Standard was a response to the savings and loan debacle, where investors learned too late about the institutions' multi-billion dollar losses. SAS No. 81 follows the provisions of SFAS No. 115 to measure and record security transactions and the dictates of APB Opinion No.18, The Equity Method of Accounting for Investments in Common Stock, to audit investments. But the new standard requires bank management to prepare for three innovations: Auditors will request access to materials, previously less relied upon as evidence; new people-specialists in their field-may accompany the auditors; and auditors will apply new criteria to gather adequate evidence. The purpose of this paper is to review provisions of SAS No. 81 pertinent to auditing bank investments to help prepare bank management for changed audit procedures.

A UNIQUE INDUSTRY: BANKING

The banking industry faces increased risks from evolving industry competition (e.g., from brokerage firms, dealer-brokers, and finance and insurance companies, leaving fewer banks, each holding more financial assets), the instability of world financial markets and new exposures to changes in investment values relative to other industries. As part of their response to competition, many banks entered into more volatile security and real estate investment activities to recover lost revenue opportunities. …