Appendix No. 39

to the Order of the Ministry of Finance of the Russian Federation of January 9, 2019 No. 2n

International report on practice of audit of 1000 of "Feature of audit of financial instruments"

The international report on practice of audit (MOPA) 1000 "Features of audit of financial instruments" should be considered together with "The preface to the Collection of international standards of quality control, audit and survey checks, the other tasks providing confidence, and tasks on rendering the accompanying services". The international reports on practice of audit do not confer on auditors responsibility for observance of additional requirements, in addition to already containing in the International Standards of Audit (ISA), and do not influence obligation of the auditor to observe all International standards of audit which action extends to this audit engagement. The international reports on practice of audit provide to auditors the practical help. It is supposed that they shall extend the organizations which are responsible for development of national standards or to be used by preparation of the corresponding materials at the national level. Besides, they offer materials which can be used by auditing organizations in case of development of the training programs and internal instructions.

Introduction

1. Financial instruments can be used by the financial and non-financial organizations of any size for the most different purposes. One organizations have considerable number of financial instruments and large volume of transactions with them, and others can perform only the insignificant number of financial instrument transactions. Some organizations can open line items on financial instruments, receiving benefits due to acceptance on themselves is risky whereas others can use financial instruments for decrease in certain risks due to hedging of these risks or management of them. This International report on practice of audit (MOPA) is applicable to all these situations.

2. In case of audit of financial instruments the following international standards of audit (ISA) have special value:

(a) MCA 540 <1> establishes the auditor's obligations relating to check of estimative values, including the estimative values connected with financial instruments which are estimated at fair value;

--------------------------------

<1> MCA 540 "Audit of estimative values, including assessment of fair value, and the corresponding disclosure of information".

(b) MCA 315 (reviewed) <2> and MSA 330 <3> concern identification and risks assessment of essential misstatement of the financial reporting and acceptance of adequate measures in response to these risks;

--------------------------------

<2> MCA 315 (reviewed) "Identification and risks assessment of essential misstatement by means of studying of the organization and its environment".

<3> MCA 330 "Audit procedures in response to the estimated risks".

(c) in MCA 500 <4> it is explained that enters concept of the auditor proof, and the auditor's obligations connected with development and carrying out audit procedures for the purpose of receipt of the sufficient competent auditor evidences allowing the auditor to draw valid conclusions which will form the basis of auditor opinion are considered.

--------------------------------

<4> MCA 500 "Auditor proofs".

3. The purpose of this report consists in that:

(a) provide general information about financial instruments (Section I);

(b) consider questions of audit which should be considered in connection with financial instruments (Section II).

The international reports on practice of audit provide to auditors the practical help. It is supposed that they shall extend the organizations which are responsible for development of national standards or to be used by preparation of the corresponding materials at the national level. Besides, they offer materials which can be used by auditing organizations in case of development of the training programs and internal standards.

4. This report is applicable to the organizations of any size because in case of use of financial instruments all organizations can be exposed to risk of essential misstatement of the financial reporting.

5. The instructions for evaluating <5> containing in this report, most likely, will have bigger value for the financial instruments estimated at fair value or on which information on their fair value reveals, and instructions for the directions which are not connected with assessment equally are applicable to the financial instruments estimated as at fair value, and on depreciated cost. Besides, this report is applicable also to financial assets, and to financial liabilities. This report does not consider such tools as:

--------------------------------

<5> In this report the terms "assessment" and "measurement" are used in identical value.

(a) the simplest financial instruments, for example money, ordinary loans, trade accounts receivable and trade accounts payable;

(b) investments into the equity instruments which are not addressing at the exchange, or

(c) insurance contracts.

6. Besides, in this report the specific questions of financial accounting concerning financial instruments, such as hedging accounting, profits or losses are not considered in case of initial recognition of the financial instrument (often called profits or losses of "the first day"), offset, transition is risk or impairment, including creation of reserve under losses on loans. Though these questions can be related to financial accounting of financial instruments in the organizations, consideration by the auditor of question of how to provide observance of specific requirements to financial accounting, is not discussed as he is beyond this report.

7. Audit according to International standards of audit is booked proceeding from the fact that management of the organization and if it is pertinent, persons who are responsible for corporate management recognize certain obligations. These obligations include evaluating at fair value. This report does not assign obligation to management or persons who are responsible for corporate management and does not replace with itself the laws and regulations determining duties of specified persons.

8. This report is developed in the context of concepts of fair presentation of general purpose financial statements, however under certain circumstances it can be useful and in cases of use of other concepts of preparation of the financial reporting, such as concepts of preparation of the financial reporting of special purpose.

9. In this report in the center of attention there are assessment prerequisites, and also representations and disclosures, however in it are also considered, though is less detailed, such prerequisites as completeness, accuracy, existence, and also the rights and obligations.

10. Financial instruments are subject to influence of factor of uncertainty of assessment which is determined in MCA 540 as "inaccuracy of measurement inherent in estimative values and the relevant disclosed information" <6>. Uncertainty of assessment depends among other factors on that how difficult the financial instrument is. Nature and degree of reliability of information by means of which it is possible to receive confirmation of assessment of financial instruments significantly differ that exerts impact on uncertainty of assessment of these tools. In this report for designation of uncertainty of assessment connected with measurement of fair value the term "uncertainty of assessment" is used.

--------------------------------

<6> MSA 540, Item 7(c).

Section I. General information about financial instruments

11. In different concepts of preparation of the financial reporting financial instruments can be determined differently. For example, in the International Accounting Standards (IAS) the financial instrument is determined as any agreement which leads to emergence of financial asset at one organization and the financial liability or equity instrument at other organization <7>. Can act as financial instruments: money; equity interests of other organization; the right determined in the agreement to receive money or the obligation to make payment by money or to perform exchange of financial assets or obligations; some agreements under which repayment of obligations is performed by own equity instruments of the organization; some contracts signed concerning non-financial Articles or some agreements issued by insurance companies, but not corresponding to determination of the insurance contract. Financial instruments of wide range - from loans and deposits on which simple conditions, to difficult derivative financial instruments, the structured products and some commodity contracts are provided fall under this determination.

--------------------------------

<7> International accounting standard (IAS) 32 "Financial instruments": submission of information", Item 11.

12. Financial instruments differ on complexity level though complexity of the financial instrument can be caused by different factors, such as:

- very large volume of separate cash flows when due to the lack of uniformity it is required to carry out the analysis of each flow or large number of cash flows, united in groups, to estimate, for example, credit risk (in particular, the secured debentures (SD));

- difficult formulas for calculation of cash flows;

- uncertainty or variability of cash flows in the future, for example, owing to availability of credit risk, options or financial instruments with long completion date.

The sensitivity of cash flows to changes of market conditions, the more difficult is higher and assessment of fair value of the financial instrument will not be more certain, most likely. Besides, owing to certain circumstances there can sometimes be difficulties when evaluating financial instruments which in usual conditions quite easily give in to assessment, for example tools which market lost activity, or tools with long completion date. Assessment of derivative financial instruments and the structured products becomes complicated if they represent combination of separate financial instruments. Besides, financial accounting of financial instruments according to certain concepts of preparation of the financial reporting or in case of certain market situation can appear difficult also.

13. One more reason of complexity of assessment is amount of the financial instruments which are available for the organization or amount of trading activities with these tools. Though the simple interest rate swap in itself can be simple, the organization which is the holder of large number of such swaps can use difficult information system for identification and assessment of these tools, and also for carrying out transactions with them.

The purpose of use of financial instruments and risks connected with it

14. Financial instruments are used:

- for the purposes of hedging (that is to change the existing structure of risks of the organization). Treat them:

- - forwards on purchase or sale of currency with the purpose to fix future exchange rate;

- - converting of future interest rates in the fixed or floating rates due to use of swaps;

- - purchase of option contracts with the purpose to protect the organization from the specific change in price, including contracts which may contain the built-in derivative financial instruments;

- for the purposes of trading activities (for example that the organization could open risk line item for extraction of benefit from short-term market fluctuations);

- for the investment purposes (for example that the organization could receive benefits in the form of the income from long-term investments).

15. By means of financial instruments it is possible to reduce exposure of the organization to certain business risks (for example, to risks of change of the exchange rates, interest rates and goods prices) or to complex impact of these risks. On the other hand, the complexity inherent in some financial instruments can become the reason of the increased risk also.

16. The business risk and risk of essential misstatement of the financial reporting raise in that case when the management and persons who are responsible for corporate management:

- not fully realize the risks connected with use of financial instruments, and their qualification and experience are not enough for management of these risks;

- have no knowledge and experience necessary for carrying out their proper assessment according to the applicable concept of preparation of the financial reporting;

- did not implement in the organization the effective control system over financial instrument transactions or

- in an inadequate way hedge risks or perform speculative operations.

17. Absence at management of complete understanding of the risks inherent in any financial instrument, can make direct impact on capability of management to manage these risks properly and as a result can threaten viability of the organization.

18. Main types of the risks characteristic of financial instruments are listed below. This list is not exhaustive, and for the description of the specified risks or for classification of components of specific risks various terminology can be used.

(a) The credit risk (risk of non-execution of contractual commitments by the partner) is risk of non-execution of one of the parties of the financial instrument of the obligations therefore financial damage will be caused to other party. This risk is often connected with default. The credit risk includes risk of not carrying out calculations which arises if one party of the transaction fulfilled the obligations, and the payment was not received from the client or the partner.

(b) The market risk is risk of fluctuations of fair value or future cash flows on the financial instrument in connection with change of market prices. The currency risk, interest risk, risk of the change in price for goods and risk of change in value of equity can be examples of market risk.

(c) The liquidity risk is the risk connected with inability timely to purchase or sell the financial instrument at the proper price due to the lack of market opportunities for realization of this financial instrument.

(d) The operational risk is connected with special procedure for processing which is required for financial instruments. The operational risk can increase in process of complication of conditions of the financial instrument. Poor control of operational risk can lead to strengthening of risks of other types. The operational risk includes:

(i) that leads risk that control facilities in the form of confirmation and reconciliation are insufficient to incomplete or inexact reflection of financial instruments in financial accounting;

(ii) risk of inadequate documentary registration of transactions and insufficient monitoring of these transactions;

(iii) risk of the wrong accounting and processing of transactions and inadequate risk management, arising in connection with these transactions and consequently, risk of incorrect reflection of economic aspects of trading activities in general;

(iv) the risk of excessive trust of employees to the accuracy of evaluation methods which is carried out to lack of necessary checks therefore assessment of transactions is incorrectly carried out or is estimated inadequate image the related risk;

(v) risk of insufficient accounting of use of financial instruments in policy of the organization in the field of risk management and in the corresponding procedures;

(vi) risk of losses because of insufficiently effective or inefficient internal processes and systems or as a result of action of external factors, including risk of making of unfair actions by both the employees, and third parties;

(vii) risk that the evaluation methods used for measurement of financial instruments are applied incorrectly or out of time;

(viii) the legal risk which is component of operational risk and is connected with the losses received as a result of actions of legislative or normative bodies which nullify or otherwise make impossible execution by the end user or his partner of obligations in accordance with the terms of the agreement or the related arrangements on offset. For example, the legal risk can arise owing to insufficient or wrong documentary execution of the agreement; impossibility to forcibly achieve execution of arrangements on offset in case of bankruptcy; adverse changes of the tax legislation or availability of conditions in the charter which prohibit to the organizations to make investments in financial instruments of certain types.

19. Among other questions concerning the risks arising in connection with use of financial instruments it is possible to call the following:

- the risk of unfair actions which can increase if, for example, the employee having opportunity to make unfair actions understands financial instruments and according to the procedure of their accounting is better, than the management and persons who are responsible for corporate management;

- risk that general agreements about offset <8> can be incorrectly reflected in the financial reporting;

--------------------------------

<8> The organization which performs number of financial instrument transactions with the same partner can sign with this partner the general agreement about offset. Such agreement provides single settlement on all financial instruments to which operation of the agreement, in case of violation any of agreements extends.

- risk of transition of some financial instruments from category of assets in category of obligations during their effective period and risk that this transition can quickly be performed.

The control facilities relating to financial instruments

20. Important factors for determination of necessary level of complexity of internal control system of the organization are the amount of the financial instrument transactions made by the organization and level of complexity of these tools. For example, the small organizations for achievement of the purposes can use products with less complex structure, and also simple processes and procedures.

Disclaimer! This text was translated by AI translator and is not a valid juridical document. No warranty. No claim. More info