Investment, Debt, & Equity By David N. Ricchiute AUDITING CHAPTER 16 Investment, Debt, & Equity By David N. Ricchiute

TOPICS Nature of financing cycle Controls over long term debt, equity securities Auditor’s consideration of internal control Substantive tests of investments, long-term debt, equity balances Auditor judgment for discretionary items Assurance, consulting opportunities GBW 8th ed., Ch. 16

FINANCING CYCLE Capital funds received from Capital funds used for Investors Creditors Capital funds used for Operations Temporary investment GBW 8th ed., Ch. 16

DOCUMENTATION Separate custody & recording for internal control Bond certificate Commercial paper Stock certificate Treasury bill GBW 8th ed., Ch. 16

CUSTODY & RECORDING Custody Recording 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. 16

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. 16

CONTROLS & EQUITY SECURITIES Issuance, retirement, dividends Authorized by Board Stock certificates Prenumbered consecutively Canceled when retired Physically safeguarded GBW 8th ed., Ch. 16

AUTHORIZATION: Investments Objective, Error, Procedure Investment 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. 16

RECORDING: Investments Objective, Error, Procedure 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. 16

ACCESS: Investments Objectives, Errors, Procedures Objective Error Procedure Access 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. 16

INTERNAL CONTROL DOCUMENTATION Test controls over investments only if sufficient transactions If not sufficient transactions, obtain understanding of controls Internal control questionnaire Memorandum Plan substantive tests GBW 8th ed., Ch. 16

SUBSTANTIVE TESTS: Existence, Occurrence Investments Debt Stock Confirm externally held securities Inspect internally held securities Test cutoff Confirm debts Examine bonds Inspect unissued instruments Verify balances Examine supporting documentation, authorization GBW 8th ed., Ch. 16

SUBSTANTIVE TESTS: Completeness Investments Debt Stock Test cutoff Analytical procedures Inspect, account for unissued instruments Verify balances GBW 8th ed., Ch. 16

SUBSTANTIVE TESTS: Rights & Obligations Investments Debt Stock Confirm externally held securities Inspect internally held securities Confirm debts Examine bonds Confirm bonds & interest payments Verify balances GBW 8th ed., Ch. 16

SUBSTANTIVE TESTS: Valuation Investments Debt Stock Verify transactions Confirm externally held securities Check prices Confirm loans Recalculate interest, amortizations Verify balances GBW 8th ed., Ch. 16

SUBSTANTIVE TESTS: Presentation, Disclosure Investments Debt Stock Compare presentation, disclosure to GAAP GBW 8th ed., Ch. 16

SUBSTANTIVE TESTS: Valuation of Marketable Securities 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. 16

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. 16

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. 16

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. 16

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. 16

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. 16

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. 16

SUBSTANTIVE TESTS: Capital Stock, Retained Earnings, EPS 3 Completeness Perform analytical procedures Presentation & Disclosure Review for classification, adequate disclosure GBW 8th ed., Ch. 16

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. 16

MANAGEMENT DISCRETION & CLASSIFICATION Unrealized gains, losses provide opportunities to manage earnings Auditors have incentives to assure that management complies with requirements of SFAS No. 115 Monitor management’s intent GBW 8th ed., Ch. 16

ASSURANCE & CONSULTING Before 2000 Investment advising was previously a profitable advisory service After 2000 SEC does not approve of investment advising for audit clients GBW 8th ed., Ch. 16