3/7\223 

United States Government Accountability Office

Washington, DC 20548 

March 21, 2011 

Technical Director 

International Auditing and Assurance Standards Board 

545 Fifth Avenue, 14th Floor 

New York, New York 10017 

Subject: International Auditing and Assurance Standards Board (IAASB) October 

2010 Exposure Draft for a proposed International Auditing Practice Statement 

(IAPS) entitled “IAPS 1000, Special Considerations in Auditing Complex Financial 

Instruments.”

This letter provides the U.S. Government Accountability Office’s (GAO) comments on 

the IAASB’s proposed practice statement regarding special considerations in auditing 

complex financial instruments. 

We agree with the intent of this guidance, which is to provide background 

information to the auditor regarding special considerations when auditing complex or 

derivative-type financial instruments, and we believe that this is a positive step in 

establishing guidance that will help auditors understand the special considerations 

involved in auditing complex financial instruments. In addition, this guidance is welltimed to assist the international audit community as the use of complex or derivativetype financial instruments becomes more prevalent. 

Responses to Specific Questions 

The board is seeking views on the following questions related to the content of the 

proposed IAPS. We provide the requested comments below. 

1. Is the material included in the proposed IAPS appropriate in light of the 

proposed status and authority of new IAPSs? 

We agree that the material included in the proposed IAPS is appropriate in light of the 

proposed status and authority of new IAPSs. The proposed IAPS 1000 clarifies the 

purpose of the IAPS, imposes no new requirements beyond those described in the 

ISAs, and will assist auditors in understanding the applicability of the relevant IAPS. 
2. Is the balance of material included in the proposed IAPS appropriate in 

light of its purpose of assisting a wide range of auditors on an international 

basis? 

In general, we agree that the balance of the material included in the proposed IAPS is 

appropriate, because it is written at a sufficiently high level to provide useful 

clarifications for a wide range of auditors. 

3. Does the proposed form of the IAPS, including the use of two separate 

sections and shaded tables, enhance its readability?

We agree that using two separate sections, one providing background information 

about complex financial instruments and the other on audit considerations related to 

complex financial instruments, is a practical way of addressing the needs of the 

broadest group of auditors and enhances the readability of the document. We have 

concerns, however, about the use of shaded tables in this IAPS. 

Although the purpose of the shaded tables is to enhance the readability and highlight 

background material, the length and breadth of several of these tables interspersed 

within the guidance on audit considerations related to complex financial instruments 

may detract from the readability of the proposed IAPS. The IAASB might want to 

consider moving these tables to an appendix to improve the cohesion of the guidance 

in the body of the IAPS while separately retaining background material that many 

readers would find useful. 

To further improve the readability of the IAPS 1000, we suggest the board consider 

organizing the guidance and related background material around the major audit 

phases such as planning, risk assessment, internal control, substantive testing, and 

presentation and disclosure as was done in Practice Note 23.1

 We believe audit 

guidance arranged in a sequence that would be familiar to most auditors would 

improve its usefulness. 

4. Should an effective date be established for the proposed IAPS and, if so, 

what would be an appropriate date? 

The effective date for the IAPS 1000 guidance should be immediate, because it relates 

to existing ISAs. 

Other Comments 

Controls Related to Complex Financial Instruments

Paragraph 17 of IAPS 1000 provides examples of key elements of process and internal 

control related to an entity’s complex financial instrument transactions. In the case of 

complex financial instruments and agreements, we think it advisable that the 

guidance emphasize the need for separation of functions between front office trading 

and back office support. We suggest that you add to the fourth bullet of paragraph 17 

under segregation of duties wording to that effect so that it would read: 

 

1

UK’s Auditing Practices Board (APB) Practice Note (PN) 23 (Revised) 

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 “Segregation of duties between those investing in the complex financial 

instruments and those responsible for valuing such instruments; as well as, in 

the case of larger operations, the segregation of functions between front 

office trading and back office processing and confirmation operations;...”

Assessing and Responding to the Risks of Material Misstatement – 

Paragraphs 32 – 34 of IAPS 1000 discuss overall consideration of risks related to 

complex financial instruments and the auditor’s assessment of those risks. Given the 

high risk of fraud and material misstatements related to assertions on completeness, 

valuation, and presentation and disclosure,2

 it is important that the auditor obtain a 

thorough understanding of the internal control environment and assess the design 

and implementation of controls even if the auditor decides to take a substantive 

approach. Accordingly, we suggest integrating a reference to the control assessment 

procedures in ISA 315 in paragraph 34 so that it would read: 

 “The auditor’s assessment of identified risks at the assertion level in 

accordance with ISA 3153

includes evaluating the design and implementation

of internal control. It also provides a basis for considering the appropriate 

audit approach for designing and performing further audit procedures in 

accordance with ISA 330 ...” 

Procedures related to Completeness, Accuracy, and Existence of Complex Financial 

Instruments

Paragraph 47 of IAPS 1000 provides examples of procedures that may provide audit 

evidence to support the completeness, accuracy, and existence assertions. For 

complex instruments and agreements, asking the counterparty to also confirm the 

absence of any side agreements in external confirmations may provide audit 

evidence. ISA 505 External Confirmations, specifically paragraph A1, addresses the 

auditor’s use of external confirmation procedures “... to confirm the absence of 

certain conditions, such as a ‘side agreement’.” However, before undertaking 

confirmation procedures, auditors use professional judgment, based on risk and 

materiality, to determine the most effective procedures for obtaining sufficient 

appropriate audit evidence, including whether or not to use confirmation procedures 

in specific circumstances. Accordingly, we recommend adding to the second bullet of 

paragraph 47 a reference to ISA 505 and to the importance of professional judgment 

in determining whether to use confirmation procedures, as follows: 

 “External confirmation of bank accounts, trades, and custodian statements 

and, if applicable, the existence of any side agreements.4

 This can be done by 

direct confirmation with the counterparty (including the use of bank letters), 

where a reply is sent to the auditor directly. Alternatively this information 

may be obtained from the counterparty’s systems through a data feed. Where 

 

2

 ISA 315, par. A111 (b) & (c) 

3

 ISA 315, par. 13 and A66 – A68; par 15 -17 and A79-A80 

4

 ISA 505, External Confirmations, paragraphs 7(a) and A1. 

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this is done, controls to prevent tampering with the computer systems 

through which the information is transmitted may be considered by the 

auditor in evaluating the reliability of the evidence from the confirmation. 

External confirmations, however, do not provide adequate audit evidence 

with respect to the valuation assertion, nor do they supplant auditor 

judgment by presuming that confirmation procedures are the most effective 

audit procedure to address the risk of material misstatement.” 

Internal Audit Function

Internal auditors are not limited to communicating their findings to management. It 

may also be appropriate to communicate their findings to those charged with 

governance. 

Paragraph 111 discusses the role of the internal audit function, and states that an area 

where the work of the internal audit function may be particularly relevant is in 

conducting regular evaluations to provide management with assurance that financial 

instrument activities are being properly controlled. Communicating findings to those 

charged with governance is another area where work of the internal audit function 

may be particularly relevant. Accordingly, we recommend that you add the 

consideration of reporting to “those charged with governance” to the first sub-bullet 

of the sixth bullet of paragraph 111, as follows: 

 “Conducting regular evaluations to: 

• Provide management and, where applicable, those charged with governance 

with assurance that financial instrument activities are being properly controlled; 

and ...” 

Considerations Specific to Public Sector Entities

During the recent worldwide financial crisis, unprecedented government intervention 

in private markets occurred. As a result of these interventions, governments acquired 

unique financial instruments that posed valuation challenges, including some with 

related parties or with parties in which the transactions were not at arms length. 

Since these unique financial instruments often have increased risk of material 

misstatement and the potential need for additional disclosures, we encourage the 

inclusion of a brief discussion of the potential challenges in auditing complex 

financial instruments held by public sector or governmental entities. Such a 

discussion could be included as a consideration specific to public sector entities, 

similar to those in the International Standards on Auditing (ISAs).5

Auditor Reporting on Significant Matters Related to Complex Financial Instruments

The recent financial crisis has highlighted the difficulty in valuing complex financial 

instruments in certain environments. The guidance should clarify that, in such 

circumstances, the auditor might determine that it would be appropriate to discuss 

significant information related to the valuation of complex financial instruments, 

 

5

 ISA 540, par. A11; ISA 330, par. A17; ISA 315, par, A21, A 35, A65, & A 113. 

Page 4 
such as a discussion of estimation uncertainty, in the auditor’s report as an emphasis 

of a matter paragraph or other-matter paragraph, as discussed in ISA 706. This 

discussion could include guidance on instances when an auditor might report on 

significant matters related to auditing an entity’s complex financial instruments. 

Suggested Additional Guidance on Testing Valuation Models

The guidance could be improved by clarifying that in assessing risk and determining 

the nature, timing, and extent of substantive procedures, the auditor may consider 

the significance or materiality of specific inputs, calculations, and assumptions in 

relation to the outputs of valuation models. This would include a consideration of the 

sensitivity of the model to changes in such inputs, calculations, and assumptions. 

In addition, we recommend that you consider adding as a third sentence to paragraph 

35 “where model outputs are difficult to review analytically, an expectation that 

controls over data inputs and data processing are operating effectively also may be 

more common” so that it would read: 

 The nature and extent of internal control that exists at an entity influences the auditor’s 

determination of the nature, timing and extent of tests of controls and substantive 

procedures. An expectation that controls are operating effectively may be more common 

when dealing with a financial institution with well-established internal controls, and 

therefore controls testing may be an effective means of obtaining audit evidence. Where 

model outputs are difficult to review analytically, an expectation that controls over data 

inputs and data processing are operating effectively also may be more common.

We appreciate the opportunity to comment, and we encourage the IAASB to develop 

additional guidance as conditions and stakeholder feedback warrant. 

Sincerely yours, 

James R. Dalkin 

Director 

Financial Management and Assurance 

Cc: Prof. Arnold Schilder 

 Mr. James Gunn 

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