How auditors test ECL

How do auditors test ECL?

1. Understand the business, the ECL methods, the data flows, the controls and the governance over judgements.
2. Assess the risks of material misstatement, considering estimation uncertainty, complexity and subjectivity, and the risk of management bias.
3. Test controls where relying on them: data reconciliations, model change controls, review and approval of forecasts and overlays.
4. Test data and models: agree inputs to source systems, recalculate the model or parts of it, and test the staging logic.
5. Challenge judgements: compare forecasts with external sources, test the SICR criteria, and examine each overlay's rationale and calculation.

Which ECL judgements do auditors challenge most?

• Economic scenarios and weights: compared with consensus and central bank forecasts, and with the forecasts used for budgets and goodwill.
• SICR thresholds: whether they move loans to stage 2 in time, often tested by looking back at loans that defaulted and checking whether they were in stage 2 beforehand.
• Management overlays: the rationale, the calculation, double counting with the model, and release triggers.
• Individually assessed stage 3 exposures: collateral values, recovery strategies and timing.
• Model performance: back-testing results and outstanding validation findings.

How do auditors test SICR in practice?

A common test looks back at loans that defaulted during the year and checks which stage they were in six or twelve months earlier. If many defaulted straight from stage 1, the SICR criteria may be too slow. Auditors also recalculate staging for a sample of loans, test the data behind the PD comparisons, and check that qualitative triggers such as watchlist status flow through to stage 2.

How is ECL audited at smaller companies?

With a lighter but similar approach: agreeing the ageing report to the ledger, testing that invoices are aged correctly, recalculating the provision matrix, testing the loss rates against write-off history, considering the forward-looking adjustment, and reviewing receipts after the year end for evidence about recoverability.

What will auditors ask for?

The ECL methodology document; data reconciliations from the loan system to the model; model validation reports; the economic scenarios, weights and their approval; the overlay register with calculations; staging reports and transfer analysis; minutes of the impairment committee; and, for companies, the provision matrix with the write-off trace and forward-looking evidence.

Preparing these before the audit starts, with a short note explaining any changes since last year, usually shortens the fieldwork considerably and reduces the number of follow-up queries.

What is a key audit matter for ECL?

For listed companies, the auditor's report describes the matters of most significance in the audit. For banks, ECL is nearly always one of them, with a description of the specific risks, such as the judgement in economic scenarios or overlays, and how the audit addressed them. Reading peers' key audit matters is a useful way to see what auditors focus on.

What are common ECL audit findings?

• A 0% loss rate on current receivables, or no forward-looking adjustment, in a provision matrix.
• Overlays without documented calculations or clear release plans.
• Data used in the model that does not reconcile to the ledger.
• Intercompany loans and guarantees with no ECL assessment in parent company accounts.
• Disclosures that do not match the numbers in the reconciliation.

How should companies prepare?

Document the method once and update it each year, reconcile the data before the audit starts, keep evidence for every judgement, and back-test last year's allowance. See ECL model validation, provision matrix mistakes and post-model adjustment governance.

This guide is general information. It is not tax or legal advice for your situation.