Auditors of credit unions face a number of challenges as the sector adopts FRS 102, writes Eimear Sugrue and Rory Lynch.
The credit union sector makes a significant contribution at both a community and broader economic level, while simultaneously addressing a range of core challenges and change drivers. These range from business model and related viability challenges to moving to a new regulatory framework. Of particular relevance to this article is the move to New Irish GAAP, FRS 102.
The auditor has a significant and constructive role to play in supporting this transition, given the professional independence associated with their statutory function.
FRS 102
Auditors will be aware that FRS 100-105 replaced UK/Irish GAAP with effect for accounting periods beginning on or after 1st January 2015. The latest date by which credit unions can adopt FRS 102 is for year-end 30th September 2016.
While FRS 102 should provide a more suitable reporting framework for credit unions, the new standard will have significant implications on financial reporting for those credit unions. In this regard, auditors play a pivotal role in assisting credit unions in their preparation for adoption of the new standard.
Set out below is summary of some of the accounting issues that are likely to have the most impact on credit unions:
- The first set of financial statements under FRS 102 will require restated comparatives for the previous year and reconciliations between accounts prepared under the existing Irish GAAP and FRS 102, showing changes in reserves and surpluses/deficits. This will be a substantial project for most credit unions;
- Credit unions will be subject to the full disclosure requirements of FRS 102, which are more onerous than previous requirements, and credit unions’ underlying information systems must be capable of supporting this;
- For most credit unions, FRS 102 will have the greatest impact on financial instruments – i.e. loans and investments. Close attention must be paid to the classification of these financial instruments, which will be categorised as either basic or complex financial instruments, and the measurement basis. Credit unions are required to give due regard to the accounting principles outlined in the Credit Union Act, 1997 (“the 1997 Act”);
- Provisioning for impairments will be made on the basis of incurred losses determined by objective evidence of impairment. A prudent basis should be employed to assess whether indications of impairment exist, and credit unions must have a robust provisioning methodology with supporting data. Auditors should be vigilant and investigate large movements out of provisions; and
- There is a significant level of restructuring within the credit union sector that will present challenges for credit unions and practioners. It should be noted that under FRS 102, credit unions are not permitted to employ merger accounting.
The Central Bank expects FRS 102 to be fully implemented and complied with by all credit unions. Attention must be given to the overlap between regulation/legislation and FRS 102 – in particular, the differences in accounting and regulation definitions such as related party transactions.
Meanwhile, the Central Bank is in the process of updating the Credit Union Annual Return, which will include changes for FRS 102 and the new regulations. As adoption of a new standard is very rare, it will present a significant challenge to credit unions and this will have a potential knock-on effect on audit risk. Early auditor engagement is necessary to facilitate greater understanding of the matter and to support credit unions in preparation for transition to the new standard.
Going concern and viability
Credit unions continue to face a challenging external environment, which requires the development of sustainable business models to deliver the services that members require. Directors must satisfy themselves that their credit union is a going concern and are in a position to service their members’ needs and ensure all savings are fully secure. Credit unions, meanwhile, are required to clearly demonstrate the viability of their business.
Auditors are reminded of their objective under ISA 570 (UK and Ireland). Going concern is to conclude, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern. In some cases it appears to be unclear as to the work performed by the auditor on management’s assessment of the entity’s ability to continue as a going concern.
Section 76A of the 1997 Act requires all credit unions to have a strategic plan incorporating three-year financial projections. Where a credit union has prepared financial projections, analysis of the projections is a significant factor in considering the future outcome of events or conditions in the evaluation of management’s plans for future action. Auditors should ensure they test the assumptions underlying the financial projections.
Audit risk and reporting
The Central Bank places significant reliance on the work of the external auditor in reporting any material issues that come to their attention when conducting the annual audit engagement. The Central Bank has previously communicated concerns about the quality and content of management letters.
Following onsite Probability Risk and Impact System (PRISM) engagements, it was discovered that material and significant systems, control and related governance issues were not always reported by auditors. We take this opportunity to remind auditors of their reporting requirements to the Central Bank. In reviewing management letters, we also expect to see adequate and appropriate responses from boards and management to address the issues highlighted within appropriate timeframes.
Reporting and disclosure
Following consultation on Consultation Paper 88 – Consultation on Regulations for Credit Unions on Commencement of the Remaining Sections of the 2012 Act (CP 88), the Central Bank will introduce new regulations for credit unions on 31st December 2015.
The Central Bank is introducing these regulations as part of the continued introduction of a strengthened regulatory framework, as recommended by the Commission on Credit Unions. We expect the smooth implementation of the new regulations by credit unions.
Auditors should also note the following additional disclosure and reporting requirements in relation to annual accounts:
- Regulatory reserve requirements;
- Loans to related parties; and
- Investment income and gains.
The requirement for disclosure on loans to related parties is to disclose the total amount of loans outstanding to related parties and the loans to such persons as a percentage of the total loans outstanding. The requirement for disclosures on regulatory reserves and additional reserves is to express reserves as a percentage of total assets, together with the credit union’s dividend and loan interest rebate policy.
The regulations contain transitional arrangements in relation to liquidity, lending, investments, savings and borrowing requirements. These range from 12 months to two years and will apply from 31st December 2015.
Conclusion
Many challenges lie ahead for credit union auditors and the sector as a whole. We encourage early engagement with credit union boards and management on the degree of preparation, planning and understanding in respect of these changes. We view such early engagement as being central to successful transition to the new framework.
The Central Bank is working with Chartered Accountants Ireland in updating the Financial Reporting Council audit practice note, PN 2008 – The Audit of Credit Unions. It is expected that the Financial Reporting Council will issue the revised practice note in 2016.
Eimear Sugrue is a Regulatory Supervisors at the Registry of Credit Unions in the Central Bank of Ireland. Rory Lynch is a Regulatory Supervisors at the Registry of Credit Unions in the Central Bank of Ireland.