Conducting an Audit and Survey in Accordance with Certain Standards Set Out in the US

Bank of Israel
Inspector of Banks
Policy Department
Fax: 03-5661110 Tel: 03-5640520
P.O.B. 528, Tel-Aviv 61004

7 Adar II 5773
February 17, 2013
Circular No. 06-2370

To:
Banking Institutions and Credit Card Companies

Subject: Conducting an Audit and Survey in Accordance with Certain Standards Set Out in the US Banking Management Directive No. 304A

Introduction

1. This Banking Management Directive No. 304A "Conducting an Audit and Survey in Accordance with Certain Standards Set Out in the US" (hereinafter: "the Directive") establishes that the audit of the financial reports of banking institutions may be conducted under the auditing standards set by the Public Company Accounting Oversight Board of the United States (hereinafter: "PCAOB") or by the staff of the PCAOB.
2. Additionally, on August 15, 2012, the PCAOB published Publication No. 2012-004, which includes amendments to the auditing standards, as well as Standard No. 16 "Communications with Audit Committees". The publication was approved on December 17, 2012.
3. In light of the aforementioned, a need arose to update the Banking Management Directives. Following consultation with the PCAOB Committee and the Advisory Committee of the Israel Institute of Certified Public Accountants with the Inspector of Banks, and with the approval of the Governor of the Bank of Israel, it was decided to adopt the following guidelines, as detailed below.

Amendments to the Directive
4. The following changes have been made to Appendix 1 to the Directive regarding "Auditing Standards of the Israel Institute of Certified Public Accountants":
4.1. Section 5.1 on page 1(ג) of 304A-4 is cancelled.
4.2. Section 5.2 on page 1(כ) of 304A-5 is cancelled.
5. The following is added to Appendix 2 to the Directive regarding "Auditing Standards of the PCAOB":
Standard No. 16-11 "Communications with Audit Committees" AS16– Communications with Audit Committees

Explanation of the Directive

1. In light of the publication of PCAOB Standard No. 16, we intend to consider in the future updating Banking Management Directive No. 303 "Auditor Considerations Regarding Communications with Persons Responsible for Oversight of the Banking Entity" in order to align it with the amendments set forth in Standard No. 16.
2. The following is added to Section 4 of the Directive regarding "Auditing Guidelines of the PCAOB Staff (practice alerts)":
   Guideline No. 2 – Matters Related to Auditing Fair Value Measurements of Financial Instruments and the Use of Specialists Alert No.2 – Matters Related to Auditing Fair Value Measurements of Financial Instruments and the Use of Specialists

Guideline No. 3 – Auditor Considerations in the Current Economic Environment Alert No.3 – Audit Considerations Current Economic Environment

Guideline No. 4 – Auditor Considerations Regarding Fair Value Measurements, Disclosures, and Other-Than-Temporary Impairments Alert No.4 – Auditor Considerations Regarding Fair Value Measurements, Disclosures, and Other-Than-Temporary Impairments

Guideline No. 5 – Auditor Considerations Regarding Significant Unusual Transactions Alert No.5 – Auditor Considerations Regarding Significant Unusual Transactions

Guideline No. 6 – Auditor Considerations Regarding Using the Work of Other Auditors and Engaging Assistants from Outside the Firm Alert No.6 – Auditor Considerations Regarding Using the Work of Other Auditors and Engaging Assistants from Outside the Firm

Guideline No. 7 – Auditor Considerations of Litigation and Other Contingencies Arising from Mortgage and Other Loan Activities Alert No.7 – Auditor Considerations of Litigation and Other Contingencies Arising from Mortgage and Other Loan Activities

Guideline No. 8 – Audit Risks in Certain Emerging Markets Alert No.8 – Audit Risks in Certain Emerging Markets

Guideline No. 9 – Assessing and Responding to Risk in Current Economic Environment Alert No.9 – Assessing and Responding to Risk in Current Economic Environment

Guideline No. 10 – Maintaining and Applying Professional Skepticism in Audits Alert No.10 – Maintaining and Applying Professional Skepticism in Audits

3. In order to adopt these auditing guidelines of the PCAOB staff, these guidelines will be brought to the attention of the auditors committed to the changes.

Effective Date
8. The provisions of this circular, including the amendments to the existing PCAOB auditing standards, shall take effect for financial reports ending on or after December 31, 2013.

Update to the Document
9. The following updates are made to the pages of the "Update to Banking Management Directive":
Insert page / Remove page
304A-1-9 (4/13) [ ]4 304A-1-8 (3/11) [ ]3

Respectfully,
David Zaken
Inspector of Banks

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Banking Management Directive No. 304A
Conducting an Audit and Survey in Accordance with Certain Standards Set Out in the US

A

1. The auditing process of the auditor of a banking entity (a banking entity and a credit card company, hereinafter together: "banking entity") is a process of supervision and control by the supervisory authorities and also by the market forces, in which it is published.
2. This Directive establishes that the auditor of a banking entity shall apply at least the auditing standards set out in the US for the preparation and submission of the auditor's report regarding the annual financial reports of the banking entity, and for the preparation and submission of the review report of the auditor regarding the quarterly financial reports of the banking entity.
3. The provisions of Circulars No. 06-2175 dated 5.12.05 and No. 06-2223 dated 20.1.08 are specified. These circulars refer to the implementation of Section 404 of the Sarbanes-Oxley Act (hereinafter: "Section 404") in banking entities. Among other things, these circulars require:
   3.1. The annual report of the banking entity for the year ending on December 31, 2008, shall include a management statement regarding its responsibility for internal control over financial reporting.
   3.2. The annual report for this year shall include the auditor's opinion on internal control over financial reporting.
4. This Directive establishes, consistently with the aforementioned circulars, that every auditor preparing and submitting an opinion on the financial reports of a banking entity shall attach a report regarding internal control over financial reporting, which shall be prepared in accordance with the auditing standards set in the US on this matter. This Directive does not exempt the auditors of the banking entities from implementing the requirements of other auditing standards that apply to the audit work of the auditor, including "Generally Accepted Auditing Standards" such as the regulations of the Israel Institute of Certified Public Accountants (1973) - Law.

B
6. In order to audit the annual financial reports of a banking entity, the auditor shall apply at least the auditing standards set out in the US specified in the Appendix to this Directive. For the purpose of the review of the quarterly financial reports of a banking entity, the auditor shall apply at least the relevant auditing standards set out in the US specified in the Appendix to this Directive.

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Banking Management Directive No. 304A
Conducting an Audit and Survey in Accordance with Certain Standards Set Out in the US

The "certain auditing standards" referred to in this Directive include the auditing standards set out in the US - the Public Company Accounting Oversight Board of the United States (hereinafter: "PCAOB") (which also applies to the auditing standards published by the American Institute of Certified Public Accountants - AICPA) and the auditing guides published by the AICPA (Audit and Accounting Guides).
7. It is clarified that although these amendments to the certain auditing standards shall apply from the date of publication of this Directive, the changes specified in the Appendix or in this Directive shall be implemented in accordance with the effective date of the amendments in the US.

Attestation Report on Internal Control over Financial Reporting
8. Every auditor preparing and submitting an opinion on the financial reports of a banking entity shall attach a report regarding internal control over financial reporting, which shall be prepared in accordance with the standards adopted by the Public Company Accounting Oversight Board of the United States (PCAOB) regarding the report.
9. The report shall not be part of the engagement to issue an opinion on the financial reports.

10. The auditors of banking entities shall apply Standard No. 5 of the PCAOB "Reporting on an Audit of Financial Statements Conducted in Conjunction with an Audit of Internal Control over Financial Reporting" with the necessary adaptations according to the laws and regulations required, and additional auditing standards and/or clarifications may be set in the US in the future. In addition, with regard to the manner of implementing the requirements of Section 404, these standards and/or clarifications shall also apply to the auditors of banking entities in Israel.
11. In cases where the auditor preparing and submitting an opinion on the financial reports may report material weaknesses previously reported, the auditor shall be requested to prepare a report regarding internal control over financial reporting of the banking entity, and additionally a report regarding the question of whether the previously reported material weaknesses continue to exist.

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Banking Management Directive No. 304A
Conducting an Audit and Survey in Accordance with Certain Standards Set Out in the US

12. In the case mentioned above:
    a. The report shall not be part of the engagement to issue an opinion on the financial reports. b. The auditors of banking entities shall apply Standard No. 4 of the PCAOB "Reporting on Whether a Previously Reported Material Weakness Continues to Exist" with the necessary adaptations according to the laws and regulations required, and the auditing of the banking entity.

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Conducting an Audit and Survey in Accordance with Certain Standards Set Out in the US

Appendix
Auditing Standards Set Out in the US to be Applied When Auditing the Financial Reports of Banking Entities

1. The following auditing standards of the Israel Institute of Certified Public Accountants have been applied by the PCAOB:
   Note: The reference to the part of the PCAOB website is in the order of the AU section.

(1) Generally Accepted Auditing Standards
AU 150 – Generally Accepted Auditing Standards Due Professional Care in the Performance of Work AU 230 – Due Professional Care in the Performance of Work

(2) Consideration of Fraud in a Financial Statement Audit AU 230.12 ,316– Consideration of Fraud in a Financial Statement Audit (3) Cancelled (4) Cancelled (5) Cancelled

(6) Illegal Acts by Clients
AU 317 – Illegal Acts by Clients
(7) Cancelled

(8) The Auditor's Consideration of the Internal Audit Function in an Audit of Financial Statements AU 322 - The Auditor's Consideration of the Internal Audit Function in an Audit of Financial Statements

(9) Service Organizations
AU 324 – Service Organizations

(10) Communication About Control Deficiencies in an Audit of Financial Statements AU 325 - Communication About Control Deficiencies in an Audit of Financial Statements (11) Cancelled

(12) Auditing Fair Value Measurements and Disclosures AU 328 – Auditing Fair Value Measurements and Disclosures

(13) Analytical Procedures
AU 329 - Analytical Procedures

(14) The Confirmation Process
AU 330 – The Confirmation Process

(15) Auditing Derivative Instruments, Hedging Activities, and Investments in Securities AU 332 – Auditing Derivative Instruments, Hedging Activities, and Investments in Securities

(16) Management Representation
AU 333 - Management Representation

(17) Inquiry of a Client’s Lawyer Concerning Litigation, Claims, and Assessments AU 337, AU 560.12 – Inquiry of a Client’s Lawyer Concerning Litigation, Claims, and Assessments

(18) Auditing Accounting Estimates
AU 342 - Auditing Accounting Estimates

(19) Audit Sampling
AU 350 - Audit Sampling

(20) Cancelled

(21) Consideration of Omitted Procedures after the Report Date AU 390 – Consideration of Omitted Procedures after the Report Date

(22) The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles AU 411 – The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles

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Conducting an Audit and Survey in Accordance with Certain Standards Set Out in the US

(23) Consistency of Application of Generally Accepted Accounting Principles – Change in the Reporting Entity AU 420.07-.11 – Consistency of Application of Generally Accepted Accounting Principles – Change in the Reporting Entity (24) Cancelled

(24) Subsequent Events
AU 560 - Subsequent Events
Subsequent Discovery of Facts Existing at the Date of the Auditor's Report AU 561 - Subsequent Discovery of Facts Existing at the Date of the Auditor's Report

(25) Reports on the Application of Accounting Principles AU 625 – Reports on the Application of Accounting Principles

(26) Interim Financial Information
AU 722 – Interim Financial Information

2. The following auditing standards of the PCAOB:
   (1) Audit Documentation
   AS3 - Audit Documentation

(2) Engagement Quality Review and Conforming amendment to the Board's Interim Quality Control Standards AS7 – Engagement Quality Review and Conforming amendment to the Board's Interim Quality Control Standards

(3) Audit Risk
AS8 – Audit Risk

(4) Audit Planning
AS9– Audit Planning

(5) Supervision on Audit Engagement
AS10– Supervision on Audit Engagement

(6) Consideration of Materiality in Planning and Performing an Audit AS11– Consideration of Materiality in Planning and Performing an Audit

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Conducting an Audit and Survey in Accordance with Certain Standards Set Out in the US

(7) Identifying and Assessing Risks of Material Misstatements AS12– Identifying and Assessing Risks of Material Misstatements

(8) The Auditor's Responses to the Risks of Material Misstatement AS13– The Auditor's Responses to the Risks of Material Misstatement

(9) Evaluating Audit Results
AS14– Evaluating Audit Results

(10) Audit Evidence
AS15– Audit Evidence

(11) Communications with Audit Committees
AS16– Communications with Audit Committees

3. The following auditing guides of the AICPA have been applied by the PCAOB:
   (1) AICPA Audit and Accounting Guides, Industry Guides – Banks and Savings Institutions

(2) AICPA Audit and Accounting Guides – General Guides - Auditing Derivative Instruments, Hedging Activities and Investments in Securities

(3) AICPA Audit and Accounting guides – General Guides: Analytical Procedures

(4) AICPA Audit and Accounting Guides – General Guides: Audit Sampling

(5) AICPA Audit and Accounting Guides – General Guides: Consideration of Internal Control in a Financial Statement Audit

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Banking Management Directive No. 304A
Conducting an Audit and Survey in Accordance with Certain Standards Set Out in the US

4. The following auditing guidelines of the PCAOB Staff (practice alerts):
   (1) Alert No. 2 – Matters Related to Auditing Fair Value Measurements of Financial Instruments and the Use of Specialists Alert No. 2 – Matters Related to Auditing Fair Value Measurements of Financial Instruments and the Use of Specialists

(2) Alert No. 3 – Audit Considerations Current Economic Environment Alert No. 3 – Audit Considerations Current Economic Environment

(3) Alert No. 4 – Auditor Considerations Regarding Fair Value Measurements, Disclosures, and Other-Than-Temporary Impairments Alert No. 4 – Auditor Considerations Regarding Fair Value Measurements, Disclosures, and Other-Than-Temporary Impairments

(4) Alert No. 5 – Auditor Considerations Regarding Significant Unusual Transactions Alert No. 5 – Auditor Considerations Regarding Significant Unusual Transactions

(5) Alert No. 6 – Auditor Considerations Regarding Using the Work of Other Auditors and Engaging Assistants from Outside the Firm Alert No. 6 – Auditor Considerations Regarding Using the Work of Other Auditors and Engaging Assistants from Outside the Firm

(6) Alert No. 7 – Auditor Considerations of Litigation and Other Contingencies Arising from Mortgage and Other Loan Activities Alert No. 7 – Auditor Considerations of Litigation and Other Contingencies Arising from Mortgage and Other Loan Activities

(7) Alert No. 8 – Audit Risks in Certain Emerging Markets Alert No. 8 – Audit Risks in Certain Emerging Markets

(8) Alert No. 9 – Assessing and Responding to Risk in Current Economic Environment Alert No. 9 – Assessing and Responding to Risk in Current Economic Environment

(9) Alert No. 10 – Maintaining and Applying Professional Skepticism in Audits Alert No. 10 – Maintaining and Applying Professional Skepticism in Audits

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Banking Management Directive No. 304A
Conducting an Audit and Survey in Accordance with Certain Standards Set Out in the US

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Updates
Version No. 06 Circular
1 2242 Original Circular 11/02/09
2 2272 Update 8/7/10
3 2298 Update 3/4/2011
4 2370 Update 17/2/2013