The New York State Society of CPAs is getting behind the efforts of the International Auditing and Assurance Standards Board to clarify the guidance for auditing the valuations of complex or illiquid financial instruments, such as derivatives.

The IAASB proposed the enhanced guidance in its new exposure draft, International Auditing Practice Statement 1000, "Special Considerations in Auditing Complex Financial Instruments." In a comment letter, the NYSSCPA said it agrees with the IAASB that market conditions, interest rates and credit quality all have a “profound impact” on the valuation of complex financial instruments. Thus, management and those charged with valuation need to have a clear understanding of all the relevant elements of the instruments and the related transactions.

Auditors need to understand the process by which this understanding is gained in order to ensure financial statements are accurate and evaluate the risk of material misstatement,” the society’s comment letter states.

Amid the market turmoil and financial crisis in the past few years, audits of complex financial instruments and related disclosures were highlighted as being of the utmost importance. In April 2008, the Financial Stability Forum recommended that the IAASB consider the lessons learned during the market turmoil and enhance guidance in this area.

The proposed guidance, known as IAPS 1000 for short, was developed in response to this, according to the IAASB. It adds guidance for auditors in a number of areas, including the use of specialized skills or knowledge in the audit, particularly in relation to the valuation of complex financial instruments; credit risk, especially when valuing financial liabilities; auditing procedures and timing; and communications with regulators.

The proposed standard goes a long way toward clarifying the “murky waters” of auditing complex financial instruments, said Mark Springer, a principal drafter of the NYSSCPA’s comments and member of NYSSCPA’s Auditing Standards Committee.

The exposure draft, he said, “highlights some of the special skills and knowledge necessary to do that and notes what auditors should consider.”

The NYSSCPA also recommended there be related guidance added to a section of the proposed IAPS, as the society believes this understanding “is essential and might be overlooked by practitioners.”

The NYSSCPA’s letter aims to help the IAASB clarify details in the proposed standard and verifies some of the things they are trying to do, Springer noted. “A lot of our comments are minor tweaks, but they’re very good tweaks,” he said.

The NYSSCPA’s is also supporting a second proposal by the IAASB to replace a number of its existing IAPSs with modified and updated versions.

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