Accounting
Assessing credit losses in financial statement audits: A guide for auditors
Published
7 months agoon

Credit losses represent a significant area of focus in financial statement audits. As economic conditions fluctuate and accounting standards evolve, auditors face increasing challenges in evaluating how organizations estimate and report credit losses, and in providing a comprehensive overview of credit loss assessment in financial statement audits.
This article will explore the concept of credit losses, examine relevant regulatory frameworks, discuss vital challenges auditors encounter, and offer best practices for effectively auditing credit loss estimates. In addition, it will also describe key emerging trends and technologies shaping the future of credit loss auditing.
Credit losses occur when a borrower fails to repay a debt according to the initial agreement. These losses are typically reported as allowances for credit losses or loan loss provisions in financial statements. They represent the estimated amount of debt that may not be collected, reflecting the credit risk associated with a company’s financial assets.
For auditors, understanding how companies calculate and report credit losses is crucial. This process often involves complex estimates and judgments, as companies must forecast future economic conditions and borrower behavior. The shift toward more forward-looking models, such as the Current Expected Credit Loss model in the United States, has further increased the complexity of these estimates.
Auditors must evaluate whether these estimates are reasonable and supported by appropriate evidence, ensuring that financial statements accurately reflect the company’s credit risk exposure.
Regulatory framework and standards
Various standards and regulations govern the accounting for credit losses, which have undergone significant changes in recent years. In the United States, the Financial Accounting Standards Board introduced Accounting Standards Update 2016-13, which implemented the CECL model. Internationally, the International Accounting Standards Board
These standards require companies to recognize expected credit losses over the life of a financial asset rather than waiting for a loss event to occur. This forward-looking approach aims to provide financial statement users with more timely and relevant information about credit risk.
Auditors must stay current with these standards and any related interpretations or guidance issued by regulatory bodies. They must also understand how these standards apply to different types of financial assets and industries to effectively audit credit loss estimates.
Critical challenges in auditing credit losses
Auditing credit losses presents several challenges:
- Complexity of models: Credit loss models often involve complex statistical techniques and numerous assumptions. Auditors must assess whether these models are appropriate and whether the assumptions used are reasonable.
- Data quality and availability: The accuracy of credit loss estimates depends heavily on the quality and completeness of historical and current data. Auditors must evaluate the reliability of data sources and the processes used to collect and maintain this information.
- Judgment and estimation uncertainty: Credit loss estimates involve significant judgment, particularly in forecasting future economic conditions. Auditors must evaluate the reasonableness of these judgments and ensure appropriate disclosure of estimation uncertainty.
- Rapidly changing economic conditions: Economic volatility can quickly render historical data and assumptions obsolete. Auditors must consider how companies have incorporated recent economic trends and events into their estimates.
- Internal controls: Assessing the effectiveness of internal controls over the credit loss estimation process is crucial but can be challenging due to the complexity and judgment involved.
- Potential management bias: Given the subjective nature of credit loss estimates, there’s a risk of management bias. Auditors must remain skeptical and alert to potential manipulations of these estimates.
Best practices for auditors
To effectively audit credit losses, auditors should consider the following best practices:
- Develop a thorough understanding: Gain in-depth knowledge of the company’s business model, credit risk management practices and the specific credit loss estimation methodology.
- Assess model appropriateness: Evaluate whether the credit loss model aligns with accounting standards and suits the company’s specific circumstances. When dealing with complex models, consider involving specialists.
- Test key assumptions: Critically evaluate the reasonableness of key assumptions used in the credit loss model. This may involve comparing assumptions to industry benchmarks, historical data, and economic forecasts from reliable sources.
- Perform sensitivity analyses: Assess how changes in key assumptions impact the credit loss estimate to understand the model’s sensitivity and identify potential areas of concern.
- Evaluate data integrity: Test the completeness and accuracy of data used in the credit loss model. This includes both historical data and current information used to inform forward-looking estimates.
- Review disclosures: Ensure financial statement disclosures adequately explain the credit loss estimation process, key assumptions and areas of uncertainty.
- Assess internal controls: Thoroughly evaluate internal controls’ design and operating effectiveness over the credit loss estimation process.
- Consider management bias: When selecting assumptions or data used in the estimation process, remain alert to potential indicators of management bias.
- Document thoroughly: Maintain clear and comprehensive documentation of audit procedures performed, evidence obtained, and conclusions regarding credit loss estimates’ reasonableness.
- Stay updated: Continuously monitor changes in accounting standards, regulatory guidance, and industry practices related to credit loss estimation and auditing.
Emerging trends and technologies
The field of credit loss auditing is evolving rapidly, driven by technological advancements and changing regulatory landscapes. Emerging trends include:
- Increased use of artificial intelligence and machine learning in credit loss modeling;
- Greater emphasis on real-time data analysis and continuous auditing techniques;
- Enhanced data analytics tools for identifying patterns and anomalies in large datasets;
- Growing focus on climate-related risks and their potential impact on credit losses; and,
- Increased regulatory scrutiny of credit loss estimates, particularly during economic uncertainty.
The impact of AI on auditing credit losses
Artificial intelligence is revolutionizing how credit losses are estimated and audited. Its ability to quickly process vast amounts of data and identify complex patterns is particularly valuable in this field.
Here are some key areas where AI is making a significant impact:
1. Enhanced pattern recognition. AI algorithms can analyze historical data to identify subtle patterns indicating increased credit risk. For example, an AI system might detect that customers who make frequent small purchases followed by large purchases are more likely to default. This pattern might need to be more nuanced for traditional analysis methods to catch.
Example: An auditor reviewing a bank’s credit loss estimates could use AI to analyze the transaction patterns of thousands of credit card holders. The AI might identify a correlation between certain spending behaviors and the likelihood of default that the bank’s model hasn’t accounted for, prompting the auditor to question the completeness of the bank’s risk assessment.
2. Improved forecasting. AI models can incorporate a broader range of variables and data sources to improve the accuracy of credit loss forecasts. This includes nontraditional data such as social media posts, online behavior, or macroeconomic indicators.
Example: When auditing a mortgage lender’s expected credit losses, an AI system could analyze not just traditional factors like credit scores and income but also incorporate data on local real estate trends, employment statistics, and even climate change projections for coastal properties. The auditor could assess whether the lender’s forecasting model is sufficiently comprehensive.
3. Real-time risk assessment. AI systems can continuously update risk assessments as new data becomes available, allowing for more dynamic credit loss estimates.
Example: An auditor reviewing a company’s accounts receivable might use an AI tool that continuously monitors customer payment behaviors, news about customer companies, and industry trends. This could help the auditor assess whether the company’s credit loss allowances are updated frequently enough to reflect current risks.
4. Anomaly detection. AI can quickly identify unusual patterns or transactions that might indicate errors in credit loss calculations or potential fraud.
Example: When auditing an extensive portfolio of loans, an AI system could flag individual loans or groups with risk characteristics that don’t align with their assigned risk ratings. This could help auditors focus on areas where the credit loss estimates might need to be more accurate.
5. Automation of routine tasks. AI can automate many routine aspects of auditing credit losses, such as data gathering, reconciliations, and basic calculations. This allows auditors to focus more on complex judgments and risk assessments.
Example: An AI system could automatically gather loan data, calculate expected loss rates based on historical performance, and compare these to the client’s estimates. The auditor could then focus on evaluating the reasonableness of any differences and assessing the qualitative factors that might justify them.
6. Enhanced scenario analysis. AI can rapidly run multiple complex economic scenarios to stress-test credit loss models, providing auditors with a more comprehensive view of potential risks.
Example: When auditing a bank’s loan loss provisions, an AI system could quickly generate and analyze hundreds of potential economic scenarios, considering factors like interest rates, unemployment and GDP growth. This could help the auditor assess whether the bank’s scenario analysis is sufficiently robust and comprehensive.
While AI offers significant benefits, it’s important to note that it also introduces new challenges for auditors. These include ensuring the reliability and appropriateness of AI models, understanding the “black box” nature of some AI algorithms, and maintaining professional skepticism when working with AI-generated insights. Auditors must develop new skills to effectively leverage AI tools while still applying their professional judgment to the audit process.
Auditors should stay informed about these trends and consider how they might impact their audit approaches and methodologies.
Final word
Auditing credit losses remains a complex and challenging task. By staying informed, applying best practices, and leveraging emerging technologies, auditors can enhance the effectiveness and efficiency of their work, ultimately contributing to the reliability and transparency of financial reporting.
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Accounting
Senate unveils plan to fast-track tax cuts, debt limit hike
Published
5 hours agoon
April 2, 2025
Senate Republicans unveiled a budget blueprint designed to fast-track a renewal of President Donald Trump’s tax cuts and an increase to the nation’s borrowing limit, ahead of a planned vote on the resolution later this week.
The Senate
Republicans say they are assuming that the cost of extending the expiring 2017 Trump tax cuts will cost zero dollars.
The draft is a sign that divisions within the Senate GOP over the size and scope of spending cuts to offset tax reductions are closer to being resolved.
Lawmakers, however, have yet to face some of the most difficult decisions, including which spending to cut and which tax reductions to prioritize. That will be negotiated in the coming weeks after both chambers approve identical budget resolutions unlocking the process.
The Senate budget plan would also increase the debt ceiling by up to $5 trillion, compared with the $4 trillion hike in the House plan. Senate Republicans say they want to ensure that Congress does not need to vote on the debt ceiling again before the 2026 midterm elections.
“This budget resolution unlocks the process to permanently extend proven, pro-growth tax policy,” Senate Finance Chairman Mike Crapo, an Idaho Republican, said.
The blueprint is the latest in a multi-step legislative process for Republicans to pass a renewal of Trump’s tax cuts through Congress. The bill will renew the president’s 2017 reductions set to expire at the end of this year, which include lower rates for households and deductions for privately held businesses.
Republicans are also hoping to include additional tax measures to the bill, including raising the state and local tax deduction cap and some of Trump’s campaign pledges to eliminate taxes on certain categories of income, including tips and overtime pay.
The plan would allow for the debt ceiling hike to be vote on separately from the rest of the tax and spending package. That gives lawmakers flexibility to move more quickly on the debt ceiling piece if a federal default looms before lawmakers can agree on the tax package.
Political realities
Senate Majority Leader John Thune told reporters on Wednesday, after meeting with Trump at the White House to discuss the tax blueprint, that he’s not sure yet if he has the votes to pass the measure.
Thune in a statement said the budget has been blessed by the top Senate ruleskeeper but Democrats said that it is still vulnerable to being challenged later.
The biggest differences in the Senate budget from the competing House plan are in the directives for spending cuts, a reflection of divisions among lawmakers over reductions to benefit programs, including Medicaid and food stamps.
The Senate plan pares back a House measure that calls for at least $2 trillion in spending reductions over a decade, a massive reduction that would likely mean curbing popular entitlement programs.
The Senate GOP budget grants significantly more flexibility. It instructs key committees that oversee entitlement programs to come up with at least $4 billion in cuts. Republicans say they expect the final tax package to contain much larger curbs on spending.
The Senate budget would also allow $150 billion in new spending for the military and $175 billion for border and immigration enforcement.
If the minimum spending cuts are achieved along with the maximum tax cuts, the plan would add $5.8 trillion in new deficits over 10 years, according to the Committee for a Responsible Federal Budget.
The Senate is planning a vote on the plan in the coming days. Then it goes to the House for a vote as soon as next week. There, it could face opposition from spending hawks like South Carolina’s Ralph Norman, who are signaling they want more aggressive cuts.
House Speaker Mike Johnson can likely afford just two or three defections on the budget vote given his slim majority and unified Democratic opposition.

Financial advisors and clients worried about stock volatility and inflation can climb bond ladders to safety — but they won’t find any, if those steps lead to a place with higher taxes.
The choice of asset location for bond ladders in a client portfolio can prove so important that some wealthy customers holding them in a taxable brokerage account may wind up losing money in an inflationary period due to the payments to Uncle Sam,
“Thats going to be the No. 1 concern about, where is the optimal place to hold them,” Spranger said in an interview. “One of our primary objectives for a bond portfolio is to smooth out that volatility. … We’re trying to reduce risk with the bond portfolio, not increase risks.”
READ MORE:
The ‘peculiarly bad location’ for a bond ladder
Risk-averse planners, then, could likely predict the conclusion of the working academic paper, which was
“Few planners will be surprised to learn that locating a TIPS ladder in a taxable account leads to phantom income and excess payment of tax, with a consequent reduction in after-tax real spending power,” McQuarrie writes. “Some may be surprised to learn just how baleful that mistake in account location can be, up to and including negative payouts in the early years for high tax brackets and very high rates of inflation. In the worst cases, more is due in tax than the ladder payout provides. And many will be surprised to learn how rapidly the penalty for choosing the wrong asset location increases at higher rates of inflation — precisely the motivation for setting up a TIPS ladder in the first place. Perhaps the most surprising result of all was the discovery that excess tax payments in the early years are never made up. [Original issue discount] causes a dead loss.”
The Roth account may look like a healthy alternative, since the clients wouldn’t owe any further taxes on distributions from them in retirement. But the bond ladder would defeat the whole purpose of that vehicle, McQuarrie writes.
“Planners should recognize that a Roth account is a peculiarly bad location for a bond ladder, whether real or nominal,” he writes. “Ladders are decumulation tools designed to provide a stream of distributions, which the Roth account does not otherwise require. Locating a bond ladder in the Roth thus forfeits what some consider to be one of the most valuable features of the Roth account. If the bond ladder is the only asset in the Roth, then the Roth itself will have been liquidated as the ladder reaches its end.”
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RMD advantages
That means that the Treasury inflation-protected securities ladder will add the most value to portfolios in a tax-deferred account (TDA), which McQuarrie acknowledges is not a shocking recommendation to anyone familiar with them. On the other hand, some planners with clients who need to
“More interesting is the demonstration that the after-tax real income received from a TIPS ladder located in a TDA does not vary with the rate of inflation, in contrast to what happens in a taxable account,” McQuarrie writes. “Also of note was the ability of most TIPS ladders to handle the RMDs due, and, at higher rates of inflation, to shelter other assets from the need to take RMDs.”
The
“If TIPS yields are attractive when the ladder is set up, distributions from the ladder will typically satisfy RMDs on the ladder balance throughout the 30 years,” McQuarrie writes. “The higher the inflation experienced, the greater the surplus coverage, allowing other assets in the account to be sheltered in part from RMDs by means of the TIPS ladder payout. However, if TIPS yields are borderline unattractive at ladder set up, and if the ladder proved unnecessary because inflation fell to historically low levels, then there may be a shortfall in RMD coverage in the middle years, requiring either that TIPS bonds be sold prematurely, or that other assets in the TDA be tapped to cover the RMD.”
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The key takeaways on bond ladders
Other caveats to the strategies revolve around any possible state taxes on withdrawals or any number of client circumstances ruling out a universal recommendation. The main message of McQuarrie’s study serves as a warning against putting the ladder in a taxable brokerage account.
“Unsurprisingly, the higher the client’s tax rate, the worse the outcomes from locating a TIPS ladder in taxable when inflation rages,” he writes. “High-bracket taxpayers who accurately foresee a surge in future inflation, and take steps to defend against it, but who make the mistake of locating their TIPS ladder in taxable, can end up paying more in tax to the government than is received from the TIPS ladder during the first year or two.”
For municipal or other types of tax-exempt bonds, though, a taxable account is “the optimal place,” Spranger said. Convertible Treasury or corporate bonds show more similarity with the Treasury inflation-protected securities in that their ideal location is in a tax-deferred account, he noted.
Regardless, bonds act as a crucial core to a client’s portfolio, tamping down on the risk of volatility and sensitivity to interest rates. And the right ladder strategies yield more reliable future rates of returns for clients than a bond ETF or mutual fund, Spranger said.
“We’re strong proponents of using individual bonds, No. 1 so that we can create bond ladders, but, most importantly, for the certainty that individual bonds provide,” he said.
Accounting
Why IRS cuts may spare a unit that facilitates mortgages
Published
7 hours agoon
April 2, 2025
Loan applicants and mortgage companies often rely on an Internal Revenue Service that’s dramatically downsizing to help facilitate the lending process, but they may be in luck.
That’s because the division responsible for the main form used to allow consumers to authorize the release of income-tax information to lenders is tied to essential IRS operations.
The Income Verification Express Service could be insulated from what NMN affiliate Accounting Today has described of
“It’s unlikely that IVES will be impacted due to association within submission processing,” said Curtis Knuth, president and CEO of NCS, a consumer reporting agency. “Processing tax returns and collecting revenue is the core function and purpose of the IRS.”
Knuth is a member of the IVES participant working group, which is comprised of representatives from companies that facilitate processing of 4506-C forms used to request tax transcripts for mortgages. Those involved represent a range of company sizes and business models.
The IRS has planned to slash thousands of jobs and make billions of dollars of cuts that are still in process, some of which have been successfully challenged in court.
While the current cuts might not be a concern for processing the main form of tax transcript requests this time around, there have been past issues with it in other situations like 2019’s lengthy
President Trump recently signed a continuing funding resolution
The mortgage industry will likely have an additional option it didn’t have in 2019 if another extended deadlock on the budget emerges and impedes processing of the central tax transcript form.
“It absolutely affected closings, because you couldn’t get the transcripts. You couldn’t get anybody on the phone,” said Phil Crescenzo Jr., vice president of National One Mortgage Corp.’s Southeast division.
There is an automated, free way for consumers to release their transcripts that may still operate when there are issues with the 4506-C process, which has a $4 surcharge. However, the alternative to the 4506-C form is less straightforward and objective as it’s done outside of the mortgage process, requiring a separate logon and actions.
Some of the most recent IRS cuts have targeted technology jobs and could have an impact on systems, so it’s also worth noting that another option lenders have sometimes elected to use is to allow loans temporarily move forward when transcript access is interrupted and verified later.
There is a risk to waiting for verification or not getting it directly from the IRS, however, as government-related agencies hold mortgage lenders responsible for the accuracy of borrower income information. That risk could increase if loan performance issues become more prevalent.
Currently, tax transcripts primarily come into play for government-related loans made to contract workers, said Crescenzo.
“That’s the only receipt that you have for a self-employed client’s income to know it’s valid,” he said.
The home affordability crunch and rise of gig work like Uber driving has increased interest in these types of mortgages, he said.
Contract workers can alternatively seek financing from the private non-qualified mortgage market where bank statements could be used to verify self-employment income, but Crescenzo said that has disadvantages related to government-related loans.
“Non QM requires higher downpayments and interest rates than traditional financing,” he said.
In the next couple years, regional demand for loans based on self-employment income could rise given the federal job cuts planned broadly at public agencies, depending on the extent to which court challenges to them go through.
Those potential borrowers will find it difficult to get new mortgages until they can establish more of a track record with their new sources of income, in most cases two years from a tax filing perspective.

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