1. Finance and Investment Cycle
Chapter 10
Finance and Investment Cycle
“Credit has done a thousand times more to enrich mankind than all
the goldmines in the world. It has exalted labor, stimulated manufacture
and pushed commerce over every sea.”
--Daniel Webster
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

2. INVESTING AND FINANCING CYCLE
10-2
INVESTING AND FINANCING CYCLE
Concerned with transactions related to the use of the organization's funds (investing) and sources of those funds (financing) other than operations.
Accounts affected by investing and financial cycle transactions include investments in securities; notes and bonds payable; and, stockholders' equity accounts.

3. Inherent Risks Lease Accounting Loan covenants
10-3
Inherent Risks
Lease Accounting
Loan covenants
Related party transactions
Complex transactions
Impairments

4. 10-4

5. Investment and Finance Activities
10-5
Investment and Finance Activities
Financial Planning
Raise capital
Operate business (all other cycles)
Mergers and acquisitions
Invest excess funds

6. Exhibit 10.2 Finance and Investment Cycle
10-6
Exhibit 10.2 Finance and Investment Cycle

7. Control Considerations
10-7
Control Considerations
Transactions authorized by BOARD OF DIRECTORS
Documentation:
Investments in securities: BROKER'S ADVICE
Property, plant and equipment: VENDOR'S INVOICE (for purchased PPE) or INTERNAL COST RECORDS (for manufactured PPE)
Bonds and notes payable: Documentation from DEBTHOLDERS
Stockholders' Equity: Documentation from REGISTRAR
CASH RECEIPTS/DISBURSEMENTS JOURNALS

8. Finance and Investment Cycle: Control Procedures
10-8
Physical Controls
Securities numbered and in the client's name
Securities held by an independent custodian or in a secure location
Access to safe-deposit box requires the presence of more than one employee
Physical items periodically compared to detail records
Cash receipts from Investing and Financing cycle transactions deposited intact and daily
Separation of Duties
Transactions AUTHORIZED by the Board of Directors
General Accounting RECORDS transactions
A separate function or external custodian has CUSTODY
Performance Reviews
Compare current investing and cycle transaction data against prior-year data or expected data
Compare revenue and expenses against organization standards or expectations.

9. CONTROL OVER ACCOUNTING ESTIMATES
10-9
CONTROL OVER ACCOUNTING ESTIMATES
Communication of need for estimate
Accumulate data
Qualified personnel
Review and approval
Comparison to results
Compare with plans

10. SUBSTANTIVE TESTS–INTEREST-BEARING LIABILITIES
10-10
SUBSTANTIVE TESTS–INTEREST-BEARING LIABILITIES
Agree to BEGINNING BALANCE and CONFIRM with holders or makers.
LOAN PROCEEDS
VOUCH to cash receipts
Recalculate Discount/Premium
Confirm IBL, examine note
LOAN PAYOFF
Recalculate Interest Expense
Recalculate Gain/Loss on Retirement
Verify cash disbursements

11. INTEREST-BEARING LIABILITIES
10-11
INTEREST-BEARING LIABILITIES
INTEREST PAYMENTS
Recalculate Interest Expense
Search for UNRECORDED liabilities
Inquiry of management
Bank confirmations
Unusual amounts of interest expense
Large receipts of cash during the year
Ensure DEBT COVENANTS are met.
Inspect loan agreements.
Consider GOING CONCERN implications if not met.
Ensure proper presentation and disclosure.

12. Exhibit 10.4 Audit Documentation
10-12
Exhibit 10.4 Audit Documentation

13. AUDITING STOCKHOLDER'S EQUITY
10-13
AUDITING STOCKHOLDER'S EQUITY
Overview of audit approach
EXTERNAL PARTIES involved in record keeping
Transactions must be authorized by the BOARD OF DIRECTORS
Transactions must be consistent with the client's ARTICLES OF INCORPORATION

14. AUDITING STOCKHOLDER'S EQUITY
10-14
AUDITING STOCKHOLDER'S EQUITY
PAID-IN CAPITAL
Agree balances to prior year documentation
Examine issuances and repurchases of capital stock
Verify distribution of proceeds between CAPITAL STOCK and ADDITIONAL PAID-IN CAPITAL
Examine CASH RECEIPTS and CASH DISBURSEMENTS records
Determine that all transactions are RECORDED (TRACE from BOD minutes)
Verify that all transactions are PROPERLY AUTHORIZED

15. AUDITING STOCKHOLDER'S EQUITY
10-15
AUDITING STOCKHOLDER'S EQUITY
RETAINED EARNINGS
Agree beginning balance with prior year documentation
Verify the appropriateness of prior-period adjustment treatment
Trace net income/loss to INCOME STATEMENT
Ensure that DIVIDENDS are properly authorized by BOARD OF DIRECTORS

16. Auditing Investments: Substantive Procedures
10-16
Auditing Investments: Substantive Procedures
Agree balances to Prior Year Documentation
Purchases of investments
VOUCH to BROKER'S ADVICE (Statement)
Examine BOARD MINUTES for authorization
Sales of investments
VOUCH to BROKER'S ADVICE, CASH RECEIPTS RECORDS, and BOARD MINUTES
Recalculate gain or loss on sale
Read minutes for sales of Investments and trace to recording

17. Auditing Investments: Substantive Procedures (cont.)
10-17
Auditing Investments: Substantive Procedures (cont.)
Determine MARKET VALUE (SFAS 115)
Obtain 12/31 market price from Wall Street Journal or other sources
Evaluate for possible PERMANENT DECLINES
PHYSICALLY INSPECT or CONFIRM securities Verify Certificate Numbers to ensure that there were no unrecorded sales and subsequent repurchases
Made in company name
Can inspect at interim, if safe-deposit box
Verify DIVIDEND REVENUE
Examine CASH RECEIPTS records
Compare to external sources (Moody's, Standard & Poor's)
Evaluate presentation in BALANCE SHEET (short-term vs. long-term asset)

18. Trouble Spots in Audits of Investments
10-18
Trouble Spots in Audits of Investments
Valuation of investments at cost, market, or value impairment that is other than temporary.
Propriety, effectiveness, and risk disclosure of derivative securities used as a hedges
Determination of the fair value of derivatives and securities, including valuation models and the reasonableness of key assumptions.
Determination of significant influence relationship for equity method investments.

19. 10-19
Derivative Investments, Hedging Activities, and Investments in Securities (SAS 92)
Inquiries about the nature of investments and the reasons for holding them, especially hedging activities.
The classification affects the accounting treatment of market values and the unrealized gains and losses on investments.
Due to the complexity of SFAS 133 (Accounting for Derivative Securities and Hedging Activities), auditors may need special skills or knowledge to understand client hedging transactions, to ensure that effective controls are in place to monitor them, and to audit the transactions.

20. Auditing Fair Value Measurements (SAS 101)
10-20
Auditing Fair Value Measurements (SAS 101)
Management’s responsibility.
Market-based values preferred
If not available—use assumptions market would have used.
If not known—management can use their own assumptions
if no contrary data