Accounting Principles Council Update Debra Martin, Loyola Law School Sue Menditto, NACUBO Roger Patterson, UNC – Chapel Hill Mary Wheeler, Cornell University Tuesday, July 11

AICPA Alternative Investments Task Force

Alternative Investments What are alternative investments? Hedge funds, private equity, venture capital funds, commodity funds, fund-of- funds (to name a few) – typically in the form of limited liability partnerships, limited liability corporations, trusts … Why are we talking about them? Auditing challenges posed by investments in non-publicly traded entities raised by 2005 AICPA interpretation…left controllers scrambling for FY05 year-end audits with many questions still unanswered heading into FY06 year-end.

AICPA Auditing Interpretation AU Section 9332, “Auditing Investments in Securities Where a Readily Determinable Fair Market Value Does Not Exit” Alternative Investments Interpretation clarifies rules regarding testing measurement of fair value In such circumstances simply receiving a confirmation from a third party does not in and of itself constitute adequate audit evidence with respect to a fair market value assertion. The interpretation does not provide for what would constitute adequate evidence

AICPA Auditing Interpretations If unable to audit the existence and/or valuation of the investments, as of balance sheet date, auditor should consider a scope limitation To the best of our knowledge in fiscal 2005 no college or university received a scope limitation opinion related to the valuation of alternative investments. Conclusion…auditors and higher education institutions found another way to get comfortable with both existence and valuation.

Alternative Investments Task Force AICPA Alternative Investments Task Force Objective: to consider accounting and auditing issues with respect to alternative investments NACUBO represented by Dale Larson, University of Dallas and John Kroll, University of Chicago Deliverable: Clarified guidance Task force recommended: Management takes full responsibility for oversight and monitoring Auditor reviews and tests management’s processes and oversight Existence and valuation - GP statements, annual audit, cash flows and estimation calculations Auditor confirmations ask for detailed investment information

Audit Issues Task Force Response On July 7, “Alternative Investments – Audit considerations” Practice Aid Draft issued For review by Alternative Investment Task Force members. Target Date – July 12 – for release of final practice aid Check with your auditor Check

FY 06 Audits NACUBO Understanding of the AICPA Practice Aid Existence Assertion – do the investments exist at a given date and have recorded transactions occurred during a given period Valuation Assertion - are alternative investments reflected in the financial statements (of the institution) at appropriate amounts (fair value for higher education)

FY 06 Audits – AICPA Practice Aid Risk Inherent Control Materiality Significance Complexity Management’s responsibility Auditor’s responsibility

FY 06 Audits - Existence Auditor must have adequate understanding of relevant internal controls to plan the approach to verifying existence If verifying the existence is required Confirmation in the aggregate is not sufficient Confirmation should be on a security by security basis If Confirmation does not contain sufficient detail, the auditor should perform other procedures – for example: Observing management site visits Reviewing partnership of other legal agreements Review cash receipts and disbursements

FY 06 Audits - Valuation Management responsible for making the fair value measurements and disclosures included in the financial statements needs to establish an accounting and financial reporting process for determining the fair value measurements and disclosures Selects appropriate valuation methods Identifies and supports significant assumptions used Prepares the valuation Ensures that presentation and disclosure of fair value is in accordance with GAAP Above responsibilities can not be outsourced or assigned to anyone outside of the entity’s management

FY 06 Audits – General Conclusion Auditor’s approach will be based on their assessment of the risk of material misstatement in the financial statements Professional judgment regarding inherent and control risk Quantitative and qualitative decisions Significance of alternative investments to the F/S Nature and complexity Liquidity Management’s processes and controls Available information documenting management’s assertions Talk to your auditors! Review with your audit committee

Preparing for the Audit How should institutions prepare for FY06 year-end audits? Talk to your auditors! Documentation of policies regarding: pre-investment and post- investment due diligence and monitoring, understanding the fund’s investment strategy, method and calculation of fair value Enhance communication between the Controller’s office, the Investment office and the Treasurer’s office Don’t surprise your audit committee

Sample Best Practices for NFP’s… Pre Investment Monitoring Procedures Pre-Investment Hold a face to face meeting with the management team Conduct on-site visit(s) Evaluate investment strategy, process, portfolio, and historical track record Document review by investment office staff, including offering memorandums, legal agreements, and financial statements Evaluate how specific allocation fits within the asset class portfolio Solicit information regarding the General Partner team from third parties Do reference checks Do third party background checks on senior professionals Review and negotiate legal agreements…consider using outside counsel Complete a formal investment memo/write-up for approval

Post-investment Conduct regular in person or telephonic meetings with the GP Conduct on-site visits Review fund communications including financial statements and shareholder communications Review valuation of portfolio valuations for reasonableness Monitor portfolio performance: Compare performance to benchmark returns Review portfolio holdings on a regular basis If the investment strategy changes in mid-stream…check it out Monitor firm/manager: Review press reports for significant management changes Monitor staffing levels Monitor size of assets under management for consistency with business plan Sample Best Practices for NFP’s… Post Investment Monitoring Procedures

Assessing the reasonableness of fair values provided by investment managers: Document policies with respect to alternative investments including due diligence in manager/fund selection (fund administration, including accounting, controls, and valuation methodology should be areas of inquiry in due diligence). Obtain an understanding of the fund’s strategies and holdings, ascertaining the nature of the underlying investments (i.e. marketable securities, derivatives, private companies, real estate, etc). Sample Best Practices for NFP’s… Assessing Fair Values

Consider requesting the detail of the portfolio (underlying securities). Obtain the fund’s audited financial statements noting: (a) whether the independent auditor’s opinion is unqualified on a GAAP basis or modified; (b) the audit firm (ascertain credentials, if you are unfamiliar with the audit firm); (c) disclosed valuation methodologies; (d) other disclosures which may impact on valuation or the institution’s own disclosures; (e) date of independent auditor’s report (f) subsequent events footnote, if any (g) develop historical data on the change in valuation in the lag period (calendar year end or March 31 roll-forward for alternative and June 30 report date for institution) Sample Best Practices for NFP’s… Assessing Fair Values

More on Alternative Investments July / August Business Officer, “In the Know”, Dale Larson Possible webcast – stay tuned Accounting firms Task Force members