AUDITINGCHAPTER 16

Investment, Debt, & EquityByDavid N. Ricchiute

GBW 8th ed., Ch. 162

TOPICS

Nature of financing cycleControls over long term debt, equity securitiesAuditor’s consideration of internal controlSubstantive tests of investments, long-term debt, equity balancesAuditor judgment for discretionary itemsAssurance, consulting opportunities

GBW 8th ed., Ch. 163

FINANCING CYCLE

Capital funds received from Investors Creditors

Capital funds used for Operations Temporary investment

GBW 8th ed., Ch. 164

DOCUMENTATION

Separate custody & recording for internal controlBond certificateCommercial paperStock certificateTreasury bill

GBW 8th ed., Ch. 165

CUSTODY & RECORDING

Custody Held by internal officials, independent

custodians Minimize likelihood unauthorized sales

Recording By person independent of custody Provides detailed records of

transactions

GBW 8th ed., Ch. 166

CONTROLS & DEBT SECURITIES

Long term debt Authorized by Board Maximum limits

Unissued instruments Prenumbered consecutively Custody separate from recording

Recording separate from custody, incurrence, redemption

GBW 8th ed., Ch. 167

CONTROLS & EQUITY SECURITIES

Issuance, retirement, dividends Authorized by Board

Stock certificates Prenumbered consecutively Canceled when retired Physically safeguarded

GBW 8th ed., Ch. 168

AUTHORIZATION: Investments Objective, Error, ProcedureObjective Error ProcedureInvestment in accord with authorization

Policy violation; higher risk

Selection policies; list approved investments

Sources of funds in accord with criteria

Funds with unfavorable terms

Policies

Adjustments in accord with criteria

Misstated accounts; covenant violations

Policies, prenumbering, authorization

GBW 8th ed., Ch. 169

RECORDING: Investments Objective, Error, Procedure

Objective ErrorProcedure

Recorded at correct amounts, proper period, properly classified

Detailed records inaccurate, misstated financial statements

Processing, recording procedures; review Board minutes for directives; schedules due dates

GBW 8th ed., Ch. 1610

ACCESS: Investments Objectives, Errors, ProceduresObjective Error ProcedureAccess restricted

Securities lost, stolen, destroyed, diverted

Physical barriers, insurance, files authorized signatures, segregation

Access to forms, records restricted

Records lost, stolen; forms used to divert

Physical barriers; prenumber; insurance; periodic accounting

GBW 8th ed., Ch. 1611

INTERNAL CONTROL DOCUMENTATION

Test controls over investments only if sufficient transactionsIf not sufficient transactions, obtain understanding of controls Internal control questionnaire Memorandum

Plan substantive tests

GBW 8th ed., Ch. 1612

SUBSTANTIVE TESTS: Existence, Occurrence

Investments Debt Stock

Confirm externally held securitiesInspect internally held securitiesTest cutoff

Confirm debtsExamine bonds

Inspect unissued instruments

Verify balancesExamine supporting documentation, authorization

GBW 8th ed., Ch. 1613

SUBSTANTIVE TESTS: Completeness

Investments Debt Stock

Test cutoffAnalytical procedures

Analytical proceduresInspect, account for unissued instruments

Analytical proceduresVerify balances

GBW 8th ed., Ch. 1614

SUBSTANTIVE TESTS: Rights & Obligations

Investments Debt StockConfirm externally held securitiesInspect internally held securities

Confirm debtsExamine bondsConfirm bonds & interest payments

Verify balances

GBW 8th ed., Ch. 1615

SUBSTANTIVE TESTS: Valuation

Investments Debt Stock

Verify transactionsConfirm externally held securitiesCheck prices

Verify transactionsConfirm loansRecalculate interest, amortizations

Verify balances

GBW 8th ed., Ch. 1616

SUBSTANTIVE TESTS: Presentation, Disclosure

Investments Debt Stock

Compare presentation, disclosure to GAAP

Compare presentation, disclosure to GAAP

Compare presentation, disclosure to GAAP

GBW 8th ed., Ch. 1617

SUBSTANTIVE TESTS: Valuation of Marketable

Securities Valuation Obtain schedule investments Verify math accuracy by footing, cross

footing, reconciling to GL

For sampled transactions Examine for authorization,

documentation Compare price to published prices Test calculations for dividends, interest

GBW 8th ed., Ch. 1618

SUBSTANTIVE TESTS: Marketable Securities & Other Assertions

Existence, Valuation, Rights Confirm or physically count

Existence, Completeness Test cutoff for acquisitions, sales, income

Completeness Perform analytical procedures

Presentation & Disclosure Review for classification, adequate

disclosure

GBW 8th ed., Ch. 1619

SUBSTANTIVE TESTS: Long-term Debt 1

Existence, occurrence, Valuation, Completeness, Obligations Obtain schedule long-term debt Verify math accuracy by footing,

cross footing, reconciling to GL Examine documentation Review entries, physically inspect

GBW 8th ed., Ch. 1620

SUBSTANTIVE TESTS: Long-term Debt 2

Existence, Obligations, Valuation Confirm bonds, notes, interest

payments

Existence, Occurrence, Obligations Obtain indebtedness agreements

Examine documentation, authorizations Determine compliance with recording

procedures

GBW 8th ed., Ch. 1621

SUBSTANTIVE TESTS: Long-term Debt 3

Valuation Recalculate interest, amortization

premiums, discounts

Existence, Occurrence, Completeness Perform analytical procedures

Presentation & Disclosure Review for classification, adequate

disclosures

GBW 8th ed., Ch. 1622

SUBSTANTIVE TESTS: Capital Stock, Retained Earnings, EPS 1

Existence, Occurrence, Valuation, Completeness, Obligations Verify recorded balance

Obtain schedule changes Foot, cross foot, reconcile with GL Examine sample of entries; foot, cross

foot, reconcile Confirm externally maintained

certificates, treasury shares

GBW 8th ed., Ch. 1623

SUBSTANTIVE TESTS: Capital Stock, Retained Earnings, EPS 2

Occurrence, valuation Review issuances, stock & cash

dividends, stock splits, treasury stock for Documentation,authorization, recording,

Review treasury stock for Disbursements, sales, appropriate basis of

accounting

Valuation Recalculate EPS

GBW 8th ed., Ch. 1624

SUBSTANTIVE TESTS: Capital Stock, Retained Earnings, EPS 3

Completeness Perform analytical procedures

Presentation & Disclosure Review for classification, adequate

disclosure

GBW 8th ed., Ch. 1625

CLASSIFICATION ISSUES

Accounting for investments in debt, equity securities Classification as “held-to-maturity” or

“available-for-sale” Gains, losses recognized only on actual

sales Classification as “trading securities”

Unrealized gains, losses recognized in current earnings

GBW 8th ed., Ch. 1626

MANAGEMENT DISCRETION & CLASSIFICATION

Unrealized gains, losses provide opportunities to manage earningsAuditors have incentives to assure that management complies with requirements of SFAS No. 115 Monitor management’s intent

GBW 8th ed., Ch. 1627

ASSURANCE & CONSULTING

Before 2000 Investment advising was previously a

profitable advisory service

After 2000 SEC does not approve of investment

advising for audit clients