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
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GBW 8th ed., Ch. 16
FINANCING CYCLE
Capital funds received from


Investors
Creditors
Capital funds used for


3
Operations
Temporary investment
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DOCUMENTATION
Separate custody & recording for internal
control
Bond certificate
Commercial paper
Stock certificate
Treasury bill
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CUSTODY & RECORDING
Custody


Held by internal officials, independent
custodians
Minimize likelihood unauthorized sales
Recording


5
By person independent of custody
Provides detailed records of transactions
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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
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CONTROLS & EQUITY
SECURITIES
Issuance, retirement, dividends

Authorized by Board
Stock certificates



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Prenumbered consecutively
Canceled when retired
Physically safeguarded
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AUTHORIZATION: Investments
Objective, Error, Procedure
Objective
Error
Investment in
accord with
authorization
Sources of funds
in accord with
criteria
Adjustments in
accord with
criteria
Policy
violation;
higher risk
Funds with
unfavorable
terms
Misstated
accounts;
covenant
violations
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Procedure
Selection policies;
list approved
investments
Policies
Policies,
prenumbering,
authorization
RECORDING: Investments
Objective, Error, Procedure
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
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ACCESS: Investments
Objectives, Errors, Procedures
Objective
Error
Access
restricted
Securities lost,
stolen,
destroyed,
diverted
Access to
forms, records
restricted
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Procedure
Physical barriers,
insurance, files
authorized
signatures,
segregation
Records lost, Physical barriers;
stolen; forms prenumber;
used to divert insurance; periodic
accounting
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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
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SUBSTANTIVE TESTS:
Existence, Occurrence
Investments
Confirm
externally held
securities
Inspect
internally held
securities
Test cutoff
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Debt
Stock
Confirm debts Verify balances
Examine bonds Examine
supporting
documentation,
Inspect
authorization
unissued
instruments
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SUBSTANTIVE TESTS:
Completeness
Investments Debt
Stock
Test cutoff
Analytical
procedures
Analytical
procedures
Verify balances
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Analytical
procedures
Inspect, account
for unissued
instruments
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SUBSTANTIVE TESTS:
Rights & Obligations
Investments
Confirm
externally held
securities
Inspect
internally held
securities
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Debt
Stock
Confirm debts
Verify
balances
Examine bonds
Confirm bonds &
interest payments
GBW 8th ed., Ch. 16
SUBSTANTIVE TESTS:
Valuation
Investments
Debt
Verify
transactions
Confirm
externally held
securities
Check prices
Verify transactions Verify
balances
Confirm loans
Recalculate
interest,
amortizations
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Stock
SUBSTANTIVE TESTS:
Presentation, Disclosure
Investments
Compare
presentation,
disclosure to
GAAP
16
Debt
Stock
Compare
presentation,
disclosure to
GAAP
Compare
presentation,
disclosure to
GAAP
GBW 8th ed., Ch. 16
SUBSTANTIVE TESTS:
Valuation of Marketable Securities
Valuation


Obtain schedule investments
Verify math accuracy by footing, cross
footing, reconciling to GL
For sampled transactions



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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

18
Review for classification, adequate disclosure
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SUBSTANTIVE TESTS:
Long-term Debt 1
Existence, occurrence, Valuation,
Completeness, Obligations




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Obtain schedule long-term debt
Verify math accuracy by footing, cross
footing, reconciling to GL
Examine documentation
Review entries, physically inspect
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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
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SUBSTANTIVE TESTS:
Long-term Debt 3
Valuation

Recalculate interest, amortization
premiums, discounts
Existence, Occurrence, Completeness

Perform analytical procedures
Presentation & Disclosure

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Review for classification, adequate
disclosures
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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
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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

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Recalculate EPS
GBW 8th ed., Ch. 16
SUBSTANTIVE TESTS: Capital
Stock, Retained Earnings, EPS 3
Completeness

Perform analytical procedures
Presentation & Disclosure

24
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
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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

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Monitor management’s intent
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ASSURANCE & CONSULTING
Before 2000

Investment advising was previously a
profitable advisory service
After 2000

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SEC does not approve of investment
advising for audit clients
GBW 8th ed., Ch. 16