Meaning and definition of model audit
A model audit refers to the colloquial term used for the tasks performed while conducting due diligence on a financial model, with the purpose of eliminating spreadsheet error. Generally, model audits are appealed by banking organizations, with the purpose of reassuring lenders and investors alike that the calculations and assumptions contained in the model are accurate, and that the results obtained by the model are dependable. When an all-inclusive review of the model is needed, the scope of review is often extended to include tax and accounting, sensitivity testing, and the verification of data contained inside the model back to the legal documentation and original financing.
Scope of a model audit
For a full-scale model audit, the following elements are essential to be included:
- a review of the model’s logic,
- a review of the consistency of the model with contractual and financial documentation,
- a review of the consistency of the model with the local GAAP and tax, and
- a review of sensitivity
Purpose of a model audit
The main purpose of a model audit includes providing assurance for reliable results. due to this reason, the party involved in conducting the review will give a level of reliability on the form of a liability amount. In case an error or omissionis detected in the model because of the negligence on auditor’s part, the organization depending on the report may opt to sue the model auditor so as to recover the loss, if any.The objective of a model audit should be to mitigate the financial risk which is being taken on by under the transaction relating to the financial model. Per se, it is more important to ascertain that the model audit features the proper scope, for it is undertaken through the use of a vigorous methodology, to recognize material errors than negotiating a liability cap if material errors are not recognized. The model is not, or in any case not as an important purpose, an insurance policy, it is for mitigating the financial risk which is being taken on.