New SAS Focuses on Derivatives and Securities


The ASB issued Statement on Auditing Standards no. 92, Auditing Derivative Instruments, Hedging Activities, and Investments in Securities in the fall (see Official Releases, JofA, Nov.00, page 130). It supersedes SAS no. 81, Auditing Investments.

The new guidance applies to

Derivative instruments as defined in FASB statement no. 133, Accounting for Derivative Instruments and Hedging Activities.

Hedging activities in which the entity designates a derivative or a nonderivative financial instrument as a hedge of exposure for which FASB statement no. 133 permits hedge accounting.

Debt and equity securities as defined in FASB statement no. 115, Accounting for Certain Investments in Debt and Equity Securities.

Judith M. Sherinsky, CPA, a technical manager with the AICPA auditing standards division, said it was issued because of changes in accounting standards related to the SAS. “The issuance of FASB Statement no. 133, as well as the explosion in the number and types of hedging activities and derivative instruments, created the need for revised auditing guidance in this area,” she said.

Sherinsky added that the guidance will help practitioners who, with limited knowledge of derivatives and hedging, may be asked by their clients to audit financial statements containing assertions about such products. Derivatives can be difficult to identify, especially if embedded in a contract or agreement. “If auditors do not have the necessary expertise,” she said, “they may have to develop it, consult a specialist or perhaps decline such engagements.”

Applying the concept of fair value, which the accounting literature increasingly supports as a means of measuring financial instruments, further complicates auditors’ work in this context, said Stephen D. Holton, CPA, a partner of Martin, Dolan & Holton in Glen Allen, Virginia, and chairman of the task force that created SAS no. 92. He explained how the new standard addressed this issue.

“Since management has to identify and properly account for all its derivatives, doing so on the basis of fair value can be complicated. For example, if you have a derivative that is measured by estimating future cash flows and then discounting them back to present value, you have to decide what rate to use, and that is a subjective determination,” he said. “So, in SAS no. 92, we combined SAS no. 81’s fair value guidance with new information on how to audit derivatives and hedging activities.”

The task force devoted a significant part of SAS no. 92 to defining and illustrating two types of risk auditors must be able to assess.

The SAS provides examples of factors that affect inherent risk—the susceptibility of an assertion to a material misstatement, assuming there are no related controls. For example, the complexity of a derivative or security or the reporting entity’s inexperience with it could increase the inherent risk of material misstatements about such products in the entity’s financial statements.

Control risk—the chance that an entity’s internal control will not prevent or detect on a timely basis a material misstatement that could occur in an assertion—receives equal attention in SAS no. 92. Among the SAS’s examples of factors that could affect control risk are monitoring by a control staff not involved in derivatives activity and the review, by senior management, of any divergence from approved derivative strategies.

To assist auditors in implementing SAS no. 92, the task force soon will issue an audit guide (product code 012520) that can be obtained by calling 888-777-7077.

Holton acknowledged that smaller auditing firms probably wouldn’t encounter the most complex derivatives on their engagements. “They are more likely to see interest-rate swaps,” he said, adding that “they will have the information they need if they focus on FASB statement no. 133, on issues discussed by FASB’s derivatives implementation group, on the AICPA audit guide for SAS no. 92 and on the SAS itself.”

SAS no. 92 is effective for audits of financial statements for fiscal years ending on or after June 30, 2001. Early application is permitted.

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